Is Wall Street Creating Another U.S. Housing Market Bubble?Housing-Market / US Housing Apr 04, 2013 - 01:02 PM GMT
Shah Gilani writes: Where there's smoke there's fire.
When it comes to rising home prices, the question is whether the on-fire price increases are a healthy sign of a housing recovery or a smoke screen masking another investor-led real estate bubble.
The answer is it's both.
So, the real question is: are the two compatible and is the trend sustainable.
The answer to that compound question is "yes" and "no," in that order.
On the surface, everything is coming up roses.
According to closely followed real estate data provider CoreLogic, U.S. home prices jumped in February by the largest amount in seven years. They rose 10.2% compared to a year ago, and were up 0.5% from January to February.
The S&P Case Shiller index of prices in the nation's 20 largest housing markets notched an 8.1% rise in January. That's the biggest year over year gain since the peak of the market in June 2006.
Home prices have now increased for 12 straight months and in 47 out of 50 states.
The biggest gains have been in some of the previously hardest hit markets. Nevada had a 19.3% gain, Arizona an 18.6% gain, and California a 15.3% gain, in just the last year.
Not Your Average Investors
But, a look under the surface reveals there's more than one way to gauge these growth roots.
Price increases have been across the huge inventory of existing homes, mostly those in foreclosure and in other "distressed" circumstances, not new homes.
Conversely, new home prices averaged $246,800 in January. That's up only 3% from a year ago. And sales of new homes in February were down 5% from January, though they are up 12% from a year ago.
That means investors are behind the rapidly rising prices for pre-owned homes, not traditional "owner-occupied" buyers.
But they're not your average investors. They are big institutional buyers.
In fact, private equity alternative investment firm Blackstone Group LP (NYSE: BX) is now the nation's largest owner of single-family homes. Founding partner Stephen Schwarzman recently said the firm is spending $100 million a week buying homes.
Last year Blackstone raised $13.3 billion in a new fund, with much of that money targeting home purchases. To date, Blackstone has already spent over $3.5 billion and owns more than 16,000 single-family homes.
But Blackstone certainly isn't the only publicly traded or private capital firm deeply invested in housing.
Silver Bay Realty Trust (NYSE: SBY) is the first publically traded real estate investment trust, spun out of publically traded Two Harbors Investment Corporation (NYSE: TWO), another REIT, that buys and manages single family homes for the rental market.
Silver Bay owns more than 3,400 homes in 10 different markets and is run by former Treasury official and Goldman Sachs executive David Miller. (In the interest of full disclosure, both TWO and SBY are positions held by subscribers to my investment newsletters, for both their business models and their huge dividend yields.)
There also are many private capital outfits investing billions of dollars that own tens of thousands of single family homes, including Colony Capital, Oaktree Capital Management, Carrington Holding Company, American Residential Properties and Waypoint Real Estate Group, to name just a few that hit anyone's radar.
A 2013 white paper by the Metropolitan Planning Council on the subject of managing rental properties includes a "case study" of Waypoint Homes, which I've included here in the sidebar below. It succinctly explains the business model pursued by the likes of Blackstone, Silver Bay and investors buying up single-family homes to put onto the rental market.
Are Big Institutions Good For the Market?
The purchase of foreclosed homes, buying them one at a time on the footsteps of courthouses around the country or from banks and lenders who facilitate distressed homeowners short-selling their underwater properties, by institutional buyers, is compatible with everyone's interest in supporting housing in our economy.
Already, and in dramatic fashion, these professional buyers have put a floor under prices and are causing price appreciation to engender homebuyer confidence and hopes that an economic recovery in housing will lead to more robust GDP growth in coming quarters.
But, while the institutional purchasing-to-rent model is seemingly compatible with across the board economic interests, serious questions arise as to whether such "Wall Street" interest will create a sustainable recovery in housing or whether it is seeding the fields of another boom-to-bust cycle.
Institutional purchasers, with cash, are already crowding out would-be owner-occupied buyers in terms of outbidding them. Additionally, tighter lending standards that now mostly require a 20% down payment have put traditional homebuyers at a disadvantage.
Meanwhile, the rental market has exploded because foreclosed property owners are being evicted, distressed and underwater owners are walking away from homes, and the creditworthiness of hard-hit previous homeowners and the general population affords them no other choice but to rent.
