It is no longer a secret that much of the recent run up in housing prices is the result of institutional investors and private equity buying houses on a bulk basis. This has made it very difficult for traditional buyers to compete in the current market as the investors are buying with all cash forcing traditional buyers to scramble to compete when they are dependent on obtaining financing in a more conservative lending environment. In some cases this has led traditional buyers to feel so desperate at the prospect of being frozen out of the market that they offer significantly over list price just to win a bidding war.
It is important to remember that it was just this fear of being left behind that led to much of the irrational exuberance near the height of the last bubble. It is also worth remembering that investors want to foster this perception in the market because buyer sentiment is critical to home price appreciation, which is key to their investment strategy. As this recent New York Times article points out, while investor capital continues to say that it is in housing for the long-term, investors’ actions are showing the first signs of heading to the exits as they scale back their acquisitions and take money off the table in the form of IPO’s. It is worth remembering, a smart investor is not likely to tell you what they are doing until they have locked in their position so they can profit off your response.
We have seen the stories about large pension investors and private equity getting into the business of buying up SFRs to fix them up, rent them out and then sell them off for a large profit once the market recovers. With the strong rental market and the recent uptick in housing prices, this would appear to be a winning strategy, at least so far. However, once the herd gets a whiff of short-term success, money starts crowding into the market chasing these higher yields. This results in more competition driving up prices on an ever shrinking pool of “distressed” housing and making the returns that the early entrants enjoyed, harder to find.
Now we can add the foreign buyer, who is not only chasing higher yields, but as the WSJ points out, is also trying to take advantage of favorable foreign exchange rates. With this new development, investors who are looking to buy SFRs not only need to beware of the institutional yield chasers but the ForEx speculators.
This does not bode well for a sustained housing recovery because both the institutional investors and foreign buyers are treating SFRs as commodities that can be traded for yield or ForEx gains, much like they did when they were packaging and selling off subprime mortgages. However, owning and operating SFRs for rent is an inherently inefficient business model for institutions because it requires too many levels of administration from the money manager, to the asset manager all the way down to the local mom & pop property manager whose job it is to collect the rent, mow the lawns and unclog the toilets when the tenants call. As with subprime lenders, once you are done paying the fees to all of these service providers, there is not a whole lot of yield left for the investors. When the initial wave of fast home appreciation fades and the yields no longer justify all of the fees being incurred to operate the homes, it is reasonable to expect that the money will leave this new cottage industry as fast as it entered. . . and then where will home prices go?