Ken Major climbs the steps of a county courthouse in a San Francisco suburb with $500,000 in cashier’s checks in one hand and a list of addresses in the other. Major is a buyer for Waypoint Real Estate, an Oakland-based investment firm that is scooping up foreclosed homes in California.

On this afternoon, he joins a dozen house flippers as an auctioneer starts hawking the latest batch of defaulted properties to hit the market. Major bids on a three-bedroom house in Antioch, and after other buyers counter, he wins at $147,600.

“We got it,” he mutters into a cellphone mike dangling from his ear. The house was valued at more than $400,000 in 2006.

Waypoint, a private-equity real estate fund with $150 million in assets, is pioneering a new approach to making money from the housing crash. Since 2007, investors have been trolling the cratered suburbs stretching from California to Florida for cheap houses to flip. And firms such as PennyMac Mortgage Investment Trust have sought value in subprime-mortgage-backed securities.

Waypoint, which owns 1,100 houses and is buying five more a day, is betting that converting foreclosures into rentals is a better way to make a profit. Other firms, such as Landsmith in San Francisco, are now cropping up and pursuing the same strategy in Arizona, California and Nevada.

‘The yields are awesome’

With many suburban homes selling for half their peak values and demand for rentals from prospective tenants climbing, Waypoint was earning a return of
8 to 9 percent on its capital as of Dec. 31, according to a quarterly report. That beats the 6.3 percent gain in the BI NA Multifamily REIT Index, which tracks the performance of 27 apartment-building operators.

The cost of renting in the United States reached an all-time high compared with that of buying a home at the end of last year, indicating that it is a good time for investors to buy, according to Deutsche Bank analysts. Should property values rebound, Waypoint may earn at least 20 percent from appreciation in an eventual sale of the houses, says Colin Wiel, who co-founded the firm in 2008 after backing technology start-ups as an angel investor.

“I never thought I’d be rolling up single-family homes,” Wiel says. “But the yields are awesome.”

Wiel and Waypoint co-founder Doug Brien make an unlikely pair of real estate entrepreneurs. Wiel, 45, is a mechanical engineer who designed braking systems for jetliners at Boeing in the 1990s. And Brien, 41, is a former place kicker who won a Super Bowl with the San Francisco 49ers in 1995 before earning a post-
graduate degree in business at Tulane University.

A $3 trillion market

In starting Waypoint, Wiel and Brien set out to show institutional investors that by using technology they could amass single-family homes the same way Sam Zell’s Equity Group Investments and other real estate giants gather apartment units in cities from New York to San Francisco.

The home rental market boasts a total property value of $3 trillion, according to Morgan Stanley housing analyst Oliver Chang. Yet institutions have long shunned it as too scattered and impractical to be profitable.

Wiel and Brien are using cloud computing, proprietary algorithms and iPads to create a virtual assembly line for buying, renovating and renting houses on a large scale. They’re also betting that many former homeowners who have jobs but couldn’t afford their mortgages will still want to live in the same communities as renters.

“The economics never made sense for a big investor to come into the market, and the technology for managing all that complexity didn’t previously exist,” Brien says. “The confluence of those two events has provided a window of opportunity for large investors.”

Last year, Columbia University’s $8 billion endowment invested $25 million with Waypoint. In January, GI Partners, a private-equity firm that manages money for the California Public Employees’ Retirement System and other pension plans, agreed to invest up to $400 million with Waypoint and acquire a minority stake in the firm.

The same month, Oaktree Capital Management, the investment firm co-founded by billionaire Howard Marks, announced a $450 million deal with Carrington Capital Management to acquire and convert foreclosed single-family homes into rental properties. Carrington rents out more than 3,000 houses in California and other states.

Starwood Capital Group is poised to enter the foreclosure-to-rental market, according to an investor familiar with its plans. So, too, are Zell and the real estate arm of Apollo Investment Management.

Spokesmen for Zell, Apollo and Starwood declined to comment.

“Until last year, single-family-home rentals was a mom-and-pop market,” says Stephen Duffy, an investment banker at Moss-Adams Capital, a firm that finances real estate investments. “Now, it’s grabbed the attention of institutional private equity because foreclosures haven’t cleared and these properties can generate high yields for years.”

