Profit from loss

Hoping there are big profits to be made in the aftermath of the housing collapse, professional investors are flocking to the business of buying foreclosed homes at distressed prices.

The investors, primarily private equity funds and groups of wealthy individuals, purchase the homes at public auctions, which are held daily on the steps of local courthouses. They refurbish the properties and try to sell them for quick profits.

Not long ago, the typical home flipper was an amateur tapping a home equity line or savings for an investment property. But professionals have rushed in, partly because of sparse investment opportunities elsewhere.

“In crisis there’s opportunity,” said Rick Hudson, president of investment firm Prosperity Group Real Estate in Irvine, Calif. “Right now, there’s huge opportunity with flipping houses.”

Closely watched gauges of professional buying have surged over the past two years.

The number of homes sold at foreclosure auctions in California increased to 4,336 in April, from 884 in January 2009, according to research firm ForeclosureRadar. It eased back to 3,483 in July as banks offered fewer properties for sale. The auctions are dominated by professional investors who shop with cash (although not usually with actual greenbacks, for practical reasons).

The binge of professional buying has helped spark a nascent housing recovery in Southern California, an area staggered by the subprime mortgage meltdown, because investors have cut significantly into a glut of foreclosed properties.

Home sales in that region rose 7.2 percent in June from May and 2.6 percent from a year earlier, according to MDA DataQuick. In July, overall sales tumbled 20.6 percent, primarily because of the expiration of federal tax credits, but the region’s median home price of $295,000 was off only 1.7 percent from June.

The fragile rebound in the broader market contrasts with the behind-the-scenes scramble at foreclosure auctions.

“There’s a tremendous amount of capital that is desperate to just buy anything right now,” said Gil Priel, principal of a real estate investment firm in Woodland Hills, Calif.

In some cases, well-financed newcomers are elbowing out smaller investors at auction sales.

“The people who want to go and buy a house to flip, and do one or two, are already exiting the market,” said Jan Brzeski, who manages a residential investment fund at Standard Capital in Los Angeles.

The swarm of new investors, however, is making a treacherous and labor-intensive business even tougher.

Investors must do their homework on dozens of homes for every one they buy. Legal and other impediments usually prevent them from going into homes prior to buying them, leaving no way to gauge repair costs. And despite being foreclosed on, the original owners often still live in the houses. That forces buyers to pay them to leave, a dynamic known as cash-for-keys.

The influx of new players is pushing up auction prices and squeezing profits. The average discount at auctions — the difference between a home’s sale price and its actual value — is 21.6 percent, down from 28 percent in January 2009, according to ForeclosureRadar.

Last year, Chase Merritt, a Newport Beach, Calif., private equity fund management firm, notched strong returns from California auction sales, said Chad Horning, its chief executive. Chase Merritt bought a property in Costa Mesa in June 2009 for $315,500 and sold it 2½ months later for $470,000. It bought a Mission Viejo home for $305,371 and sold it within two months for $375,000.

Chase Merritt launched its first foreclosure fund in May 2009 and has started two more funds since then. But “it’s literally gone from a business that’s very attractive, even lucrative, 12 to 18 months ago to something that almost doesn’t make sense,” Horning said.

“It’s just like the housing bubble,” he said. “It’s almost like we’re in a bubble at the courthouse steps.”