U.S. Investor Rose Eyes Rebound, One House at a Time

NEW YORK (Reuters)—Bruce Rose, founder of hedge fund Carrington Capital Management LLC, and a pioneer in the roller-coaster market for mortgage credit, is set for the next phase of the housing crisis: recovery.

Carrington is planning several new funds, at least one of which will step into local real estate markets expected to recover first, Mr. Rose said in a rare media interview at his office in Greenwich, Conn.

Another fund has already seen success with properties in Texas and Colorado, he said during the interview last week.

Mr. Rose is also rejecting lower estimated prices for his portfolio of homes that has grown through foreclosures, noting that fire sales by banks are exaggerating the market downturn. He is selling his properties one by one, and making much more money than rivals in the same position.

"We began to sense a bottoming of the market with the new [U.S.] administration, and began to focus on areas that we believe will recover early," he said.

The U.S. housing market is entering its third year of downturn that has triggered huge losses as homes are foreclosed and investors shun mortgages. The recession is adding to the fallout, and home prices are still sliding despite White House efforts to save 9 million homeowners with cheaper mortgages.

The pronouncement is a rare insight from Mr. Rose, 51, who left a life as aircraft mechanic and charter flight operator in 1980 to enter finance and sell ultra-safe mortgage bonds issued by Ginnie Mae, the agency that pools government-backed loans. In 1990, Mr. Rose helped engineer the first bona fide sale of mortgage credit risk at brokerage Paine Webber. Later at Salomon Brothers, he financed the early subprime lenders.

Since starting Carrington in 2003, Mr. Rose packaged $23 billion in subprime mortgages. Many of the bonds included loans originated by now-bankrupt New Century Financial, whose unit for collecting and distributing payments Mr. Rose later acquired.

Carrington kept between 6% and 12% of the riskiest parts of the securitizations, and forged unique contracts that let it direct any foreclosure and liquidations of the underlying loans.

Securitizations are now under fire from Congress, blamed for triggering the crisis by raising the money that encouraged lenders to loosen underwritings to boost volume. Their failings are a key focus of planned U.S. regulatory reforms, which Mr. Rose favors, to realign lender and investor interests.

Among the proposals, lenders are to take at least a 5% stake in what they sell, to ensure "skin-in-the-game."

"That's what we do—skin-in-the-game—and I think that's what makes us different from any other mortgage investor out there," he said.

To protect that skin, Mr. Rose is counting on his servicer, which like others, has taken the spotlight in the housing slump since its decisions can limit or increase losses to investors.

Carrington Mortgage Services has stubbornly held on to foreclosed homes through the crisis, insisting that bulk sales were hurting bonds supported by the properties. This strategy has ignited criticism from bondholders who claim Carrington is delaying sales of bank-owned properties and modifying loans recklessly to get delinquent homeowners up-to-date.

This, critics say, prolongs payments to Mr. Rose's sub-investment grade securities at the expense of the senior investors who might be made whole sooner if a home is sold. Mr. Rose says Carrington is looking out for all bondholders, as required by bond pooling and servicing agreements.

The strategy is "as long as possible, to keep the borrower in the house, and keep cash flowing to maximize the proceeds of the trust. That's always been our focus," Mr. Rose said.

When a home must be sold, Carrington does it house-by-house to get top dollar, he said.

Carrington found that as home price indexes fell, the more its selling prices outperformed the broker price opinions (BPOs) which are used by home value appraisers.

The retail market is about 15% higher than where banks are dumping hordes of unwanted inventory, which is driving home price indexes lower, he said.

Last week Carrington closed a sale in Littleton, Colo., at $277,100, 13% above two BPOs obtained in April. A home in Freeport, Texas, sold June 11 for $180,250, higher than two March BPOs of $169,432 and $130,900.

In harder-hit Florida, Carrington sold a Cape Coral house for $116,000 compared with BPOs in the mid-$90,000 range.

"We try to be the best sale on the block, not the first sale on the block," Mr. Rose said.

Mr. Rose is now eyeing East Coast and West Coast property that should perform better as markets turn. He said he expects rust-belt states and those dependent on the struggling auto industry will lag.

"As [distressed opportunities] diminish, we'll start with the origination strategy again," he said.

