Donald R. Mullen Jr., who helped Goldman Sachs Group Inc. profit from the U.S. housing crash, is giving the firm and its clients a way to gain from the recovery.
Mullen, 54, has raised almost US$1 billion to buy single- family houses to rent since leaving Goldman Sachs last year as head of global credit and mortgages, five years after overseeing the bank’s bet against the imploding subprime home-loan market. His Fundamental REO LLC has already purchased or is close to acquiring almost 2,500 properties through foreclosure auctions, government agencies and even an Arizona non-profit that promotes affordable-home ownership, property records show.
Mullen plans to spend as much as US $2 billion by 2016, joining private-equity giants including Blackstone Group LP and Colony Capital LLC seeking to take advantage of home prices 29% below the 2006 peak and rising demand for rentals from Americans blocked out of homeownership. Investors, including former bankers and bond traders, are rushing to buy and renovate properties, as well as secure Wall Street funding to turn what’s been a mom and pop business into an institutional asset class.
“All the apartments for rent in miami are the biggest trade in the real estate space,” said Justin Berman, a former Goldman Sachs banker who runs Atlanta-based Berman Capital Advisors, a private wealth firm with about US$550 million under management. “They can’t get their hands on enough homes.”
Front Line
Mullen, a shaven-headed patron of the arts from River Edge, New Jersey, has spent his career at the front line of Wall Street’s most profitable fixed-income businesses. Since graduating from Yale University in 1981, he’s worked in high- yield sales for First Boston, Drexel Burnham Lambert Inc. and Salomon Brothers Inc. He rose to be head of credit and a board member at Bear Stearns Cos. and started as a partner when he joined Goldman Sachs in 2001 to bolster its unit financing junk- rated companies.
In his latest endeavor, Mullen and former Bear Stearns colleague Curt Schade are purchasing homes in Arizona, California, Florida, Georgia and Nevada for between US$70,000 and US$190,000, planning to rent them for US$900 to US$1,950 a month, according to a Goldman Sachs presentation obtained by Bloomberg.
Fundamental REO is being backed with as much as US$100 million of capital from Goldman Sachs and its employees, as well as funding from its private clients, according to marketing documents and people familiar with the fundraising, who asked not to be identified because the details aren’t public.
Mullen and Andrea Raphael, a spokeswoman for New York-based Goldman Sachs, declined to comment.
Surging Demand
Mullen is building his inventory as investors drive up property prices faster than rents and the supply of low-cost homes from repossessions shrinks. Home sales fell 0.6% in March to an annual pace of 4.92 million while prices jumped 11.8% to a median US$184,300, the biggest gain since November 2005, the National Association of Realtors reported today from Washington. Foreclosure filings fell to 152,500 in March, from a high of 367,000 three years earlier, according to RealtyTrac.
“It’s getting more challenging because there are more competitors every day and there’s fewer distressed homes,” Jonathan Gray, global head of real estate for Blackstone, which has spent more than US$4 billion to buy 24,000 rental houses in the last year, said during an interview last week.
To expand quickly, Mullen bought Empire Group LLC, a Scottsdale, Arizona-based investment firm that has purchased more than 1,100 houses in the Phoenix area, and now runs Fundamental REO’s western region.
Affordable Housing
In Clark County, Nevada, and Maricopa County, Arizona, records show at least three deeds bought by Fundamental REO and Empire, from Affordable Housing Partners LLC, a non profit “dedicated to providing affordable housing to individuals and families, educating homeowners, and expanding homeownership to those in need,” according to its website.
While that may give Mullen’s firm a chance to avoid auctions, it also helps families needing a temporary home, according to Joseph Prestia, a manager at Affordable Housing.
“There are thousands upon thousands of families that have bad credit and can’t qualify to buy a home,” Prestia said in a telephone interview.
Buying sprees by investment firms such as Mullen’s means they are often paying a premium, according to Bruce Norris, president of the Norris Group, a closely-held real estate investment firm in Riverside, California. Norris paid US$131,000 for a nine-year-old five-bedroom house in October that he fixed and resold to Fundamental REO for US$175,000 the same month, according to property records.
Retail Prices
“If those guys bought from us, we sold at retail,” Norris said in a telephone interview. “They aren’t finding deals. They’re just finding inventory.”
Fundamental REO is also in talks to purchase portfolios of homes in Texas and Florida from Landsmith LP, a San Francisco- based single-family rental company established in 2008 that buys and sells as many as 300 properties a month.
“They’re able to buy significant numbers of houses and are thoughtful about how and where they deploy their capital,” Landsmith Chief Executive Officer James Breitenstein said in a telephone interview.
Mullen is Fundamental REO’s CEO while Schade is president, after working most recently as chief operating officer at hedge fund Pinebank Asset Management. Investors are wagering their Wall Street experience will translate to being a large-scale landlord.
‘Big Short’
After Mullen joined Goldman Sachs in 2001, the bank rose from 12th in arranging leveraged loans for companies to fourth in 2007, when he was named to oversee Daniel Sparks, the head of Goldman Sachs’s mortgage department.
At the time, the mortgage business had built a position the firm’s then-Chief Financial Officer David Viniar called “the big short,” a US$13.9 billion bet against subprime mortgage- related securities, according to a report by the U.S. Senate Permanent Subcommittee on Investigations.
That year, the business made US$1.2 billion in net revenue for Goldman Sachs by shorting subprime mortgage-backed securities, a position CEO Lloyd Blankfein described as a “hedge” against its holdings of other home-loan securities. Going short helped make Goldman Sachs Wall Street’s most profitable firm, even as many of its clients lost money, according to the Senate report.
