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The Sneaky Game Banking Giants Are Playing to Suck More Money From the Foreclosure Crisis

Banks are outbidding private equity Funds at foreclosures, believing they can beat them at the pump-and-dump game.

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It’s also important to not to dismiss this as “oh, this is just two counties in Florida.” Large banks are not set up to have local offices operate with discretion and go load up on real estate because the manager thinks it is a hot time to buy. This is clearly a policy decision at work, and the policy decision appears to be to “outbid” the private equity giant Blackstone:

Most industry analysts attribute the change in direction to the so-called “Blackstone effect.”

The infusion of capital from the giant New York-based hedge fund and several others like it has boosted home values and tightened supply since Blackstone began buying single-family investment homes in Southwest Florida last fall.

Coupled with pent-up demand from baby boomers, and conditions that make it difficult for many boom-time purchasers to list a home for sale, banks can hold onto distressed houses with less long-term risk.

“Why sell for pennies on the dollar to Blackstone, when they can do it themselves now,” Adamaitis said. “Blackstone set the market, and now banks are taking advantage of the opportunity. They now have all of the top variables to control the market.”

The idea is that the banks would turn down bids at auction — presumably from a local flipper or investor — to instead list the property on public Realtor databases, where it can draw higher offers from owner-occupiers.

The lenders hope to mitigate their losses on their bad loan by cutting out the middleman and waiting for prices to increase.

So we can expect to see similar behavior (which amounts to holding inventory off the market through bidding it back in at the courthouse) in markets with high PE fund activity. Readers can hopefully add to this list, but aside from big chunks of Florida, it includes Las Vegas, Phoenix, and Atlanta.

Needless to say, there are a lot of risks to this strategy. The first is that even in the Sarasota-Manatee market, with supposedly tight inventories, banks are only getting hit and miss results with this “let’s beat the speculators at their game” idea. Trying to best PE funds (whose exit is not typically a sale to an end user, but a rental income stream and an IPO of the rental company) isn’t necessarily smart, particularly if you are using Blackstone as your benchmark. That fund is the “buy Microsoft” of the private equity world. They can get away with mediocre investment performance due to the strength of their brand name. In the last real estate cycle, they famously bid for Sam Zell’s Equity Office Trust in February 2007, which was seen at the time and proved to be a peak of market buy.

By contrast, savvy real estate operator and early rental market entrant Carrington said more than a month ago that they had stopped buying homes altogether because dumb money was ruining the market, as in overbidding. From Bloomberg:

“We just don’t see the returns there that are adequate to incentivize us to continue to invest,” Rose, 55, chief executive officer of Carrington Holding Co. LLC, said in an interview at his Aliso Viejo, California office. “There’s a lot of — bluntly — stupid money that jumped into the trade without any infrastructure, without any real capabilities and a kind of build-it-as-you-go mentality that we think is somewhat irresponsible.”

The second issue that is if the banks don’t find buyers for these speculative purchases fairly quickly, the homes often deteriorate. Even though the strategy (in many cases) is premised on holding the property for a year or two to catch a rising market, that assumes the banks do a decent job of securing and maintaining the properties. Their track record is that they often don’t. Conversely, unlike the banks, the PE funds don’t lease out the properties as is. They all expect to at least spruce them up a bit; some even hunt for ones that need particularly types of upgrades that they’ve set out to do in a standardized way (same toilets, vanities, etc; they’ll bid with their upgrade in mind, meaning if their typical bathroom rehab won’t work, they won’t make the offer).