By Al Yoon

The LTV, IRR, DSCR And ROI: Ensuring Accurate Numbers

The majority of real estate investment and development decisions are numbers driven, but it
is important to realize that not all parties are concerned with the same numbers. Therefore, each party in a given real estate transaction would benefit from a greater understanding of the matrices that are important to the others involved.

For example, when an investor is talking to a lender about a transaction, it may not make sense to discuss internal rate of return (IRR) or equity multiples, but it would be very important to bring up the maximum allowable loan-to-value (LTV) ratio. Or, when a developer is trying to raise equity, the investors may not care much about debt service coverage ratios (DSCRs), but they may be very concerned with the cash-on-cash return, for example.

Consequently, it is important to understand each of these matrices and how they are derived. For many of the more complex calculations, participants may find it easier to use Excel or some other spreadsheet software to calculate these numbers. Please refer to the corresponding figures to learn how to input these formulas into the spreadsheets or otherwise perform the calculations. Equity for real estate investments can come from a number of different sources.

Many small investors and developers raise equity from friends and family or from high-net-worth individuals that they may know. Larger real estate companies may have their own dedicated capital, or they may be partnered with opportunity funds or other institutional investors. Regardless of the source, calculating the performance of each invest-ment is essential, and the three most common matrices used are IRR, cash-on-cash return and equity multiple. Using these matrices enables investors to evaluate the expected performance of each investment and compare it to other possible investments.

The IRR is usually the first number that most institutional equity groups ask for when they are presented with a new real estate investment. For a given investment, the IRR is the discount
rate that makes the net present value of all cashflows equal to zero. When calculating an IRR, you must remember to discount negative cashflows in future years back to time zero at a safe rate. Doing so is necessary because the calculation built into the IRR function in most software will assume that these cashflows are discounted at the IRR. Obviously, this assumption causes investors to set aside insufficient cash to fund these future shortfalls.

It is possible to use the modified modified IRR (MIRR) function on many spreadsheets, but then you must also decide upon a reinvestment rate for future positive cashflows. At the
current time, most institutional real estate investors are still using IRR over MIRR and are typically interested in both un-levered and levered IRRs. The un-levered IRR for a project is
calculated using the cashflows before debt service. Although most investors prefer to use some level of leverage when purchasing properties, the un- levered IRR is still very useful.

Remember that when you leverage an investment, you are adding additional risk. Therefore, an un-levered IRR is closer to a risk-adjusted return than a levered IRR. The levered IRR is calculated using cashflows after loan proceeds and debt service. This figure is usually the number that investors are most concerned with, as it is a good indication of the actual return that they will receive on their investment. Each institution’s criteria for investing are different: Core investors may be happy with levered IRRs in the mid-teens, while value-add and opportunistic investors often look for mid-high twenties or better.

While the IRR displays an investment’s performance over the investment’s entire holding period, many investors are interested in that performance at a given point in time. This performance can be measured as a return on investment (ROI) or cash- on-cash return.

The ROI for a given investment can be measured by subtracting the cost of the investment from the gain from the investment and then dividing the difference by the cost of the investment.

The cash-on-cash return is calculated in a similar way, but it uses cashflows after loan proceeds and debt service. The cash-on-cash return is important to investors who are seeking
current income. Equity investors also want to know how many dollars they are going to receive over the entire holding period for each dollar that they invest. This is often referred to as the equity multiple or holding period return. It is typical for investors to get a minimum
of two times their initial investment back out over time.

From a recent article in:

Commercial Mortgage Insight
August 2008 issue
By Joseph R. CaCCiapaglia

CalPERS To Boost Private Equity Target

June 9, 2009

Aiming to buy low, the nation’s largest public pension fund is poised to increase its private equity investments by about 40%.

The California Public Employees’ Retirement System is set to approve an increased target for corporate buyout and venture capital investments to 14%, up from 10%. Under the plan, private equity and venture capital investments could reach 19% of the fund’s total assets; currently, CalPERS invests 13% in the asset classes.

“This is a great time to make some good deals,” spokesman Clark McKinley told Reuters. “when markets are down, it’s a good time to buy.”

The boost to p.e. and VC comes at the expense of CalPERS’ equity portfolio, which includes hedge funds. The pension giant has no plans to change its hedge fund allocations, McKinley said, but losses by the hedge funds and other equity managers employed by CalPERS have effectively cut its exposure to them.

From FINalternatives June 9, 2009