The question is: How will banks view potential new mortgage purchasers buying homes in markets that have been rapidly bid-up? Will they view the appreciation that's already taking place and continuing to be driven by institutional cash buyers as a loss of the hoped-for appreciation homebuyers need to keep ahead of the cost of owning a home and the loss of purchasing power in fundamentally deflationary environment for hard assets?
What will happen when the billions of dollars in cash that's being laid out is recouped by institutional investors when they securitize the cash flow of their rental properties with backing collateral being the rented homes themselves?
We've been down this road before. Only last time the cash flows originated from homeowners with supposedly "skin in the game." What skin in the game do renters have?
What will institutional investors do with their illiquid assets, sit on them like banks did in the old days? Or will they figure out a way to "liquify" them if the hoped for yield they calculate on their rental income falls or home prices start to slip again?
Just because institutional investors are thought to be long-term investors and can theoretically wait out any further bumps in the housing market, it doesn't mean they won't head for the exit doors all at the same time like they did with the mortgage-backed-securities they all speculated in.
The questions are out there, and so is the future as far as housing prices.
For my money, riding this wave is reminiscent of riding the appreciating housing train in the early 2000s. I'm going to follow the tracks of the institutional buyers until they reach their ineluctable end, at which time, I'm going to sell all my long positions and short everything once again.
Think about it, folks. Real things and paper things are created for the sole purpose of trading them by Wall Street alchemists who too often get their lab coats splattered with the blood of middle class Americans.
Everything is "tradable" now-even the houses in your neighborhood.
The founders of Waypoint Homes, Colin Wiel and Doug Brien, initially focused REO-to-Rental efforts in the San Francisco Bay area beginning in 2008, building its portfolio of nearly 2,000 homes one transaction at a time and avoiding bulk disposition deals. Currently, Waypoint Homes is expanding; the company is buying and renting in southern California and Arizona, and as part of a national expansion campaign, recently purchased its first homes in the Chicago metro area, specifically in Aurora and Elgin. Waypoint acts as a medium to long-term investor.
- Use technology and on-site exterior inspection to assess a home's value.
- Staff input a "livability score" from the property to evaluate its marketability. Waypoint also relies on a "geographic scoring system" with metrics such as ease of transportation (freeways and public transit) as well as "historical property value performance."
- Buys REOs primarily through auction. Acquired homes are usually $10,000 to $50,000 less than the median home prices in their selected cities.
- Doubled rental portfolio from October 2011 to June 2012. Waypoint Homes' goal is to reach capacity at 10,000 to 15,000 single-family rental homes.
- Expected returns on its current portfolio are usually at 8% to 9% for its multiple limited partnerships with investors.
Renovation and property management
- Acquires two to five homes per day and immediately begins rehab: Title agents look for second mortgages or liens, while specialized staff goes door-to-door to assess the homes.
- Contractors renovate in 25 days or less. With a rehab cost of no more than 35% of the purchase price, contracted work typically includes standard paint, fireplace whitewashing, and installing wood laminate as well as kitchen countertop granite.
- Tenants must have 37% debt-to-income ratio.
- One-third of foreclosed homes are occupied by former homeowners or tenants at time of purchase, but three out of four occupants are voluntarily moved - $1,000 cash-for-keys - or evicted.
- Waypoint offers a rent-to-buy option. Under a 24-month lease, tenants can accumulate "reward credits" each month. The tenants can qualify for 5% toward "cash-back" at the lease's end (which can be extended) or a 10% rebate on a down payment to own a home.
Mid-range investors: For-profit
Who they are: In the Chicago metropolitan communities surveyed, typically these investors have a portfolio of 15 to 25 homes, but they may be working at a much larger scale, for instance up to 200 homes.
How they buy: Purchase REOs at auction at deep discounts, typically with cash. They also may purchase valueless properties from outsized investors repackaging bulk portfolios. Typically, this property owner does not invest in the property as an asset manager but treats it as a source of cash flow.
What they buy: Distressed, low-value properties that most developers - with the exception of mission-driven developers and land banks - will avoid because the cost of rehabilitation typically exceeds potential market sales or rental revenue.
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