Editors Note: This article was originally featured in the August issue of DS News.
Mortgage and real estate-related investment opportunities abound throughout various securities and properties, as long as investors take the steps necessary to understand the underlying market conditions—and the properties themselves.
But the cost of due diligence continues to rise in today’s economic environment, according to experts. So whether evaluating mortgage notes, servicing rights, properties for flips or long-term investments, multi- or single-family rentals, the rules are the same. The assets—including those underlying the securities—their communities, and other macroeconomic factors need to be carefully evaluated.
New building still lags behind where it was 15 years ago, pushing the value of single-family properties higher across the country, according to David Lykken, Founder and President of Transformational Mortgage Solutions.
“There’s a lack of inventory,” he said.
The best values tend to be in those areas with low taxes and a good business climate—like Texas, Lykken says. Low taxes by themselves aren’t enough, and the proof is in recent events in Kansas. After having reduced its taxes to among the lowest in the country, the state pushed them back up in early summer.
The difference, according to Lykken, is that Kansas doesn’t have a good base of growing companies, whereas many areas of Texas do.
In addition to considering tax rates, Logan Mohtashami, Senior Loan Manager at AMC Lending Group, says to look for investments in areas with strong schools.
“Look to local areas, and see how educated and skilled the local people are by checking out city statistics,” Mohtashami said. “The better educated the city, the higher the wage and lower unemployment.”
To separate the areas with good schools from those with faltering schools, investors should look at publicly available data and performance metrics, including standardized test scores, graduation rates, attendance rates, and suspension rates, Mohtashami says.
“A distressed property in those areas is a good value,” he said.
Mohtashami recommends that investors consider distressed properties in areas with rebounding economics, too, such as Detroit or Baltimore, because they offer better value appreciation than other properties—especially if they’re in good school districts.
“There’s always value in any area,” Mohtashami said.
Lykken says that urban properties and those closer to suburban areas tend to provide good values as well because, as a country, there’s been some movement away from full-on telecommuting toward a combination of telecommuting and in-office work. So investments in single-family homes beyond urban areas and close-in collar communities will tend to lag. However, on the West Coast, prices are so high that people are willing to live further out and drive in, according to Mohtashami.
Investors buying properties with the intention of re-selling need to factor in a growing affordability gap that means the number of potential buyers for a property, particularly on the high end, is continuing to dwindle.
Single-family homes continue to appreciate in value at 7 to 9 percent per year—faster than wages do, so the affordability gap for potential new homeowners continues to increase, Lykken and Mohtashami both say.
According to Trulia, some of the best single-family investment markets are Jacksonville, Cape Coral-Fort Myers, Deltona-Daytona Beach-Ormond Beach, Tampa-St. Petersburg, and North Port-Sarasota-Bradenton, Florida; Grand Rapids, Michigan; Colorado Springs, Colorado; Charleston, South Carolina; San Antonio; and Phoenix. All benefit from growing or stable economies, and all but Grand Rapids and Colorado Springs offer warm weather throughout the year.
“Mortgage notes are continuing to hold their value,” Lykken said.
Though they’re interest-rate sensitive, mortgage notes shouldn’t be placed in the same investment bucket as interest-rate sensitive investments like utilities and bonds, because mortgage notes are backed by solid assets. Other interest-rate sensitive investments tend to be more affected by regulations, corporate earnings, and other corporate factors that don’t affect real estate.
As interest rates go up, there’s a smaller supply of notes with lower interest rates, according to David Holding, VP of Production and Capital Markets at Mortgage Equity Partners.
In July, new Fannie Mae coupons for 30-year mortgages were at just over 3.5 percent, with some older coupons ranging a little more than 4 percent. While the higher-rate ones have attractive yields, they are also at risk for early payoff if rates drop, Holding said.
According to Holden, the notes paying lower interest rates have some advantages over the higher-yielding notes—particularly for investors seeking a steady income stream.
The best bet, Holding said, is usually to purchase mortgage notes in the middle of the yield range, which protects the investor against early payoff, as well as the possibility of interest rates rising too far ahead of the rates of the notes.
Some subscription services like Thompson Reuters can provide investors with good insight on current note rates, historical performance, interest rate forecasts, and other factors that could affect note performance, Holding said. However, not all mortgage notes paying the same rates are the same, Lykken and several other experts noted. They recommended taking the time to carefully review the properties underwritten by the notes, which means conducting inspections and appraisals, looking at payment histories, and more. If such research is beyond the investor’s capacity or expertise, there are several third-party firms that offer such services.
“There’s a lot of science behind investing in performing and nonperforming notes,” said Rick Sharga, EVP of Ten-X, a real estate platform that allows buyers, sellers, and real estate professionals to search, list, and transact properties completely online. There’s no one-size-fits-all approach. People have different strategies. Nonperforming are the easiest pools to work with, because you may be able to get some of them to perform.”
According to Gagan Sharma, CEO of BSI Financial Services, investors will typically choose to specialize in buying either performing, nonperforming, or re-performing loans. In any of those cases, the investor needs to investigate not only the performance of the loans themselves but also the current creditworthiness of the borrowers and the condition of the properties themselves.
