This all started around 2009, when the Blackstone Group, the huge private equity firm, realized that it could buy up REO's, fix them up slightly, rent them out, and earn cash-on-cash yields in the range of 6% to 9%. Initially this financial sector was known as the REO-to-rental industry.
Cash-on-cash yields of 6% to 9% were huge, considering that CD's were paying less than 1% and ten-year Treasuries, curiously known as the long bond, were paying less than 2.75%. We have all heard of stories of New York investment bankers, flying out to the suburbs of football team cities, driving around for five hours, and then buying 30 to 50 homes in a single day. These were the Blackstone guys, and this brilliant move by the Blackstone Group marked the bottom of the Great Recession.
Want to know just how brilliant? Many of these rental homes went on to appreciate 25% or more, on top of the 6% to 9% cash-on-cash returns. This is capitalism in its most admirable form. "Greedy capitalists" played a major and very beneficial role in ending of the Great Recession. They created a floor on housing prices, when housing prices were in a free fall. They replaced fear with greed.
By the way, REO stands for Real Estate Owned. It is a term used by banks to record on their books properties upon which they have foreclosed. There is a huge accounting penalty imposed upon commercial banks for maintaining REO's on the books. This is why commercial banks are desperate to dump their REO's as soon as possible, even though it means the bank has to take a painful haircut (a painful loss of part of its initial investment).
A cash-on-cash return is your cash return on your downpayment or on your purchase price, if you pay all cash. The Blackstone boys paid all cash; hence their very handsome cash-on-cash returns.
Example:
Herb Black buys a rental home for $100,000, putting down $40,000 in cash and obtaining a $60,000 first mortgage from a bank. He rents the house out for $1,100 per month. His real estate taxes, insurance, repairs, and other expenses amount to $300 per month. His mortgage payments are $400 per month. He therefore has a positive cash flow of $400 per month or $4,800 per year. His cash-on-cash return is therefore 12% ($4,800 divided by $40,000 times 100%).
Today the number of bank foreclosures is way-way down. Gone are the days when millions of homes were in foreclosure, and houses could be purchased for a fraction of their replacement cost. The REO-to-rental industry to winding down to just a memory.
However, bond yields remain at very low levels. Certificates of deposit are still paying less than 1%, and the long bond is still yielding less than 2.75%. It therefore still makes sense for an investor in search of yield to buy homes and rent them out. An investor can still earn a handsome 5% to 7% return on his money.
Just as fix and flip loans are all the rage right now, Wall Street is gearing up to buy billions of dollars in buy-to-rent loans. Wall Street is becoming the secondary market for private money loans. A secondary is where mortgage loans that have already been originated are bought and sold. Be sure to grasp the concept that the loans have already been made. Title has closed. The borrower and the seller already have their dough. Only then are these loans bought and sold in the secondary market.
The secondary market for buy-to-rent loans is starting to blossom. Wall Street is salivating, so you will now hear the term, buy-to-rent loans, everywhere. I urge you to get ahead of this tidal wave. Blackburne & Sons is looking to make buy-to-rent loans almost nationwide.