The prospect for an extended period of high levels of home loan delinquencies, foreclosure proceedings and real estate owned (REO) is causing regulators, mortgage lenders and investors to reexamine traditional approaches to handling REO. This is generating increased interest in an interim strategy of a transition from single family REO to rental uses of such properties.

Investors may find that government and private sector programs offering bulk sales of single family REO properties offer attractive opportunities in the current housing market. Investors will want to consider the following key points:

  • The relative advantages and disadvantages of a straight purchase or a joint venture arrangement with the REO owner;
  • The availability and terms for financing of a bulk sale acquisition;
  • The capacity to manage geographically dispersed single family properties; and
  • Potential exit strategies and rental period requirements.

Background of the GSE Bulk Sale REO-to-Rental Program

In August 2011, the Federal Housing Finance Agency (FHFA) and the Departments of the Treasury and of Housing and Urban Develop-ment requested suggestions from the public on options for maximizing value to taxpayers and increasing private investment in the housing market, including approaches that support rental housing in regard to REO held by Fannie Mae, Freddie Mac and the Federal Housing Administration (Covered Entities). In January 2012, the Board of Governors of the Federal Reserve Board (FRB) issued a white paper on the U.S. housing market.1 The FRB concluded that REO-to-rental programs could be a viable and attractive response to current conditions in the housing market, including the excess supply of vacant homes.

On February 1, 2012, the FHFA announced the commencement of an REO Initiative for qualified investors to purchase pools of foreclosed properties from Fannie Mae or Freddie Mac (together, the GSEs) that would be rented for a specified number of years. On February 27, 2012, it announced a pilot transaction in which Fannie Mae will offer approximately 2,500 units in eight subpools located throughout the country in metropolitan areas with some of the highest foreclosure rates. The results and structure of the pilot transaction have not yet been announced.

Transactions under the REO Initiative may ultimately take a variety of forms:

  • An equity investment in a entity which is formed to hold REO properties contributed by the GSE. This could involve various alternatives regarding ownership interests, control over servicing, property management, rental periods and exit strategies; or
  • Sales with financing provided by the GSE or a third party.

The Covered Entities control large amounts of REO and will be acquiring additional REO. As a result, they have the potential to engage in programs that could move significant amounts of foreclosed single family proper-ties into rental status.

General REO Bulk Sale Purchaser Considerations

Investors in REO bulk sale transactions will need to consider a wide range of issues, which may vary depending on the structure of the particular transaction. These issues may include:

  • The structure of the purchasing entity;
  • Issues relating to rights of parties that previously owned the REO property;
  • State and local laws regarding tenants' rights;
  • Availability and terms of financing;
  • Potential for securitization;2
  • Geographic dispersion of properties;
  • Availability of property management services;
  • Terms of property management services arrangements;
  • Tax considerations; and
  • Disposition strategies.

FRB REO Policy Statement for Banking Organizations

In another recent related development, the FRB on April 5, 2012, issued a policy statement (Policy Statement) on rental of REO owned by organizations that are supervised by the FRB (collectively, Banking Organizations) encouraging them to consider rental options. In light of the extraordinary market conditions that currently prevail, the FRB stated that Banking Organizations may rent REO properties (subject to the statutory and regulatory holding period limits) without satisfying the standard requirements to demonstrate continuous efforts to market the property, provided that suitable practices and policies are followed.

In addition, under the Policy Statement, while residential REO is typically treated as a substandard asset, residential properties with leases in place and demonstrated cash flow from rental operations sufficient to generate a reasonable rate of return would generally not be treated as classified assets. At the same time, however, Banking Organizations with large inventories of REO intended for a rental program must develop policies and practices for addressing the risks associated with rental activities, including dealing with the liability risks arising from rental activities and the legal requirements associated with the potential need to take action against tenants for rent delinquency.


The development and testing of REO-to-rental strategies, including the structuring and financing of REO acquisitions, are likely to dominate activity in residential property markets for many months to come. Future DechertOnPoints will highlight further developments in this area, including securitization options.


1 See our January 2012 DechertOnPoint, Federal Reserve Board's White Paper on the U.S. Hous-ing Market: Private Equity Take Note.

2 It has been reported that Moody's plans to release commentary on possible rental related securitization structures.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.