Housing Market Update: The Low-Hanging Fruit is Gone

“Investors Pile Into Housing, This Time as Landlords,” blares The Wall Street Journal headline.

Purchasing single-family residences to rent out used to be a simple mom and pop business. Investors could count on rents and prices marching in tandem at a steady 3% annual pace.

Not anymore. The big money is buying up houses left and right. Wall Street wanted in on the housing boom in the early to mid-2000s, and now it wants its share of the rebound.

Blackstone, the world’s largest private equity firm, has already bought over 20,000 units for $3.5 billion. And the company is far from done, expanding its credit line with Deutsche Bank AG to $2.1 billion from $600 million. Another big player is Tom Barrack’s Colony Capital, which has raised $2.2 billion to buy single-family homes and just recently more than doubled the size of its portfolio.

Like recent investment frenzies, new public offerings are raising money to get in the game. Silver Bay Realty Trust raised $263 million in December, while American Homes 4 Rent and American Residential Properties Inc. plan to come to the market soon.

Home sales rebounded last year in a number of beaten-down markets, and institutional investors are the reason. Institutional investors comprised 30% of Miami sales, 23% of Phoenix sales, 21% of Charlotte sales and 19% of Las Vegas sales.

Prices increased accordingly. Phoenix posted year-over-year gains of 23%. Las Vegas prices popped 12.9%, Miami 10.6% and Charlotte 5.3%.

These investor-driven price spikes have turned the rental economics equation upside down just as renters are harder to find and keep.

Las Vegas broker Tina Africk, who manages 60 single-family home rentals, told Bloomberg that houses that were formerly rented in 30 days can now take 60-90 days to fill. At the same time, rents have fallen about $100 a month from a year ago.

In Phoenix, sales prices are soaring, while rents are up only 1.6%. The competition for renters is keen. Arizona’s quick repossession process has cleared the market quickly. Most people who have lost their homes have found a place to rent already. “There are a lot of properties out there, so the competition to get your property rented is fierce,” leasing agent Cathy Svoboda told Bloomberg. “Tenants are very savvy. If you’re overpriced by $25, they’ll let you know and go to another one around the corner.”

Rents in battered Atlanta are also soft, according to James Breitenstein, whose company has bailed out of Phoenix while buying 300 homes in Atlanta and Las Vegas.

Writing for Bloomberg, John Gittelsohn and Prashant Gopal point out that big investors are chasing the same type of house — three-bedroom homes built since 1990. “They’re effectively pushing prices up on each other,” ex-Morgan Stanley analyst Oliver Chang told the Bloomberg reporters.

“One of the risks is prices run up and therefore the rental economics don’t justify the business model,” says Jade Rahmani, an analyst with Keefe Bruyette & Woods. “The problem could be that you would have assets that are up a lot in value, which isn’t the worst thing in the world. The risk would be that everybody goes to sell at the same time.”

While the big money pays more for the same or less rent, there is still a dark cloud hanging over the market. CoreLogic estimates that 10.4 million homes remain underwater nationwide. With 52.4% of its mortgages underwater, Nevada is still the top for residential distress. Florida is next for negative equity, with 40.2% of its mortgages, followed by Arizona with 34.9%, Georgia with 33.8% and Michigan with 31.9%.

According to CoreLogic the average underwater homeowner has negative equity of $45,000.

As bad as that is, these numbers portray a healing housing market. However, some people aren’t buying it. Las Vegas real estate agent Mark Rowley says his local market has improved only because inventory is being artificially constrained by the backup in foreclosure filings.

“We need a normalized supply of houses to be able to assess what one should think of the local market health,” Rowley told the Las Vegas Review-Journal. “It comes back to the key question: How many people are not paying their mortgages, but still living in their houses?”

Las Vegas appraiser Mike Brunson posed the same issue to CNBC’s Diana Olick. “People in Las Vegas talk about shadow inventory to the point where nobody really wants to talk about it anymore,” Brunson said. “People will argue and say it isn’t, but I can name a dozen people off the top of my head who have been in their houses for over three years without a payment.”

In a commentary for the Las Vegas Review-Journal, Steve Hawks, owner of Platinum Real Estate Professionals, guesses that 80,000 homeowners in southern Nevada are not making mortgage payments. This provides a big shot in the arm for the local economy. Assuming an average payment of $1,200, that means there’s nearly $1.2 billion in discretionary income flooding the local economy that wouldn’t be there if payments were being made.

But the legislation in Nevada that has kept foreclosures off the market will be amended. The 50,000 vacant homes and homes occupied by delinquent homeowners will be become available inventory. The flood of inventory will depress rents. Then, as Hawks explains, “The funds will find the homes are not generating the cash flow they had told their investors they would. The next step will be to sell off quickly and cash in on the higher price and 40% capital appreciation. Nobody wants to be holding the last bag when the sell button is hit.”

While investors rush in to buy anything they can get their hands on, there is no renewed economic growth or job creation in Las Vegas. Perhaps that’s why rents actually dropped 4.1% in the fourth quarter, while asking prices for homes jumped.

With the 10-year U.S. Treasury bond yielding less than 2% and junk bonds hitting a record-low yield in the 6% range, investors are hungry for yield. But everyone should remember that the more you pay for a stream of rents, the lower the yield. For instance, an unnamed source for Grant’s Interest Rate Observer said late last year that he hadn’t bought anything in Phoenix since early 2012 because prices were already too high.

Grant’s imagined a hypothetical home purchase of $130,000 with rents of $1,200 a month. But after boiling out all the expenses, the net came to only 3.5%. Better than owning a 10-year government bond, but it wouldn’t cover the investor’s cost of capital. “I’m losing money on that house, or I’m betting purely on appreciation,” the publicity-shy investor told Grant’s.

This is no time to bid against fully funded competitors for low yields and sketchy renters, all with a stealth supply of underwater houses hanging over the market. The low-hanging fruit in housing has already been picked.


Doug French
for The Daily Reckoning