The REO to Rental Investing Model

The following blog post is the second in a series of posts based on a course that Jan Brzeski and Greg Hebner taught at UCLA Extension in early 2013. The course will be offered again on August 10, 2013. For more information, please visit the UCLA registration page.

The REO to Rental Investing Model

"Low valuation, high current yield and long-term appreciation potential make single family home rental properties an intelligent investment for institutional investors."   –Bill Ackman, Pershing Square Capital Management, L.P.

REO stands for Real Estate Owned.  This term is used for property which is owned by a lender as a result of foreclosure or forfeiture where the lender did not short-sell the property or sell it at auction to a third party.

The REO-to-Rental investing model is to buy the house when the market is low, rent it for current income and then sell it when the market recovers (or, in some cases, to form a real estate investment trust, or REIT, and take it public).  To do this, investors must acquire single-family homes or condominiums from lenders for attractive prices, preferably below retail market value.   Then the investor rehabilitates the properties, adding value by fixing up an uninhabitable or neglected houses.  Finally the investor leases the houses to families wishing to live there.

REO to Rental Investing Model Features Moderate Investment Risk

-        Another major housing price decline is unlikely in the next few years, in our view. Home prices tend to move in cycles and the current "up" cycle appears to be far from exhausted. New construction has been far below typical numbers for many years, and the supply of home for sale is very limited relative to recent norms.

-        Rental demand is likely to remain robust

REO to Rental Investing Model Provides Multiple Sources of Return

-        Banks selling houses to all-cash buyers for attractive prices

-        Adding value by fixing up neglected homes.

-        Overall housing market recovery

-        High rental demand as many former owners become renters

-        Former home owners, often with growing children, prefer to rent houses with yards rather than apartments.