Just because the banks are on one side of an issue does not always mean they are wrong, just that they might be right for the wrong reason.
The Wall Street Journal reports today that a Fannie plan to subsidize substantial investors in rental properties is stymied thanks to bank lobbying. The housing giant had planned to launch a program to lend to institutional investors in single family rental properties (note that small investors would not have access). The rationale was to “jump start” a housing recovery and boost short term demand. Banks argue they are willing to lend and hence there is no need.
The truth is that professional investors are already pursuing the single family home market aggressively, which means the case for goosing their returns with cheap government funding is weak. Spreads between returns on single family rentals and multifamily rentals are the highest they have ever been. Professional investors also believe they have solutions to managing dispersed homes: concentrations within suburban areas (as in you buy a lot in say Atlanta, not in 10 cities across the South), renovating properties using standard installations (for those that do rehabs) so that you can inventory only one type of bathroom faucet). Investors also see certain plusses in single family homes relative to apartments: less frequent turnover. Multifamily buildings typically experience 50% turnover in a year, while renters of single family homes stay in place longer (and rental income loss due to turnover is a big cost).
Mind you, I’m not completely sold on the bull case (which sees all the risks to the upside). But there are investors now who are assembling portfolios and earning attractive current yields who aren’t assuming home price appreciation as part of their total returns. And even the enthusiasts have reservations about certain markets as far as the jobs outlook in concerned (Las Vegas, for instance). Similarly, cities where they can’t get enough concentration are off the list (for instance, I’d imagine Birmingham, AL would be off the radar for most, due to the the size of city, the dispersion of homes: too many in the price range they regard as too risky from a quality of tenant perspective, and the lack of a driver of jobs growth).
The reason for investor optimism? They are renting properties for more than a mortgage payment would be….if the borrower could get a mortgage. So it’s the mortgage availability that is driving the rental opportunity. If you are self-employed, you simply cannot get a mortgage; I know of people who were willing to put 50% down who were rejected. And W-2 borrowers need 20% down.
Investors regard single family rental conversions the most attractive opportunity in the housing/mortgage space, and remember, this is now perceived to be the bright spot in this technical economic recovery. Another indicator is that Fannie and Freddie have been piloting bulk sales programs. Investors are already beyond that (largely due to the fact that the programs were taking too long to get launched and also were more cumbersome than they had anticipated). They are pursuing multi-channel sourcing strategies, and banks are finding buyers for the sort of properties investors would want (modern construction, roughly $50,000 to $200,000). Institutional investors are buying them individually (some are even conducting door-knocking campaigns of homeowners whose houses are not on the market but look like short sale candidates and report good success), or even from local aggregators who will buy a small number of properties of the type that would appeal to professionals investors.
Banks are admittedly charging juicy interest rates for investors in portfolios of single family homes; I’ve heard 13% for loans of only 3 years. But the caution isn’t unwarranted. This is a new model and the operators can’t point to a track record as far as stability of income stream, costs, tenant turnover, wear and tear on the home. In a year or two, institutional investors will have more data about how this market has performed and will have a much better sense of the risk level and hence what would be an appropriate level of return to require.
The public policy goal of Fannie and Freddie was to increase homeownership. The only reason for supplying funds to large, absentee landlord would be to reduce losses on liquidating foreclosed homes that they’ve guarantee. The newfound investor enthusiasm for this type of investment says government support is not justified. Indeed, the investors unwittingly undermine their own case. From the Journal article:
“Financing from Freddie would be the greatest economic stimulus,” says Aaron Edelheit, chief executive of American Home Real Estate Co., which owns more than 1,500 houses and is actively buying more. “You’d have the greatest land grab you’ve ever seen.”
The media is already awash with talk of the housing recovery; if there’s a barrier to buying based on this newfound enthusiasm, it is far more on the homeowner side than on the investor side. The last thing most current homeowners would want to see is government intervention to skew the playing board in favor of renters rather than fellow homeowners as neighbors. There is already tons of capital being deployed in to rental properties even in the absence of institutional funding. There is no policy justification for subsidizing investors, particularly given that the GSEs could win up owning this market, raising questions of how they exit without disrupting it (once investors get access to subsidized funding, they bid up asset prices accordingly. While fixed income investors would no doubt fill the gap upon a Freddie withdrawal, it would not be on such advantaged terms. The market would face at best a repricing, at worst some investors dumping portfolios of homes as they face higher funding costs when their debt matures, exposing the tenants to the likelihood of lower quality property management.
So in a fight between the mercenary interests of two groups, spread hungry-banks and self-confessed potential land-grabbers, ordinary citizens look to be winding up with the least bad remedy. Too bad we aren’t always so lucky.