Waypoint and its rivals may eventually spin off pools of single-family home rentals into real estate investment trusts. Still, even the best technology cannot replace the labor-intensive process of acquiring and leasing thousands of
houses scattered across scores of Zip codes.

Finding renters

Waypoint’s researchers must plumb school desirability ratings, crime statistics and other hyperlocal data to ascertain the income value of each house. Its title agents must often disentangle foreclosures from second mortgages and liens. And leasing representatives have to find qualified renters in communities struggling with high unemployment rates.

“This is a nascent market, and the model still hasn’t proved out,” says Rick Magnuson, executive managing director of GI Partners, which has $6 billion under management. “But we believe this rental strategy will produce good economic returns for our investors and help arrest the housing market’s slide.”

The Obama administration is poised to tap the foreclosure-to-rental approach as officials struggle to turn around the housing market. The president’s push to have mortgage providers make loans more affordable for homeowners has done little to stem foreclosures, says Ginna Green, a spokeswoman for the Center for Responsible Lending.

There were almost 2 million U.S. foreclosures in 2011, down 31 percent from 2010. As many as 10 million borrowers may default over the next few years if the markets continue to deteriorate, says Laurie Goodman, an analyst at Amherst Securities Group. Even though mortgage rates are hovering at a historic low of 3.8 percent, consumers bought only 324,000 new homes last year, the poorest annual performance since 1963.

On Feb. 9, the Justice Department and 49 states agreed to end a probe into abusive mortgage practices at Bank of America, J.P. Morgan Chase and three other banks after striking a $25 billion settlement with the companies. The landmark agreement, which will provide debt relief to homeowners, should help rescue many delinquent borrowers and buoy the confidence of would-be home buyers and lenders that the worst is over, says Ivy Zelman, chief executive of Zelman, a research firm.

Repossessed homes

Even so, the settlement may not be large enough to reboot a housing market saddled with $700 billion in underwater mortgages. She says institutional investors eyeing the rental market have the capital to absorb thousands of dwellings and slow the market’s decline.

Investors are already having an effect: The supplies of homes for sale in Phoenix, Orlando and other hard-hit markets have fallen more than 60 percent from their post-crash highs as bargain hunters scoop up foreclosures.

“Investors are aggressive about buying these homes in front of the government program,” Zelman says.

In August, the Federal Housing Finance Agency asked investors for input on setting up a foreclosure-to-rental program to off-load some of the 180,000 repossessed homes held by Fannie Mae and Freddie Mac, the troubled government-sponsored mortgage giants. Barclays Capital, Deutsche Bank, Fortress Investment and Waypoint were among the hundreds of firms that submitted proposals to the FHFA spelling out how investors could participate in such an initiative, according to information obtained by a Freedom of Information Act request.

Wiel says the agency may auction pools of properties to investors, perhaps coupled with federally guaranteed financing that lowers their cost of capital significantly. The Resolution Trust Corp. employed a similar policy in the early 1990s to sell off mortgages held by failed savings and loan banks.

On Feb. 27, the FHFA unveiled a pilot program to sell repossessed houses in Los Angeles, Phoenix, Florida and other hard-hit markets to investors who qualify with the agency. Waypoint submitted an application. “This could be a total game changer for us,” Wiel says.

It is striking that Washington is looking to Wall Street for answers after investors’ zeal for subprime mortgages helped foment the housing morass, Green says. She says a boom in rentals may encourage mortgage lenders to foreclose on delinquent homeowners instead of reworking their loans to be more affordable.

Still, she says, leasing defaulted houses does reduce the corrosive impact they have on communities. “Nobody wins when houses are empty,” Green says.

Wiel and Brien, both graduates of the University of California at Berkeley, met at an angel investing conference Wiel was hosting in San Francisco in 2008. They talked about the housing crash and agreed that plunging property values in the Bay Area’s bedroom communities presented an irresistible opportunity. So they set up a company with $1 million of their own money and acquired 26 houses during the next six months.

From the outset, the pair applied technology to a business rooted in the shoe-leather world of appraisals, home inspections and foreclosure sales on courthouse steps.

“We asked, ‘How do we systematize and automate everything? How do we scale?’ ” says Wiel, an upbeat man who is fond of techie lingo. By 2011, they had hired almost 100 employees and raised more than $90 million from investors in seven funds. Waypoint’s office in a downtown Oakland high-rise is bustling with activity.

