Apr242015
How to analyze rental properties with hedge fund algorithms
The OC Housing News analyses every for sale property on the MLS for its potential as a cashflow investment based on advanced hedge fund algorithms.
Between late 2010 and early 2012, I purchased 53 homes in Las Vegas — sight unseen. I used a service that provided pictures of the properties, but since these were all auctions, sometimes the inside views were not available, so I had no idea what I would find if I won at auction.
Does that sound scary or crazy?
It was a manageable risk. Usually, whenever I bid on a property where I couldn’t see the inside, I simply bid less to give myself an allowance in case I had to replace everything, and sometimes I still won the property at auction. I purchased one property only to discover after we opened the door that the former owner removed the entire kitchen, cabinets, counters, appliances, everything. However, I bought that property with such a large discount that I didn’t spend near the savings on replacing the entire kitchen.
If you know your after-renovation resale price, and if you know construction prices in the area, buying houses sight unseen is not as risky as you might imagine.
Automating the process
The most time consuming part of bidding on properties was analyzing each deal. I manually pulled rental and resale comps on over 1,500 properties in order to obtain the 53 I purchased. I had to copy and paste this information into a spreadsheet that crunched the numbers to generate my bids. I knew there had to be a more efficient way, but I couldn’t justify the expense of a system that would fully automate the process — I envisioned such a system, and I hoped some day to implement it.
In the spring of 2012, I was approached by an OC real estate developer who was asked by his capital partner to put together a proposal to buy rental properties at auction similar to the REO-to-rental companies that sprang up during that period. With my experience in Las Vegas and my understanding of residential rental acquisitions, I was responsible for developing the systems we would use to analyze deals.
Although these REO-to-rental companies like to come across as being immensely sophisticated, none of it is rocket science. The basic math is actually quite simple. As I worked to bring the venture to fruition, I also developed the algorithms necessary to assess rental and resale values automatically. When the deal fell apart, I was left with a lot of disappointment but also a fully developed property analysis system — the system implemented on this site today.
Racing to Buy Homes Sight Unseen
Residential real estate to be the next frontier for speed-based investing
By Timothy W. Martin, April 13, 2015 11:53 a.m. ET
ATLANTA—It took Akuansa Graham seven minutes on a recent morning to craft a $124,000 bid for a three-bedroom Buford, Ga., home he had never seen.
The Starwood Waypoint Residential Trust executive went to public auctions in the years after the financial crisis looking to buy homes lost to foreclosure. Now the 38-year-old crouches over a computer and relies on algorithms that evaluate home values, proximity to schools and crime rates to outrace rivals for any remaining bargains offered by real-estate agents.
This is exactly what I did each morning. It’s far easier now with a fully automated system to weed out the poor candidates. If I were doing similar work today, I would use the automated system to generate a list of potential targets, then I would analyze comps to verify the accuracy of the projections. The system eliminates most of the wasted time that otherwise would be spent evaluating unsuitable properties.
With the low-hanging fruit from the housing bust mostly picked, Wall Street-backed buyers of real estate are increasingly turning to quantitative data analysis as a way of accelerating their search for a dwindling supply of available homes that can be transformed into rental properties. Math-driven models powered by historical patterns can size up homes sight unseen and calculate future income in minutes, allowing private-equity giant Blackstone Group LP, the Alaska Permanent Fund Corp. and other bulk purchasers to skirt neighborhoods with softer rental demand or properties that need costly repairs.
Advances in how companies use technology to evaluate mountains of data has quickened everything from stock trading to student test-performance evaluations to patient care. Behind the new speed in real estate is a change in how big buyers find most of their properties.
And this same system is available to everyone here on this site.
Oakland, Calif.-based Starwood Waypoint, one of the six, said it has cut the time it takes to calculate a first bid on a house to eight minutes. “We encourage our guys to make an offer before they see the house,” said Ali Nazar, Starwood Waypoint’s chief experience officer. “I don’t want to wait for anyone else. Our competitors are also fast.”
Since their bids always contain a number of contingencies allowing them to get out of the contract, bidding quickly, sight unseen, is not a big risk. Since these aren’t auctions, they will see it before they buy it.
Operating from the firm’s largest branch office at a former meatpacking plant in Atlanta, Starwood Waypoint’s acquisitions team evaluates potential purchases with a data map that ranks the “livability” of local neighborhoods according to information provided by local employees of the firm who frequently visit the area. Factors include proximity to retailers and how noisy the neighborhood is.
Employees ultimately weigh about 15 variables when calculating a bid price, the monthly rent and renovation costs. Employee bonuses are based on the accuracy of their home bids and rental estimates.
