REO-to-rental hedge funds cashing out
A wave of consolidation in the REO-to-rental business has hedge funds selling bulk portfolios. Will this impact the housing market?
In early 2012, the REO-to-rental business model was projected to be a $100 billion industry. These investors provided a significant boost to housing demand in 2012 and 2013, but the activity of these funds abruptly stopped in 2014 because prices became too high to meet their return thresholds. 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.
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. 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.
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.
Many housing bears also sounded the alarm about these investors dumping these properties on the MLS in large numbers leading to another big drop in home prices, but that won’t happen. 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. In fact, these investors are selling to each other and keeping this supply off the MLS.
By MATTHEW GOLDSTEIN, June 27, 2014 3:58 pm
A year ago, buying foreclosed homes to rent out was the sure-thing trade for investment firms backed by money from private equity companies, hedge funds and pension systems. But with the supply of cheap foreclosed homes dwindling, some early investors are looking to cash out a bit by flipping homes to competitors.
The Waypoint Real Estate Group, one of the first companies to raise money from private investors to buy foreclosed homes, is quietly shopping as many as 2,000 houses in California that it acquired in the last few years in several private investment funds …. The homes, which are largely rented, are being shown to other companies backed by investor money that have also scooped up distressed houses in states including Arizona, California, Florida, Georgia, Illinois and Nevada.
This kind of industry consolidation is expected. It takes a large number of homes to justify the administrative overhead, and the investor groups with the most efficient systems and lowest cost of capital will end up owning and operating these rentals.
Waypoint is considering selling about half of its 4,000 homes. Some of the biggest institutional investors in the market for foreclosed homes — companies like the Blackstone Group, American Homes 4 Rent and American Residential Properties — have slowed their pace of acquisitions in response to an increase in home prices and a dearth of foreclosed homes that do not require significant renovation. …
“Consolidation is a natural thing as inventory goes down,” said Aaron Edelheit, a former hedge fund manager and chief executive of a smaller company in Atlanta, the American Home, which manages more than 2,500 rental homes in several Southeastern cities.
Over all, institutional buyers have bought over 386,000 single-family homes across the country since 2011, according to RealtyTrac, a property research company.
Those numbers sound large, and it is a significant percentage in certain sub-markets, but overall these numbers don’t represent a large portion of the housing market that sees over 5 million sales a year.
That institutional buying has had a significant effect, especially in cities like Phoenix, Las Vegas, Atlanta and parts of Southern California, where housing prices plunged the most during the financial crisis. The institutional investment in those places helped fuel double-digit recoveries in home prices in the last year and brought some stability to local housing markets, though critics contend that institutional buyers have crowded out first-time buyers.
Investor activity, including these large hedge funds, certainly impacted the housing market, as evidenced by the big decline in demand in 2014.
Waypoint appeared to be in no rush to sell the homes and might opt to sell them piecemeal.
No dumping. If they need to sell them on the MLS, they will, but it’s much quicker and easier to sell them in bulk to another investor, so that’s what will likely happen.
For housing bears looking for an upcoming apocalypse, The deflating Chinese real estate bubble is far more concerning.