On a recent Monday morning, Milton Bernal walked up the steps of the Pomona courthouse and stood among a sea of people. He had a cell phone, a bagged lunch – and a cashier’s check for $1 million.
It’s a lot of money, but those who want to snatch up any foreclosed homes and condos at auction need big cash – and a good plan.
Bernal is a buyer for Starpoint Properties LLC, a Beverly Hills real estate investment company that has big cash and such a plan. It figured how to make a nice profit by buying, fixing and selling foreclosed homes in the last several years even though the residential market was dead and most flippers had gone away. Its two main secrets: buy low and use only cash.
But suddenly, Starpoint is seeing a change in the market. With the perception that the housing market is at or near bottom and an economic recovery may be near, an increasing number of flippers – using borrowed money – are showing up again at auctions. And they are bidding up the prices.
In fact, there were 10 bidders for the condo Bernal hoped to buy for about $100,000. He was outbid; the unit ended up selling for tens of thousands of dollars more.
“If nobody is interested, you can bid a penny over and win,” he said. “But with some of these single-family residences, there are sometimes 10 bidders.”
Back in Beverly Hills, Starpoint’s chief executive, Paul Daneshrad, said he has seen about twice as many bidders getting into the foreclosed home auction market lately, and that’s making his business a bit more difficult.
“Our prices have gone up and margins have gone down,” Daneshrad said. “We are expanding our markets. Before we were only at one or two auctions. Now we have to go to seven or eight to find the same number of homes.”
In Daneshrad’s business, the work may be harder now, but certainly no supply shortage exists. There is a backlog of nearly 1.34 million U.S. homes in foreclosure, and only about 41 percent were in the auction stage as of January, according to foreclosure and auction database Realty Trac. That’s many times more than there would be in a healthy market.
In Los Angeles County alone, nearly 59,000 homes are in foreclosure, and the supply available to buyers has increased sharply over the last three months as banks have released inventory. There were 5,414 foreclosed homes up for auction in January, compared with 3,560 in October.
All that supply might seem to favor Daneshrad’s business. But it seems to have drawn even more flippers back.
Eric Paulsen, co-chief executive of real estate auction website Auction.com in Newport Beach, said the steady supply of foreclosures is alluring to savvy flippers.
“Where else are you going to get positive income?” he asked. “Banks are paying 1 to 2 percent on interest, and you have real estate where you have a good chance of getting low- to high-teens returns. It’s a good place and good time to be looking in the real estate market.”
Unusual investor Starpoint has an unusual pedigree for a home flipper. Founded in 1995, the company originally made its business buying income-producing apartment complexes across Southern California. It has a portfolio of more than 4 million square feet, nearly all in multifamily properties, valued at roughly $450 million. The company was aggressively buying multifamily properties until about 2007, when the housing market crashed. Suddenly, apartments crowded with displaced homeowners became a hot investment commodity, driving up prices. About two years ago, Daneshrad decided to try home flipping when it became clear that the company needed to generate more revenue. It had already laid off a handful of its more than 100 workers and a second round of cuts was a possibility. “The multifamily market, it’s very difficult to find any value there. This is helping us keep growing,” he said. Starpoint has made its business work – even as the market has slid downward – with a simple strategy: use its own money, buy residences at a sharp discount and employ in-house teams to rapidly renovate them for resale. The company said it has flipped more than 100 homes since starting about 18 months ago. Starpoint purchases a home about every other day exclusively at auctions throughout Los Angeles and surrounding counties, and has about 15 homes in its possession at any given time, most in the San Fernando Valley. The company has strict criteria it follows at auctions. Besides using its own cash, it buys homes for about roughly two-thirds the average sales price of similar surrounding homes and focuses on the lower end of the market: homes and condos with auction prices that generally range from $100,000 to $150,000. Once acquired, homes are fixed up by Starpoint crews, which replace battered cabinets, repair hardwood floors, install new carpeting and slap on fresh coats of paint. The renovations can cost from a few thousand dollars to $20,000 and take up to two or three months. Most homes are sold for about $200,000 after being on the market about 75 days. That means that even if the company pays as much as $150,000 at auction and spends $20,000 on renovations, the profit will be about $30,000. “We have learned through a hit-and-miss process, you have to make sure you are buying the right product. Otherwise it’s not going to sell and you are going to sit on the asset for a while and reduce your pricing,” Daneshrad said. Indeed, fast flipping is critical to the business model of Starpoint, which has practically zero money costs since it doesn’t borrow but instead uses the capital built up from years in the apartment business. However, the company wants to get all of its money back from each project by selling it quickly; Starpoint does not want to sit on its money by renting out the properties. And that’s one area where its business model is getting some pressure.
Arixa Capital Advisors LLC is another L.A. real estate investment firm in the business. It both lends to clients flipping homes and is an equity partner with some.
Jan Brzeski, who manages the firm’s lending and flipping funds, said he has heard from clients that auctions are becoming more crowded with institutional investors and money as more investors see an opportunity to make a return.
“The better deals I’m seeing are not coming through auctions. I think that market has gotten bid up,” Brzeski said, noting some clients have established relationships with banks and buy directly from them.
One reason auction prices are rising is that new investors are being drawn into the business using borrowed money from lenders such as Arixa. Unlike Starpoint, they can sit on the properties for years, using rental income to make payments on loans and waiting for housing prices to increase before selling.
Richard Green, director of the USC Lusk Center for Real Estate, said such a strategy is sound because many former homeowners prefer to rent out homes, not apartments.
“In general, I don’t think flipping is a good idea, but a long-term hold strategy is very good,” Green said. “If you can buy at a discount, then yields will be very good relative to anything else you do.”
Of course, the long-term hold strategy doesn’t work for Starpoint. However, the company has no plans to change its core business model.
Daneshrad said the company plans to move into other depressed markets where its low-cost, fast-flipping strategy can work for several more years.
“We are expanding and opening up in San Diego within the next 90 days, and we are also opening up in Northern California and possibly Las Vegas in this calendar year,” he said.
He also is considering partnering with other companies and investors to continue to broaden its capital base and market reach.
“We have several interested groups and we have commitments and are working through those,” he said.
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