“Mortgage backed securities (MBS) is a $6.5 trillion business,” he said. “By far the majority securitize performing loans on real property issued by government agencies in the United States. MBS have become a pillar of global investing for governments, institutional investors and private individuals, providing predictable and fixed rates of return.”
Even failing subprime mortgages retain sufficient asset value to provide global investors with double digit rates of tax-free return, he added.
ARE, one of the largest firms investing precisely in non-performing first mortgages, acquires and manages pools of these loans at a discount. ARE’s pass-through structure allows investors to select specific properties and receive fixed interest payments plus distributions of earnings as the loans are worked out or liquidated.
“The sheer volume and discounts for non-performing loans today has created a very attractive situation for astute investors,” said Kirsch. “The key lies in analysis of the underlying real property.”
Kirsch suggests:
* No-nonsense evaluations. Property values in some zip codes continue to rise while others fall precipitously. It’s back to the basics – appraisals, inspections and cold hard determination of underlying property values. In today’s market, fund managers can select mortgages with yield potential from pools to create a portfolio.
* Act decisively. Non-performing mortgage loans present four options: make them perform again, refinance, swap cash for keys to prevent foreclosure or foreclose the property. Kirsch comments that successful workout arrangements have improved in 2007 to 25% from 12% a year ago. Foreclosure hearings have so clogged the courts that timely property management can generate solid returns for international investors in the funds.
* Use harsh criteria. How to find a property’s real value through poor underwriting and appraisal standards for non-prime loans written during the “feeding frenzy” of 2005 and 2006 and amidst real estate prices that have ballooned for years? Kirsch uses the 30-day liquidation value to compare the pricing of non-performing loans in pools. Against this valuation ARE models cash flow potential if the property is worked out, refinanced or liquidated.
Kirsch noted the flood of global liquidity in the 1970s made possible and was responsible for the growth of U.S. mortgage-backed securities as the premier global fixed income investment. The supply of investment funds and tolerance for risk has also been partly to blame for the unrestrained go-go days of the sub-prime lending segment of MBS.
“Repercussions from the unrestrained growth in private label, non-government agency mortgage loans the past three years, accompanied by relaxed lending and administration standards, is certainly a strong reason for international investors to scrutinize their portfolios,” said Kirsch. “So far, the market risks are outweighed by the solid asset values of American real estate.”
