Mar192014

Institutional home buying abruptly tapers off

Institutional buyers of real estate to hold as rentals abruptly slowed down in early 2014 due mostly to higher real estate prices harming returns.

Las_VegasSingle-family homes became an institutional asset class with the collapse of the housing bubble. Previously, it was too difficult to acquire a large number of single-family homes at prices that provided attractive returns. Typically, owner-occupants bid up prices far too high, and the increased management costs make returns far less than multi-family projects. Since the housing bust concentrated foreclosures in certain markets, and since prices were so low that cash yields greatly exceeded multi-family, private equity groups plunged into these markets and acquired large portfolios of homes.

From the beginning the naysayers were out in force. ZeroHedge, whose writing I generally like, has been particularly dismissive of this asset class. Housing permabears trashed it, but then they trash everything related to housing, so this isn’t surprising. The political left decried this business model because it reduced home ownership rates and undid years of their efforts to convert renters into owners — although the housing bust did that anyway.

I was an early proponent of this business model. In May of 2010, I wrote the post Buy Las Vegas real estate. As most regular readers know, I formed two investment funds to acquire Las Vegas homes, and at the time, many thought I lost my mind. Unlike most investors, I don’t base investment decisions on short-term movements in price; instead, I examine cashflow, and the cashflow opportunity in Las Vegas was obvious, just as the cashflow opportunity was obvious to the private equity funds that later entered these markets with billions of dollars.

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Few people expected the housing market to bottom in 2012, and most of the private equity funds who started buying these properties figured they would have several more years of foreclosure processing to acquire more homes. Unfortunately, lenders aren’t as stupid as most thought; once the banks realized they were the largest players in the REO-to-rental space, they stopped processing foreclosures. Someone at the banks realized it made more sense to delay the foreclosure and profit from the rebound in prices rather than complete the foreclosure and allow the hedge funds to make this money at the banks’ expense.

When the banks stopped processing foreclosures, and when the REO-to-rental funds entered the market, supply dried up, and demand increased, so the housing market bottomed, and prices went up quickly. Since house prices rose to the point REO-to-rental funds couldn’t make the returns they wanted, since owner-occupant demand flatlined for the last 4 years at mid-90s levels, and since the weak economy showed no sign of improvement, the combination of these factors told me that sales volumes were going to plummet in 2014, and the institutional buying would end.

On January 2, 2014, I began the year with the post Bold California housing market predictions for 2014, where I made the following forecast:

Sales volumes will decline from 2013 levels

Most economists predict home sales and prices will rise in 2014. The consensus retreats to safe predictions with a high probability of success, particularly given the momentum from 2013. I believe the consensus will be wrong, and sales volumes will decline, house prices may rise, but sales volumes in 2014 will be lower than 2013.

So what happened so far? Purchase applications hit a 19 year low.

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I went on with my predictions:

The biggest demand cohort in 2013 was investors, many paying all-cash. With house prices 20% higher or more, these investors will not be nearly as active in 2014. In fact, I predict one of the big housing stories of 2014 will be just how dramatically and abruptly these investors pull back. For sales volumes to increase from 2013 levels, owner-occupants must make up the difference. With a continued tightening of loan standards and a relatively weak economic recovery, I don’t see that happening.

So how did I do on that one? Institutional investor home buys hit 22-month low. And why did that happen?

Blackstone’s Home Buying Binge Ends as Prices Surge: Mortgages

By John Gittelsohn and Heather Perlberg Mar 14, 2014 1:57 PM PTLas_Vegas_foreclosure

Blackstone Group LP (BX) is slowing its purchases of houses to rent amid soaring prices after a buying binge made it the biggest U.S. single-family home landlord.

Blackstone’s acquisition pace has declined 70 percent from its peak last year, when the private equity firm was spending more than $100 million a week on properties, said Jonathan Gray, global head of real estate for the New York-based firm. After investing $8 billion since April 2012 to buy 43,000 homes in 14 cities, the company has narrowed most of its purchasing to Seattle, Atlanta, Miami, Orlando and Tampa.

Last July, a local housing market analyst sounded the alarm that institutional buying was an unstoppable Juggernaut destined to cause problems. I thought his concerns were baseless because these investors would turn off the money spigot as easily as they turned it on (See: Investor activity to plummet, home sales volumes will drop). Obviously, these funds have turned off the money, which is one of the reasons sales are down so much this year.

