Beware the Foreclosure Allure
an article by Wall Street Journal's James R. Hagerty
Many investors have been tempted by the idea of buying foreclosed homes in bulk from banks, at a steep discount. But the experiences of a Washington, D.C.-based property investment firm, Redbrick Partners LLC, show it can be difficult to manage a large number of single-family rental homes scattered across a metropolitan area.
Though Redbrick was never in the business of buying foreclosed homes, the firm in recent years bought hundreds of properties in working-class areas of East Coast cities including Baltimore, Philadelphia and Trenton, N.J. It hired local managers to handle rentals and maintenance.
Now Redbrick, formed in 2003, has concluded that it is too costly to manage those homes and is trying to sell most of them. Tom Skinner, one of Redbrick's managing partners, notes that fixing leaky toilets and other common problems is much more complicated in a diverse array of homes than in an apartment building where fixtures are standard and the manager can walk from unit to unit.
With the number of foreclosures skyrocketing, banks and other creditors have said they are getting lots of feelers from investors interested in buying large numbers of homes, but few if any large bulk sales have been completed so far. That is partly because of the difficulties of managing lots of homes spread across a large area.
Barclays Capital estimates that there are 811,000 bank-owned homes in the U.S., up from 129,000 two years ago, and predicts that the total will rise 60% more before peaking late next year. So far, banks typically are selling the homes one by one, through real-estate agents, and to a lesser extent at auctions.
Until recently, Redbrick sought to own large numbers of single-family houses scattered across several states. The firm has raised a total of nearly $50 million in equity for four investment funds, selling limited partnership interests in them to individuals and institutions.
As a landlord, Redbrick was competing with mom-and-pop operators who often live next door to their rental properties and keep costs low by doing repairs themselves. Owners of rental housing are more motivated than employees hired to do the dirty work, Mr. Skinner says. That work sometimes requires a strong stomach: A Redbrick employee once had to wipe blood off the wall after a tenant shot his girlfriend to death.
In Baltimore and Trenton, Redbrick said in a recent letter to investors in one of its funds, "we have not been able to generate positive cash flow from these assets through our internal property management organization and have also been unable to identify satisfactory third-party property managers."
Three years ago, Redbrick had to compete with speculators who were snapping up dilapidated row houses in gritty urban neighborhoods. Now Redbrick is struggling to sell those houses. That is proving difficult because tight credit has disqualified many potential buyers and falling values have discouraged others.
The first Redbrick fund has produced annual returns of about 20% a year for investors, Mr. Skinner says. That is partly because the homes were purchased well before the peak of the housing boom and many could be sold for a profit.
But the second and third funds have suffered heavy losses, according to letters recently sent to the investors. As of June 30, the value of a $100,000 limited-partnership investment in the second fund, including past distributions of cash to investors, had fallen to an estimated $56,099. For the third fund, the value fell to $45,633 as of June 30 from the original $100,000 of investment.
Redbrick also has raised a fourth fund with equity of about $17 million. Mr. Skinner said most of that hasn't yet been invested because the company is waiting for the right opportunities in "distressed markets."
RiverOak Investment Corp., of Stamford, Conn., says on its Web site that its Fund II and Fund III have each invested $1 million in Redbrick II. Stephen DeNardo, a managing partner of RiverOak, declined to comment.
Redbrick was formed in 2003 by Jonas Lee, a former Web site entrepreneur, and Mr. Skinner, a former McKinsey & Co. consultant. They drafted in as a partner William Wheaton, an economics professor at the Massachusetts Institute of Technology who helped Redbrick analyze local economies and housing markets.
Mr. Skinner says that the original premise of Redbrick's business plan -- that it could create new, more efficient ways for investors to profit from single-family housing -- remains valid.
Redbrick's strategy now is to avoid investments that require it to manage lots of scattered properties. Instead, it aims to focus on assets such as land or housing-related securities, as well as investments with local partners who can manage the property, Mr. Skinner says.
"We've learned a lot of what works and what doesn't work," he says. "In the future, we'll do more of what works."