While this additional data is not necessary to evaluate financial performance, it’s useful for small investors who plan to hold properties long term. I also provide community information on crime, schools, neighborhood amenities, and so on.
For more details, look at the investor calculations on today’s featured property in Victorville. If you click on the address, you will be taken to the property details page. There are tabs for comparable resales and comparable rentals to verify pricing and rental income. On the comparable rentals tab, you can examine both active and closed sales. This property shows that it could easily rent for the $1,000 price generated by the automated system. If someone purchased this as a rental, it would likely perform as the investor calculations show. This particular property has a cap rate of 5.4% with a cash-on-cash return of 8%. In today’s market, that’s not bad.
[dfads params=’groups=23&limit=1&orderby=random’]
[listing mls=”SB15078698″]
Larry, you’re a credit to the industry (much needed). Thank you for taking your time to do what you do. Kudos!
btw, since it has been proven that the financial model underpinning housing literally boils down to:
conjure up, as if by magic, provide cheap/easy money(blow a bubble); then, once the upside has been determined to be maximized, take away the cheap/easy money(pop the bubble) fomenting a consolidation event..
…and considering this chart
going forward, it would be prudent to factor-in price depreciation as an additional monthly cost to own, v renting.
Respectfully,
el O
I remember at the peak of the housing bubble Patrick.net had a rent versus own calculator that put in loss of value as one of the inputs. It nearly always said it was better to rent than to own.
His calculator was a refreshing change from the totally bogus rent versus own calculators found on most sites that put in 5%+ appreciation and annual rent increases without regard to expenses. Those calculators nearly always showed it was better to own, which is why realtors developed them.
I think the NY Times’ worksheet is good too:
The worksheet asks all the right questions, and your assumptions in some areas can swing the decision dramatically. The end result is the right question though, “If you can rent this place for $____, then renting is better.”
For the house I’m interested in, assuming an annual decrease is value of 1% for ten years creates rental parity. So, if I assume greater depreciation, it’s better to rent over that period. However, the longer the holding period, the lower the equivalent rent must be. If you assume a 3% annual rent increase, and a twenty year holding period, then the rent must be $1K lower today than net costs.
In other words, in my example, you would need to assume that after twenty years the house would be worth 20% less than it’s price today (2% general inflation rate assumption), and you would need to assume little to no rent increases over that entire twenty years, in order to conclude renting is wiser than owning.
This has always been my biggest complaint about these calculators.
If you look at long term growth rates, housing appreciates at between 3% and 4% even in the strongest markets. Compound growth rates above 4% simply can’t happen because prices are ultimately tethered to income.
Unfortunately, if you ask a realtor, they will tell you houses appreciate between 5% and 10% per year, and occasionally they do, but not on a compounded basis.
If you plug numbers larger than 4% into the appreciation assumptions, the calculators will readily comply, but it will never happen in the real world, and the results will almost always point to buying.
So what we have is a combination of bad assumptions meeting bad math that gives people a false impression of how well they will do buying residential real estate.
Also, most calculators ignore the carrying costs in maintenance and taxes.
If I assume a 3% annual appreciation rate, it’s a no-brainer that buying is better than renting, in my example at least.
When you include appreciation buying is always going to be better than renting.
In CA appreciation has often been more than the cost of rent.
Are you feeling lucky?
Nope, not feelin’ lucky. That’s why I’m sliding that appreciation bar into the negative numbers to see how bad it could get.
Of course you must assume an appreciation rate, and rent increase rate. That is what counts. If your calculator does not do that, then it has a rental bias.
And you had better add a water factor in your calculator. Because if the new home builders are denied new water taps, which appears to be the case, then the sky is the limit on existing home prices.
Nonsense!
When the water dries-up, an exodus of businesses/residents commences, NOT an influx; ie., see history.
Nonsense!
The drought is overhyped by a left wing administration who lives by the mantra “reduce, resuse, and share”. They forgot to mention that, while the snowpack is lower, more water is in storage. Next, they will stop flushing massive amounts of water to save a fish. Problem solved.
But, the left wing also has an agenda to stop new development, and they will under the drought excuse. All while people contine to move to California and no new apartments or homes built to house them. Home prices are going to go verticle. Just less supply and more demand. Rents will also go verticle. Bet that scenario is not in the rent vs. buy calculator. Get ready for stunning increases.
By the way, verticle mean turning point, and at that point, they will go vertical, which means straight up.
tl has a good point. Anything Sacramento does to hinder home builders is only going to exacerbate the current housing shortage.
