Vulture Funds, Cuckoo Funds & Co-Living

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Vulture Funds, Cuckoo Funds & Co-Living

What is a Vulture Fund?

A vulture is a scavenger which means that it feeds on dead animals. The name “vulture fund” comes from the perception that these funds make money from troubled / distressed assets ie they profit from the misfortune of others. Some proponents of such funds feel that “phoenix fund” would be a more deserving title in that they take troubled situations and help those involved to rise again and move forward.

The funds themselves are typically private equity or hedge funds which are essentially pools of money aggregated typically from large institutional investors (pension funds) and/or high net worth individuals, professionally managed for a fee by the fund managers. Their raison d'être is simple: make as much money as possible for their investors. They do this by buying the distressed assets of financial institutions at a discount to face value with a view to recovering more than they paid for the asset.

The obvious question is why would a financial institution facilitate this transfer of wealth from their shareholders to the vulture funds ie why will they sell a loan book at a discount to face value? The first reason is that the bank knows that the face value of the loan book won’t be recoverable as many of the loans will be “underwater” ie the loans are in default and often the underlying security is worth less than the balance outstanding on the loan. For example, a bank may have a collection of distressed loans with a total face value of €5bn but estimates that in reality only €4bn will actually be recoverable as the borrowers can’t repay and the underlying assets, if repossessed, will not result in the full recovery of the face value of the loan. Furthermore, working the loan book would literally take years in order to extract maximum value and minimise reputational damage that would be incurred if seen to be being too aggressive with borrowers, particularly those in family homes.

So why don’t the banks “work their loan books”, do deals with borrowers who can’t pay, repossess assets from those who won’t and get back as much of the €5bn as they possibly can? Very often they do but banks are somewhat restricted in what they can do to resolve a distressed loan. For example, if a bank takes a loan of €1m, agrees to write off €200,000 and does a deal to collect €800,000, the moral hazard concern is that other borrowers hear this and too look to get a discount on their debt ie by giving some distressed borrowers deals, a bank could undermine the value of the remaining loans where borrowers choose not to repay in the hope of getting similar write-downs.

In terms of repossessions, these are bad for the banks’ brands and something they try to avoid as much as possible. So giving discounts and repossessing, which are the natural resolutions to a distressed loan, are not attractive to banks. However, European Central Bank rules mean that banks are under pressure to get their NPL (non-performing-loan) ratio to below 5% of their overall loan book. So banks need to get these NPLs resolved one way or the other, they are slow to repossess and can’t be seen to be offering write-downs. The ability to pool together a whole host of distressed loans and offload them to a vulture fund is a quick, clean means of getting these loans off their books, getting cash in, reducing NPL ratio and some would say outsourcing their dirty work to the vulture funds.

The vulture funds don’t have the same constraints as a bank. First off, they have no consumer facing brands to protect as such, unlike the main banks that very much do. A vulture fund is not at all concerned about any brand damage incurred in evicting people to repossess their property. Cutting a deal with a borrower again is a tool that vulture funds will use; remember they have bought the loans for less than their face value so they can offer the borrower a write-down and still make a profit. In short, the vulture funds offer the banks an efficient means of cleansing their balance sheets with limited brand damage and without creating moral hazard for their remaining borrowers. The funds get to buy Dollar bills for less than a dollar and keep the difference.

What is a Cuckoo Fund?

A “cuckoo fund” is a term given to a fund (typically a hedge fund with institutional investors) that buys up an entire block of apartments directly from the developer before they ever hit the open market. The rationale for the term “cuckoo fund” is that cuckoos elbow the eggs of other birds out of their nest and take the nest for themselves. The pejorative analogy is that these funds elbow first time buyers, eager to get on the property ladder, out of the way thereby depriving them of the opportunity to buy the apartments themselves.

From the developer’s point of view, a “cuckoo fund” is a very attractive option for a number of reasons. Firstly, they take the whole development in one go, eliminating estate agency fees and also dramatically reducing the time it takes to sell out the development thereby increasing the developer’s return as they get their investment back more quickly than selling individually to the public. Cuckoo funds also typically tend to be backed by institutional investors, typically pension funds, looking for safe, solid, long-term cash flows for their members. While getting a good return on their investment is of course a key concern, they are often willing to pay high multiples of rent (accept low yields), in return for the virtual guarantee of the cashflow in the long term owing to the strong demand for rental accommodation particularly in Dublin.

The risk profile of a vulture fund is typically far more aggressive than a cuckoo fund. If a vulture fund is buying Dollar bills (loan books) for 70 cents, there is the possibility that when all is said and done, the Dollar bills are only worth 65 cent ie there is a real potential for loss as well as gain, depending on how much money can be extracted from the troubled borrowers and the assets underpinning their loans. A cuckoo fund on the other hand is buying a rock-solid rental income stream for decades to come and as such has a far lower risk threshold than a vulture fund.

What is a REIT?

A Real state Investment Fund (REIT) is a vehicle through which investors can pool their funds together in order to invest in real estate as a collective, under professional management. The appeal for an investor is that they can have exposure to the property sector without having the responsibility of the day to day management of the property portfolio itself. A REIT in Ireland must distribute 85% of its property related income to shareholders who in turn pay tax on this income. REITs are traded on the stock exchange and retail investors can buy shares as they might in any other public company. So for example, an investor with €10,000 will not have a sufficient sum to buy a property but can buy the shares of a REIT and participate pro-rata based on their shareholding in the success of that fund.

What is Co-Living?

Co-living is a new development in Ireland but is an established means of living in many European countries and the US. Pitched as being akin to boutique hotels, the “guests” enter into a license with the owner to rent a room for a set period of time. The rooms can be quite small; some developers are looking to build developments with rooms as small as just 6 square metres, but there are ample communal areas such as kitchens, gyms, cinemas etc. Co-living is promoted as being an ideal choice for young, affluent (they don’t tend to be cheap), mobile, single (couples typically aren’t allowed), often tech’ workers who intend to be in a city for a relatively short stint ie a couple of years before moving on. The developments tend to have inhouse social activity coordinators who organise social activities for the inhabitants; accordingly, the developments tend to be attractive to sociable people keen on making new friends ie foreign workers who have recently arrived in a city.

Controversially, those staying in the development are classified as licensees as opposed to tenants and a such don’t have the protection of the Residential Tenancies Act in terms of maximum rent increases, notice periods and more.

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