In e-mails cited in the investigation, Mullen raised concerns “about the representations we may be making to clients” who are being sold securities that were likely to face markdowns in value. Still, in October 2007, Mullen lauded a trader for shorting collateralized debt obligations that faced steep credit downgrades.
‘Serious Money’
“Looks like we’re going to make some serious money,” Mullen wrote, a day before the mortgage department made $110 million on the investment, according to the Senate report.
Mullen served on Goldman Sachs’s management committee, the senior partners who oversee all of the firm’s operations, as well as the risk and principal investment committees. In 2009, three years before leaving the firm, he began making personal investments in distressed real estate, according to the marketing presentation.
The wealth he’s accumulated has allowed him to become a significant donor through the Donald R. Mullen Family Foundation, giving more than US$1.4 million to charitable organizations in 2011. He serves on the boards of the Brooklyn Academy of Music, the Dia Art Foundation and the Friends of the High Line, which honored him in 2010 for a US$1 million gift.
Art Auction
His interest in art attracted attention after he engaged in a bidding war with Alec Baldwin in 2011 at a benefit auction in Long Island near his home in the Hamptons. He let the actor walk away with a Clifford Ross painting of crashing waves for US$70,000.
Wearing sunglasses for most of the evening auction, Mullen paid US$100,000 for a print by artist Barbara Kruger. It shows a man with a blindfold and red lettering that says, “He entered shop after shop, priced nothing, spoke no word, and looked at all objects with a wild and vacant stare.”
The fallout from the housing crisis that Goldman Sachs navigated so successfully is now the biggest driver of investments in single-family rentals. Homes lost to foreclosure are bought by investors at discounts and the owners who defaulted on their mortgages are potential renters.
Renters occupy 35% of single-family homes, up from 30% in 2005, before 5.5 million people lost homes to foreclosure, according to an April 17 Goldman Sachs report that estimates the asset class to be about US$2.8 trillion.
Bank Financing
Banks are increasingly offering financing to investors to buy the homes, with Deutsche Bank AG this month arranging a US$100 million loan facility to Five Ten Capital LLC backed by mortgages on the properties, a structure that may enable bonds to be issued tied to rentals.
Mullen is buying homes in 10 metro markets with his eye on expanding to Chicago, Dallas, Denver, Detroit, Houston, Miami, Sacramento and Washington, choosing neighborhoods where job growth, quality schools and low crime will attract renters, the marketing materials show.
He’s hunting in the same areas as other large buyers. Institutional investors purchased 30% of foreclosed homes in Miami last year, 23% in Phoenix and 19% in Las Vegas, according to CoreLogic.
Investors should consider buying properties that need “slightly more” capital expenditures for renovations to “reduce competition with retail consumers,” Fundamental REO’s marketing document says.
Case Studies
Mullen’s pitch book includes two “case study” homes illustrating his expected returns, which are higher than yields forecast by Goldman Sachs analysts. A four-bedroom home built in 2004 in Laveen, Arizona, southwest of Phoenix, generates a net annual income of 9.9% on US$1,675 monthly rent, after costs such as insurance, taxes, management fees, a 5% vacancy rate and 50-percent debt. A five-bedroom home built in 2005 in Snellville, Georgia, east of Atlanta, generates net annual income of 10.5% on US$1,150 rent.
That compares with average estimated single-family rental yields of 4.5% in Atlanta and 4.3% in Phoenix this year, according to an April 17 report by Goldman Sachs analysts led by Charles Himmelberg.
“Even among the ‘cheapest’ metros, rental yields average only about 5%,” Himmelberg’s report said.
While Mullen has built an in-house acquisition team, he’s outsourcing property management. That’s a risky strategy, said Aaron Edelheit, chairman of American Home, an Atlanta-based firm with more than 1,500 single-family rentals in Georgia and North Carolina that started in 2009.
Operational Efficiency
“This industry hasn’t institutionalized yet and that’s why it’s hard to do at scale,” Edelheit said in a telephone interview. “That’s why you have to do this yourself.”
Some investors are outsourcing management while taking a more targeted approach to buying homes.
“When you are spread out across too big of a geography you lose a lot of efficiency in operations,” said Clayton DeGiacinto, a former Goldman Sachs mortgage trader and chief investment officer of Axonic Capital LLC, a US$1.8 billion investment firm.
Axonic, which started a fund in June to buy foreclosures and rent them out, owns almost 300 units in Florida, said DeGiacinto. “When we focus on similar assets in close neighborhoods we can almost run operations like an apartment building. We can have the same paint in all the houses, we can have the same company doing all the grass cutting at all of the houses. It’s cheaper.”
Strong Handle
Mullen’s firm will have a strong handle on operations, according to Richard Marin, CEO of Ironwood Global LLC and a former chairman of Bear Stearns Asset Management.
He’s hired some “high-quality guys,” who worked at Ironwood, a fund that received commitments from investors of US$1.5 billion to buy non-performing loans from the Federal Housing Agency, said Marin. He abandoned the plan when the FHA balked at the deal.
“I guarantee you they know what it costs to fix a toilet in every major city in America,” said Marin, who also lectures in management at Cornell University. “And they know the top 10 purveyors in that city and what they charge down to the penny for fixing that toilet.”
Fundamental REO has at least three potential exit strategies, according to its marketing materials: sell homes one by one in six to eight years to capture price appreciation; sell in bulk to institutional investors such as insurance companies seeking cash flow; or go public as a real estate investment trust.
If big funds sell en masse in a few years, it may add downward pressure on house prices at a time when today’s low mortgage rates will be history, said Josh Rosner, an analyst with research firm Graham Fisher & Co, who warned in early 2007 that subprime loan-linked securities posed risks to the economy.
“It’ll be interesting to see if people who are used to buying and selling assets can be committed to holding assets, or efficient in managing and disposing of them,” he said.
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