Wall Street Buying Adds To Housing Boom. Is A New Bubble On The Way?
Article by, Morgan Brennan, Forbes Staff
This story appears in the June 24, 2013 issue of Forbes.
A truck backs up the driveway of a small, single-family house landlordsin Glendale Heights, Ill. and with a bang deposits an empty, dark blue dumpster behind an identical one already filled to the brim with tattered carpeting, shredded sheetrock and a worn-out workout bench. As the semi’s beeping echoes around this suburb on the west side of Chicago,
Rob Bloemker paces the home’s patchy green-brown front lawn, swiping at a map he has pulled up on his iPad.
“This home is a raised ranch, late 60s/early 70s construction, in the early stages of rehab,” explains the tall, lean bespectacled 47-year-old Californian. Bloemker taps his iPad to display all of his local assets and zero in on this address. The property is a three-bedroom, two-bath single-family home recently acquired for $110,000 in a foreclosure auction. The carpenters sawing and hammering inside will complete $28,500 worth of renovations over the next two weeks; once cleaned up it appraises at $168,000, an immediate gain of more than 20%. But Bloemker isn’t planning to sell. He plans to rent the home out for $1,575 per month and figures, after maintenance, management and other expenses, he’ll net a 7.1% annual return on his investment of $138,500.
Traditionally, buying, fixing and renting out single-family homes has been a mom ‘n’ pop affair. No longer. Bloemker is a Wall Street veteran who, until 2011, managed a $60 billion fixed-income portfolio at Boston-based Putnam Investments. He left to start his own firm, Five Ten Capital, with the aim of becoming a landlord on an industrial scale and used his Rolodex to secure $100 million in financing from Deutsche Bank .
He’s got lots of company. Billionaires, private equity firms and hedge funds have been swooping into the hardest-hit markets across the country and snapping up single-family homes by the tens of thousands. They’re plucking distressed properties out of the foreclosure pipeline with the aim of playing the housing recovery in the most direct means possible–as landlords.
Now Wall Street’s invasion of the cul-de-sac is about to enter a second phase as the money men offer income-starved retail investors new securities–REITs and bonds–backed by single-family rental homes. It’s too soon to say whether all this activity will produce a permanent and attractive new asset class or another bubble and bust, but billionaire real estate investor Sam Zell, for one, is skeptical. “An individual investor can buy 25 houses and monitor them,” hesaid recently. “I don’t know how anybody can monitor thousands of houses. I just don’t think that the logistics of that produce real positives.” Similarly,Berkshire Hathaway Chairman Warren Buffett, while bullish on housing as an investment, has described the challenge of managing huge portfolios of individual homes as “enormous.” His company has been snapping up real estate brokerage offices nationwide through its newly named Berkshire Hathaway HomeServices, but not homes themselves.
Despite the challenges, it’s easy to see the appeal of this business to the big players: Properties can be bought with cheap borrowed money and, if past cycles are any indication, should appreciate significantly from their housing-bust lows. In the meantime rents should produce a nice yield.
Ken Rosen, a real estate expert at UC, Berkeley’s Haas School of Business who has been providing Wall Street firms with market analysis, raises another long-term worry. “Interest rates are extraordinarily low, and this is causing people to bid up prices,” he says. “If they keep them low for the next few years, prices will be much higher than they are today, and I think it does run a serious risk of creating financial bubbles that are not helping the real economy.”
So far, at least, the big money has done wonders for America’s beleaguered housing market, establishing a floor on prices, revitalizing neighborhoods and sparking housing markets nationwide. No one knows exactly how many of the nation’s 12-million-plus single-family rentals the big players now own, but just since 2011 at least $10 billion in institutional funding has flowed into single-family housing–enough to buy 100,000 homes at $100,000 a pop. Thanks in part to these investments, median home prices in some hard-hit markets from Las Vegas to Atlanta have jumped 20% in the past year, inspiring declarations of “recovery.”
“We’re providing capital when people need it, and eventually we will provide inventory when they need it,” says Bloemker. Good for the renter, the neighborhood and America, he adds.
The Glendale Heights house Bloemker’s team is rehabbing sat vacant and deteriorating for the better part of two years, dragging down the value of neighboring homes. No one stepped forward to claim it in a short sale, and when you stare at the sagging pink-and-mint-colored portico, it’s not hard to understand why: A traditional home buyer would have a hard time securing both a mortgage and the funds that the extensive renovations would require. A few operators around the country have been fixing up homes for sale to individual investors or arranging financing for individual investors to do it themselves. But that’s small stuff compared with the institutional buying.
Wall Street’s landlord craze started in Phoenix, one of the markets hardest hit by the bust, with prices off as much as 55% by 2011 from their 2006 peak. Locally based American Residential Properties started off the buying in 2008, bringing in outside institutional money in 2010. (American Residential and Oakland, Calif.-based Waypoint Homes, which started buying in its own home turf in 2008, are considered the pioneers of what is now referred to as the “REO [real estate owned] to rental” industry.) By mid-2012 the largest private equity players, including the Blackstone Group and real estate specialist Colony Capital, had rolled out home-buying operations in metropolitan Phoenix.
From 2010 through mid-2012 institutional investors’ share of home purchases there grew from an estimated 15% to 26%, according to CoreLogic. Today 22% of the Phoenix area’s single-family homes are rentals, up from 8% a decade ago, reports Michael Orr, director of the Real Estate Center at Arizona State University‘s W.P. Carey School of Business. “The people who got in early made the most money,” he says. “Those who arrived last year have done [only] okay because prices have gone up.” He figures at today’s prices the rental cap rate–the net rental income to cost–is just 5% to 6%.