I suggest you two drop the drama 101 elective @ GWC, and take a reading comprehension class instead
Once again …
“WHEN the water dries-up, an exodus of businesses/residents commences, NOT an influx; ie., see history.”
BTW, there are currently several thousand homes listed F/S in OC, so the notion there is a housing shortage is nothing more than hot air.
Bank of America Asks Appeals Court to Throw Out $1.27 Billion Penalty—and Remove Judge
Bank of America has requested an appeals court to dismiss a $1.27 billion court-imposed penalty against the bank over mortgage fraud and has also asked that the judge who imposed the penalty be removed from the case.
The Charlotte, North Carolina-based megabank asked the 2nd U.S. Circuit Court of Appeals for the removal of Judge Jed Rakoff of the U.S. District Court of the Southern District of New York from the case if it is remanded based on alleged impartial public statements he made while the case was pending, and in particular while the penalty phase was ongoing.
“In particular, he criticized the Justice Department for failing to pursue bank executives more aggressively for their roles in the crisis,” the bank said in the filing. “In a widely publicized article, the district judge questioned why the Justice Department had not brought prosecutions against bank executives using a theory of ‘willful blindness’ or ‘conscious disregard.'”
The filing also said Rakoff made “numerous” speeches on this theme, “with particular emphasis on the Justice Department’s non-prosecution of Countrywide’s chief executive officer, Angelo Mozilo.”
Judge Jed Rakoff is my new hero
Freddie Mac: Index Shows 40% of Metro Housing Markets Are Not Improving
Freddie Mac released its most recent Multi-Indicator Market Index (MiMi) Wednesday, and the results are a positive sign for the housing industry overall.
The new report, which now covers 100 metro areas (rather than just 50, as in previous versions), reveals that 60 percent of the nation’s top housing markets are now showing a three-month upward trend.
According to Len Kiefer, deputy chief economist at Freddie Mac, expanding the MiMi to include 50 additional metro markets has help gather more comprehensive information on the state of the nation’s housing industry.
“By adding an additional 50 metro markets to the monthly MiMi,” Kiefer said, “we are able to capture greater insights into what’s moving local housing markets heading into the spring homebuying season. The good news is after a slight stumble last month, nearly 60 percent of all markets are improving. Also, of the top 100 metro areas, over 60 are showing purchase applications up from the same time last year with over 20 of those metro areas showing double-digit percentage increases.”
New Home Sales Alert: March Down 11%, Back To…..1991 Level!
The numbers today on new home sales were pretty grim. In fact, new home sales fell in March by 11.4 percent.
In fact, new home sales fell back to 1991 levels.
Given the relatively poor recovery of wage growth and real median household income, it is not that surprising.
Now, it is true that new home sales in the frozen Northeast fell by one third. But to put that number into context, new home sales since early 2008 have been poor. So the 33.33 percent decline is not demonstrably different than other monthly new home sales since early 2008. But it is always fun to blame global warming. cooling.
Over the last few yrs, institutional/PE guys have been focused/predominant in the ‘existing’ space, so using existing sales to analyze/gauge overall housing marketplace health or economic conditions is nothing more than an exercise in futility.
On the other hand, the general public is predominant in the new home space, so for those who want a much more accurate view/perspective on what’s really going on, new homes activity is where to look.
Seasonality is a bitch, especially when you have record Winter storms after a mild February. Looking at YoY numbers removes seasonality from the equation and provides an unbiased look.
However, the March tally represents a 19.4% increase from the sales pace of March 2014. Even more broadly, the 129,000 newly built homes sold in this year’s first quarter represent a 21.7% gain from the same period of 2014.
http://www.wsj.com/articles/new-home-sales-tumble-11-4-in-march-1429798841
And according to el O:
“so for those who want a much more accurate view/perspective on what’s really going on, new homes activity is where to look”
Link provided: http://ochousingnews.g.corvida.com/how-to-analyze-rental-properties-with-hedge-fund-algorithms/
So what does a 21.7% increase say about what’s really going on?
The magnitute of that increase is indicative of
1)beating easy comps from this time last yr
2)borrowers who were denied a mort back then, are wonderously good enough this yr, now that capacity buckets need to be filled.
3)an increase in the pool of buyers who clearly do NOT understand the consequences of price.
That’s the reality of what’s going on.
1) Comps are used to measure price, not sales volume. Go back to school.
2) Evidence? Thx in advance.
3) Probably true.
