The Breakdown

Explaining Southern California's economy

Investors seeking profits overpay for foreclosures in California

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42113 full

The L.A. Times reports that Colony Capital, Tom Barrack's Santa Monica-private equity firm, has won an auction to buy "970 foreclosed homes in California, Arizona and Nevada from mortgage titan Fannie Mae for $176 million."

Fannie Mae wants those properties off its books because the agency, in receivership since the financial crisis. is in the business of backing mortgages, not operating as a landlord or broker.

But here's the salient part of Alejandro Lazo's story:

In a sign of how competitive the bidding for the foreclosed homes was, the firm paid 112% of the properties’ estimated worth, according to a breakdown of the transaction by Fannie Mae.

Several hedge funds and other big investment groups backed with Wall Street money had lined up to bid on foreclosures. These big investors view a lucrative market for foreclosed homes converted to rental properties.

The bottom line here is that investors are willing to overpay for underpriced properties, particularly when Fannie Mae is hot to unload the homes. Colony Capital can access hundred of millions of dollars at low interest rates, so paying 12 percent over appraised values for the auctioned properties isn't a problem if the money is cheap and a tight rental market promises rents that exceed mortgages.

According to Terry Sandven, Chief Equities Strategist at U.S Bank Wealth Management, average rentals in the U.S. are running at $718 per month, while average mortgages are $481. 

It's not hard to figure out how one can make money off the difference, particularly if an investor can gobble up properties in places where the foreclosure crisis has been most severe.

The Colony deal is a double-edged sword. It helps to eliminate Fannie Mae's foreclosure backlog, restoring the housing market to health and keeping prices elevated. But in California, it will continue to distort the market, pricing out buyers who aren't coming to the table with a giant pile of cash, but with a conventional mortgage.

Follow Matthew DeBord and the DeBord Report on Twitter. And ask Matt questions at Quora.

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