As distressed inventory dwindled and prices shot up in Phoenix, institutional buyers moved on to Las Vegas and southern California, then Atlanta, northern California, the Carolinas and Florida. Now the Midwest is hot–Chicago, Ohio’s metro areas, Minneapolis, Denver–even Detroit, for some high-return-seeking companies willing to take the risk.
No one has taken a bigger bite nationwide than Blackstone, the publicly traded investment firm headed by billionaire Stephen Schwarzman. Little more than a year after forming Blackstone’sInvitation Homes, backed by $4.5 billion in capital, it already owns 26,000 homes in nine major regional markets. Its holdings already trump the 10,000 homes owned by Malibu-based American Homes 4 Rent or the 9,900 owned by Santa Monica-based Colony Capital.
“We envision this to be a long-term institutional space,” says Marcus Ridgway, chief operating officer of Invitation Homes. “So our primary focus from the beginning was to do everything in-house.” Invitation Homes employs 1,000 full-time workers, plus 5,000 contractors and subcontractors. In every area it enters it hires market analysts, an acquisitions team, a remodeling team (who oversee the local contractors), a property management team and a leasing team that collaborates with local brokers.
Nationally, it continues to gobble up hundreds and sometimes thousands of homes a week, the majority purchased as one-off sales (the industry norm), during foreclosure auctions, in short sales from banks and, increasingly, from small investors. (One exception: Blackstone recently bought 1,400 Atlanta homes in a bulk sale from the family-owned Building & Land Technology Corp.)
Renovations take two to three weeks and cost about 10% of the purchase price. Most desirable are three-bedroom, two-bathroom homes with two-car garages and a lawn for the kids. This property type attracts families–the best and “stickiest” kind of tenant. While apartment dwellers stay an average of only 1.5 years, single-family home renters stay 4.5 years and typically take good care of the property, since they care about what the neighbors think.
The Blackstone machine is in full throttle in Forsyth County, a northern Atlanta suburb marked by big-box sprawl, office parks and new planned communities crushed in the downturn. Drive into one of these communities, where a clubhouse with pool and tennis courts commonly greets guests, and try to spot the rental home–it’s usually the one with the freshest paint and the greenest grass on the block. Inside these newly rehabbed homes you’ll find a master suite with an oversized tub, kitchens with granite countertops, new carpeting and walls painted a color of taupe manufactured specifically for Blackstone. Rent: $1,750 a month. More than 80% of Invitation Homes’ market-ready inventory across the U.S is already occupied. Global head of real estate Jonathan Gray has said net yield averages 6% for the entire single-family portfolio.
There’s one big problem with this pretty picture. As available inventory dwindles, prices are climbing. To stay in the game, firms have been tapping deeper and deeper pockets. For example, American Homes 4 Rent was started in 2012 by billionaire B. Wayne Hughes, the founder of the Public Storage PSA -0.69% chain, and has already acquired 10,000 homes, in part with $600 million from the Alaska Permanent Fund, which manages the state’s vast oil wealth. Ex-Goldman Sachs mortgage head Donald Mullen has raised nearly $1 billion from, in part, clients of his former firm. He plans to ultimately purchase 10,000 homes through his new venture, Fundamental REO. Not to be topped, Deutsche Bank recently raised its line of credit to Blackstone’s home-buying operation to $2.1 billion, from $600 million last year.
Some folks think it’s all getting a bit frothy. “We believe some institutional investors are overpaying for assets,” says Rick Sharga, executive vice president of the mortgage arm of Carrington Holding Co., a real estate servicing company that manages inventory for Fannie Mae and other institutions. Carrington, which jumped into purchasing single-family rentals last year with $450 million from billionaire Howard Marks‘ Oaktree Capital Management, knows firsthand about the dangers of rising prices. Initially it projected mid-single-digit returns on rent, but as prices shot up in markets like Las Vegas, returns reportedly shrunk, causing Carrington to shy away from further investment. In October news broke that Och-Ziff Capital Management Group, the big hedge fund, was getting out of the residential-landlord business completely, selling off its portfolio of 300 northern California homes because of declining rents.
As prices and risks grow, firms have been looking to the public markets for more capital–or, in some cases, an exit. In December the first REO-to-rental REIT, Silver Bay Realty Trust SBY -0.8%, debuted on the New York Stock Exchange. It has lost 0.3% since, even as the S&P 500 has gained more than 15%. In May American Residential Properties took a similar REIT public–with similar results. Other IPOs are in the pipeline, including American Homes 4 Rent and Waypoint Homes. Privately held Colony Capital recently announced plans to spin off its Colony American Homes trust in a public offering, and publicly traded home builder Beazer Homes, USA, with partner KKR , plans to spin off a trust as well.
“I think this is sustainable for probably a decade,” says Stan Ross, chairman of the University of Southern California‘s Lusk Center for Real Estate and a consultant to multiple firms plotting public offerings. “But when I look past that, I am not sure how it plays out.”
Bloemker plans to go another route. He’s hoping to bundle homes into bonds tied to rental income and projects a 3% to 4% spread over ten-year Treasurys when they start trading later this year. Ratings agencies, burned by the housing crash, are noncommittal. “One of the key issues that needs to be overcome is the limited performance data for this specific asset class,” says Suzanne Mistretta, a senior director in Fitch’s U.S. Residential mortgage-backed securities group, adding that no plan has yet to be presented to the ratings agency.
Driving around the suburbs of Chicago, through neighborhoods studded with white foreclosure notices and blue dumpsters, Bloemker is undeterred. He compares his growing stable of rentals to the $60 billion book he once managed at Putnam. “It’s no coincidence securitization is starting with me,” he wryly remarks. “The big institutional money hasn’t even come to this space yet.”
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