In a warren of cubicles, leasing reps sporting telephone headsets talk with potential renters. A half-dozen members of the home-acquisitions team are crammed into a bullpen outfitted with a brass bell that is rung with gusto every time a new house is bought. Doug Pankey, a longtime appraiser who helps run the team, reviews the foreclosures slated for auction this afternoon on two computer screens.

Waypoint uses a combination of its own proprietary algorithms and business software from to turn potential acquisitions into rentals. Pankey zeroes in on a three-bedroom residence in a middle-class subdivision of Antioch, a San Francisco suburb of 102,000 residents.

The house appears in the center of a red, pulsing orb on a Waypoint heat map that highlights the town’s most desirable blocks. The house needs $20,000 in renovation, has no liens and earns a 92 out of 100 on Waypoint’s Geographic Scoring System.

Home conversions

This proprietary program ranks potential acquisitions by factoring in location, proximity to freeways and commuter trains, and the home’s past property-value performance. Pankey watches as the program calculates that with a maximum bid of $150,293, Waypoint can rent the residence for $1,799 a month and earn a 7.7 percent annual return.

Pankey’s buyer, Ken Major, is looking at the same Antioch house profile on his iPad outside the Contra Costa County courthouse, 27 miles away, ready to bid. Waypoint maintains all of its property profiles in an online cloud database so agents in the field and supervisors at headquarters can access and update them in real time.

A month after buying the house for about $2,700 less than that maximum bid, Waypoint outfitted it with a new kitchen, carpeting and landscaping.

Many of the firm’s conversions don’t go as smoothly. On a warm January morning, James Gordon sets out to visit almost a dozen Waypoint houses that may still be occupied. Gordon, a former mortgage broker, is a home rescue specialist who negotiates with occupants to determine whether they can be converted into renters, paid $1,000 to move out, or be evicted.

About a third of Waypoint’s homes are occupied by the former homeowners themselves, with one out of four staying on as tenants. Waypoint offers to set aside a percentage of any tenant’s rent so that money can later be used toward a home purchase.

Most of the time, occupants leave within 15 days of Waypoint’s purchase because they can’t afford the rent or choose to go. Gordon returns to one residence where a family has refused to move out for six months as they pursue a legal claim that they’re the victims of mortgage fraud. No one is home, but two brand-new radio-controlled toy cars sit under the Christmas tree and family pictures line the mantle. Gordon sighs. It’s going to take more time before Waypoint earns a return on this property.

At another house, a woman refuses to open the door for Gordon. It turns out she’s one of six tenants renting rooms there. Speaking through the door, Gordon says she may be able to stay on as a Waypoint renter, but she rebuffs him.

“I’m not trying to be a bad guy, but if you don’t come to an agreement with us, we’ll have to move forward with the eviction process,” Gordon says as he slips his business card under the door.

For all of the cloud computing, the business of converting foreclosures into rentals is often about dealing with households under enormous fiscal stress. Waypoint employs former financial counselors from nonprofit organizations to help tenants repair their credit and even set up household budgets so they don’t fall behind in their rent.

As Waypoint triples the number of houses it buys daily and expands in California and possibly Nevada, Arizona and Illinois, it will have to hire dozens of appraisers, leasing agents and other personnel. The firm will have to shoulder these labor costs up front before its new funds can earn a profit.

“That pulls a lot of inefficiencies into the strategy and that can be expensive,” says Chris Hentemann, managing partner of 400 Capital Management, a hedge fund with $350 million in assets that invests in mortgage-backed securities.

In April, Waypoint launched a fund to reboot foreclosures in Southern California, and in the third quarter it recorded $324,327 in operating expenses on $23,920 in rental revenue.

A few days before Christmas, the mood is festive at Waypoint’s holiday party. Wiel and Brien hand out thank-you cards with bonuses as employees pile barbecue, chili verde and brownies onto paper plates. Taking the floor, Wiel says that the housing market has only worked through half of its backlog of foreclosures, and that the firm will double its head count as it opens new offices.

“We are at the birth of a new industry,” he says to applause.

The full version of this Bloomberg Markets article appears in the magazine’s April edition.