I think he meant to say that beating the sales figures from last year shouldn’t be too hard, and that’s probably accurate. However, it is a good sign for the overall market that last year didn’t repeat itself, particularly with mortgage rates back down near record lows.
Gold Monkey-Hammered
Gold will not bottom until gold bugs capitulate
Amid the ‘glorious’ earnings last night, Nasdaq is on its own today, surging to higher highs as The Dow and S&P are unch to down. As this exuberance exudes, gold and silver are being smashed lower… which is odd given The ECB’s threat to pull Greek financing. Crude prices are also tumbling post-Durable Goods.
Gold is getting clubbed… on major volume…
Gold Bugs index is about to break from this pattern
http://kimblecharting.tumblr.com/image/97730272696
The Gold Bugs index remains above support that dates back 10-years.
Over the past year and a half, the index has created a pennant pattern, a series of lower highs and high lows, teasing both the bulls and bears. As you can see, this pattern will be coming to an end soon.
Pennant patterns are popular for suggesting that a large move is ahead, yet which direction is a different story. This pattern does fall under the continuation of trend category, anything is possible though!
After years of disappointment, bullish miner investors should be treated to some fun upside-action if the pattern breaks out to the upside. The best plan for a pennant most often is to set back and watch for the breakout and then follow it.
This pattern would appear investors won’t have to wait long for the outcome.
It’s hard to be more wrong
Your Hindsight is no longer 20/20 (cartoon)
cha-ching…
http://stockcharts.com/h-sc/ui?s=GLL&p=D&yr=3&mn=0&dy=0&id=p52092938604
Is it just me or does it seem like those “invest in gold” commercials are airing a lot less frequently these days? Are they disappearing like the “we buy gold” storefronts from a few years ago? As retail investors pile into stocks and real estate, maybe the interest in gold has started to wane with the dumb money crowd.
Perhaps it will be a better indicator of the bottom when all the “we buy gold” storefronts disappear. If there is no demand to buy, the bottom is near.
Is China going from property bubble to equity bubble?
In 1987, a young man quit his job at the Hebei Oil Pipeline Bureau and went to seek his fortune in the nascent private property market of Hainan province’s Special Economic Zone. He was Pan Shiyi, now chairman of SOHO China, and one of China’s first private property developers. But he also experienced modern China’s first big real estate bust, when Hainan property prices crashed back to reality following a 1992 bull market inspired by Deng Xiaoping’s Southern Tour promoting his ‘reform and opening up’ policy platform.
Hainan is again at the forefront of a Chinese property slowdown. The government of provincial capital Haikou says it cannot cover its debts and is requesting a third of Hainan’s bond issuance quota as relief. Pan Shiyi, having seen all this before, is aggressively diversifying SOHO’s assets into overseas property markets.
Hainan may be an extreme case, but China’s property market will not return to its glory days of unrestrained growth. Changes to the required down payment for second home buyers and the announcement that the National Housing Provident Fund could be transformed into a Fannie Mae/Freddie Mac-style national housing fund are good policies. They may help ease the pain of the slowdown whilst preventing a devastating crash, but they will not be launching a new property market boom. And nor does the government want that.
As if in unison, as the property market began its outright decline in the second half of 2014, China’s equity market sparked into life. The Shanghai Composite Index has increased roughly 85 per cent over the past six months.
While the Chinese government does not control China’s stock markets, they are highly driven by policy changes. The share of bank financing in China’s financial sector and the associated concentration of risk has been a major concern for Chinese policymakers. The need to diversify risk across the financial system has driven the Chinese government’s support of corporations pursuing direct financing through China’s financial markets.
What the Chinese government really has little influence over is Chinese investors’ hunger for capital growth. With limited avenues for investment, Chinese investors often pile into asset classes all at once. Now that wealth management product (WMP) issuance has been curbed and the property market is declining, equities have become the main game in town for domestic investors.
New brokerage account registrations and margin financing have exploded. Macquarie’s Matthew Smith notes that margin finance positions have increased 175 per cent since September 2014. He further emphasises that, given a large portion of Chinese markets are equity stakes held by state-owned enterprises that don’t trade, margin finance as a percentage of the genuinely tradable part of the market has reached 8.2 per cent. That sets an historical precedent of margin leverage not even seen in the Taiwanese or Japanese stock bubbles.
These are figures that would strike fear into the hearts of most central banks. How the government manages the equity market boom without precipitating a dramatic crash will be one of the most important stories for China in 2015. In the current environment one can sympathise with investors like Pan Shiyi who are diversifying into overseas assets.
Cool post, thanks, you should write more about this
The Economist on housing:
http://www.economist.com/node/21648624/print