Other investors buy nonperforming notes they know are unlikely to turn around with the goal of foreclosing on the properties and selling them as as-is, or as fix-and-flip opportunities, or redeveloping the homes themselves, Sharga said. With rates on the rise, though, Sharga said it will be more difficult to convert nonperforming notes into re-performing notes because credit is becoming more expensive.
Mortgage Servicing Rights
Like notes, mortgage servicing rights can provide investors with steady income streams, but investors must be careful to dig into mortgagee payment histories to determine not only their delinquencies but also the regularity of their payments, Sharma stated.
While there are some technological tools that can automate much of this process, as with buying properties and mortgage notes, deep research and due diligence is important, experts advise.
Investors also need to vet mortgage servicers to learn about their collections success, according to Lykken. Some servicers are only good with regularly paying borrowers, while some specialty servicers specialize in recovering delinquent payments. Lykken says knowing the servicer’s history in light of the type of rights they’re buying is key.
Properties for Flips
Flipping—buying properties to fix up and sell—has become popular again after a downturn following the housing crisis.
But whether looking at single-family homes for flips or for rentals, the investor needs to have sufficient capital to support the property for several months, including necessary improvements, taxes, and interest, according to Sonja Bullard, Sales Manager for the Alpharetta, Georgia office of Bay Equity Home Loans.
Lenders often insist that the investor have the financial wherewithal to pay the expenses on the property for several months, Bullard said, and will require the investor take out a renovation loan that can later be rolled into a mortgage. The renovation loans are smaller, have higher interest rates, and shorter payment terms.
Whether the buyer is an individual seeking to flip a single property once in a while or an institutional investor that fixes and flips numerous properties annually, the rules are the same, according to Adham Sbeih, CEO of Socotra Capital, a residential and commercial lending and investment firm.
“You need to get to know the specific market that you are working in,” Sbeih said. “You need to get to know every single house in the area. That means walking or driving through the area; using tools like Google Earth, Zillow, Redfin; looking at appraisal reports; title searches; and working with local real estate agents who know the area.”
Google Earth provides users with exterior photos not only of one or multiple properties in an area but also with photographic detail that can show businesses and residential development ,as well as other indicators of economic activity. Zillow and Redfin provide prices, MLS details, and other data. Both have gained some notice recently for different reasons. Zillow has an “instant offer” feature for buyers who want to bid immediately, while Redfin recently completed an initial public offering.
Veteran real estate agents will know about local developments and can steer buyers away from poorly built homes, which some local and national builders are notorious for, says Aaron Norris, VP of The Norris Group.
“You can’t just show up and buy; you have to work with a local pro,” Norris said. “You need to go granular, and you need to go local.”
When applying for financing for one or multiple properties, it’s also important to know if a lender is at or near its capacity for a particular type of loan, according to Dean Sioukas, Co-founder and CTO of Magilla Loans, a search engine for loans. A lender might be near its capacity for 15-year single-family loans or multifamily loans, but it may have capacity for others, so an investor needs to consider multiple potential lending partners.
Different lenders will also be more competitive during different times of the year, depending on the composition of their portfolios, Sioukas says.
Though the market has largely evaporated, there are also some jumbo loans available from some lenders for the right opportunities, according to Sioukas. Lenders typically won’t issue jumbo loans for investors planning to flip a property quickly—only for those who plan to use it for themselves or a long-term investment. Even in the latter two scenarios, the lender will want extremely detailed information before making the loan.
With the cost of homeownership continuing to rise, owners of rental properties will likely be able to raise rents and still keep strong occupancy rates, but the multifamily rental market peaked a couple of years ago, according to Mohtashami. The single-family rental market tends to offer better investment values today.
To uncover the best multifamily opportunities, Mohtashami recommends delving into bankruptcy records, liens, and other legal actions filed against property management companies, as well as working with local property inspectors to determine if there are any structural or other costly issues with a property.
“Landlords need to be diligent about inspections,” said Matt Birdseye, SVP of Equity Markets at Bay Equity Home Loans. He also recommends working with local real estate agents who specialize in rental properties.
Investors need to be careful about evaluating landlords and property management companies, according to Norris.
“Look at the landlord’s experience,” Norris said. “Does he have tenants that have been there for a long time? Or does he have people moving in and out? The steadier the rental base, the less risky the investment.”
Figuring out your long-term goal is also crucial, Norris said.
“You need to determine what your goal is,” he said. “Is it to have an income stream and build some equity over time? Or are you looking to make improvements and sell the property? You need to buy the right properties for the right reasons—that’s the strength of working with someone—inspectors, real estate agents—who knows the local marketplace.”
A potential investor should also examine the property management company’s budget, with a keen eye on its payment and receivable delinquencies, Mohtashami says.
“There’s a notable difference between property management companies that are well run and those that aren’t,” he said.
Experts agree there are still plenty of good mortgage-related investment opportunities in today’s market, but to maximize the return, investors must use a combination of strategies. Calling on experienced industry professionals, leveraging new technology, and doing a little old-fashioned legwork and due diligence, such as calling local real estate agents and property managers, reviewing appraisals, and perusing property inspection reports, can shed light on the best opportunities available.