The institutional wave has passed,” Gray, who oversees almost $80 billion in property investments, said in a telephone interview. “It’s at a much lower level than it was 12 or 24 months ago.”

Private-equity firms, hedge funds, real estate investment trusts and other institutional investors have spent more than $20 billion to buy as many as 200,000 rental homes in the last two years. …

That sounds like a great deal if money and a many houses, but it is a tiny fraction of the resale market. According to the NAr, there were over 5 million homes sold in the US in 2013.

“Home prices have increased, which narrows the acquisition opportunity,” Rahmani said. “In addition, these companies have done this for a certain amount of time and there are lessons learned.”

american gothic parody 200309LOL! Yes, some of these funds have learned hard lessons. My biggest surprise has been the level of vacancy and the inability to raise rents. Historically, single-family detached homes that rent for near the median (which is what my fund bought) only see turnover once every two years, and when they do turn over, you can usually raise rent. With the influx of rental properties, landlords have been very competitive with rental rates, and tenants move more often than they used to, sometimes specifically for a better deal from a desperate landlord. I think this will change in time, but over the last two years, this has been my biggest lesson learned.

Side note: my calculations for investors on the property details in any of the listings on this site are based on the same analysis algorithms used by these funds. These calculations are all functioning properly.

Outbidding Homebuyers

Last week, a group of 80 tenant and neighborhood advocacy organizations, including the California Reinvestment Coalition, the National Community Reinvestment Coalition and the National Consumer Law Center, asked federal regulators “to address first-time homebuyers being outbid, tenants being displaced, and neighborhoods undergoing dramatic changes as private equity and investor cash continues flooding into local housing markets.”

This is the kind of bullshit spouted by the political left on this issue. Baseless nonsense.

Gray, 44, said the influence of corporate investors on home prices has been exaggerated. They represent at most 10 percent of the 2 million homes bought by investors in the last two years, according to Rahmani, the analyst.

“There’s a narrative out there that institutional buyers are driving the market,” Gray said. “But the reality is that institutional buyers are in a relatively limited number of markets, their buying is tapering and yet home prices continue to go up at a pretty strong clip nationally — even in markets where institutional buyers haven’t purchased a single home.” …

As I pointed out above, the REO-to-rental buying is a tiny fraction of the whole market. In cases where they outbid an owner-occupant, the buyer was likely bidding very low trying to get an exceptional deal. [dfads params=’groups=4&limit=1&orderby=random’]

Long Haul… Institutional investors are not going away even though their size will remain a modest part of the market, Gray said.

We’re not selling the homes. We’re building a long-term business,” he said.

The housing bears keep trumpeting that these investors are going to sell; they aren’t. As I noted in Is San Francisco, the most overvalued US housing market, going to crash?:

Investors could decide to get out of their illiquid trades and simply dump copious amounts of inventory on the market and accept whatever they get for their properties. Stock market investors do this all the time, so it could happen in housing, but it doesn’t seem likely. First, all the investors with significant inventory are seasoned real estate investors who recognize the perils of liquidating illiquid real estate assets. Most, if not all, of these firms have long-term locks on the investment capital, and they are under no pressure to force an unprofitable liquidation to recover capital. There are many other, less damaging methods of extracting cash if they needed it; they could obtain debt or refinance, sell in bulk to another investor, create their own REIT and sell shares to smaller investors, and any of a dozen other methods widely known to these players. A fire sale scenario simply isn’t plausible.

For now, these investors are done buying. The bigger question is Will lenders and investors find owner-occupant buyers when they liquidate? Nobody knows for sure. The inventory removed from the market today will come back again in the future. Most likely this inventory will be a discretionary sale similar to cloud inventory where the seller will either get their asking price or wait for another day. This overhead supply will serve as a drag on appreciation, but it won’t cause a crash.

Now that the large funds are done buying, the housing market must be sustained on owner-occupant purchases, and owner-occupants aren’t stepping up. A great deal of wishful thinking pervades the housing market. Everyone is counting on a depleted buyer pool that has too much debt, too little savings, and too little desire to carry the rally forward and provide enough demand for lenders to finally resolve the bad loans they can-kicked over the last few years.

MBA_Purchase_Applications_Index-12-2013

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[listing mls=”OC14040308″]