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Do We Really Need Freddie to Subsidize Rental Investors?

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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.

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19 comments

  1. Jim A.

    I’ve been saying for years that the bottom, when it comes would be set by intentional landlords and not owner occupiers. Of course that vision of a land full of tenants rather than owners because of a lack of mortgage availability is a big part of the reason that Fannie was created in the first place.

  2. Small.Business.Guy.1

    “…, renovating properties using standard installations (for those that do rehabs) so that you can inventory only one type of bathroom faucet).”

    Been tried. Sometimes it actually works. Occasionally.

    It sounds like a great concept, but for every 1 that works, there are multiple others that don’t work so well. And in older neighborhoods, it really doesn’t work well. People have a tendency to change their ‘cookie cutter’ homes to fit their own lifestyles – it’s the ‘American Way’. Bye bye, standardization.

    By the time you got done with the program, it’s either going to be another giant failed government bailout or it’s going to be such a ‘niche’ program which will only have minimal effect, at an extreme cost.

    I give them credit for thinking, but that doesn’t mean they got it right.

    1. Yves Smith Post author

      1. The rehabbers are a decided minority of the investors

      2. The rehabbers are doing it now. One guy talked about having 100 of the same toilet in inventory for repairs. And they choose the houses based on the ability to rehab affordably.

      3. No one of the big money investors is buying older houses. The oldest I’ve heard anyone going is early 1970s. The overwhelming majority want post 2000 houses.

  3. Tom

    Seems to me that it can be easily scammed.
    I will lend you money at 13% to buy the property and you make 10% profit from renter who now is paying a higher cost – 13% + 10% . Now mister “big investor” I am also going to retain 50% of properties on my books that you can’t have. When you “big investor” are ready to be plucked – I will sell my inventory and squeeze your money from you – cheaper to buy in your neighborhood now so give me your property that I can earn my 13% and then I will artificially make properties scarce so the price goes up – all with the help of the government. Thanks tax payers and “big investors” that are now out of business – I am even much too bigger to ever ever fail now.

  4. George Rogue

    Great post. I agree, with the great interest (and multiple players), what legitimate purpose is served by subsidizing the financing, and hence the large investors?

    This kinds or reminds me of Fannie Mae’s and Freddie Mac multifamily business. I can see the public purpose behind a decently high home ownership rate, but what’s the reasoning behind their multifamily programs? These little known programs benefit very large investors. Only a handful of lenders in the US are authorized under these programs, and the average loan amounts are in the millions. These lenders earn millions in fees every year, and large investors get below market rates on their loans. This is the reason why prices on multifamily properties are being inflated well beyond other commercial property types, perhaps to the point of a “bubble”.

    Except for a brief period after the financial meltdown, there has been many sources of financing for multifamily properties, they just cost more. So why are they subsidizing large investors?

    The argument that this creates more rental housing seems bogus. Industrial, retail and office space are not subsidized, and there is no shortgage of those kinds of properties. Actually, some of these other sectors are overbuilt.

    Perhaps it’s just another loan product for FNMA to make money on, by taking advantage of its low cost of funds and Federal backing. Also, both FNMA and Freddie have powerful friends (and I dont mean Congress) that lobby on behalf of their multifamily programs. There is just too much money being made with these “low cost” government subsidies (well, low cost until the had to be bailed out that is)

    Anyone care to comment?

  5. bulfinch

    Are we really seeing a nascent recovery in housing? I don’t believe it. It seems to me more like a gargantuan wool rug has been rolled out over a gaping hole in the floor; as one stands in the middle of said hole, the rate of descent is reduced to a degree where it seems imperceptible, but it still doesn’t make for a very solid fix.

    1. Yves Smith Post author

      The data people (including mortgage analyst Laurie Goodman) all believe it. The servicers don’t. You tell me.

      Having said that, I think they have not allowed for the possibility of weakening of employment, due to blowback from Europe, fiscal cliff/Grand Bargain spending cuts. And I think the odds favor that.

      1. Capo Regime

        Bet ya the Servicers are correct……

        The data people have been saying all manner of foolish things for some time now no?

    2. abelenkpe

      Homes in my neighborhood are being bought and flipped as if the crash never happened. These are older homes built in the 1930s-40s in west hollywood/beverly adjacent area. Back in 1999 these homes went for around 300,000. Today they go for around 1.3 million pricing out most if one believes the stats for median income in the area. We’re talking about two or three bedroom one bath older homes not something one would normally think of when discussing a million dollar home. Who is buying? And why buy here when one can rent a comparable rent controlled duplex for far less?

  6. Capo Regime

    The other thing is that say compared to apartments (garden or high rise) single family homes are tough to manage in any scale. They are simply not built for frequent turnover–lot of wear and tear on move ins and outs.

    Also, its really tough to manage portfolios of single family homes–its a detail business and distances and so forth add to costs.

    People love the idea of buying us swaths of homes and renting them out to some magic time when prices will rise. The devil is in the details-nobody has yet managed single family homes in any appreciable scale….

    1. Yves Smith Post author

      These guys are doing it now. This is not theory I saw talking.

      1. They are buying in scale in specific cities. so a lot, say on one side of Atlanta.

      2. They believe that the dead zone is between 4 and 400 homes.

      3. As I said above, much less turnover in single family homes. This is a different universe of renters. Ones with kids could be pretty long term. And some investors give good incentives for tenants to take decent care of the house.

      I agree you’ll see plenty of screw ups but these guys do seem to have approaches for the obvious problems. How well they work over time remains to be seen.

      1. Capo Regime

        It will be interesting to see what premium emerges say vis a vis the multifamily rental model in the Atlanta model. Solid asset managers in multifamily can get you 10% to 12% in some markets in a well trod cost effective fashion. I saw that a fund picked up 5,000 REOS in Tampa (single family) and am keen to see how the execute the management. Been in the multifamily biz for a long time (30 years) in several states so trust me am watching this with baited breath…..Thus far am struck at how many people putting these structures together are deal guys and not real estate guys. There will be some gains but a lot of pain as well……

      2. PeonInChief

        One model, that of Waypoint, seeks to reduce turnover by taking people who once owned homes, but have suffered foreclosure. The tenants don’t have many other options, so they pay higher rent and are likely to stay for a fairly long time. They’re also willing to pay higher prices. I don’t have any idea how this would work long-term.

        As for rehab, just look at the pictures of rentals on their web sites. They must buy everything–carpet, stoves, countertops–with a volume discount.

  7. steve from virginia

    All these second-tier speculators who believe they have found the ‘bottom’ are going to get crushed.

    The problem with most distressed housing is poor location and dependence upon private auto transit which in turn is dependent upon low real fuel prices.

    When fuel prices are high relative to other costs, funds are diverted to fuel use (waste) which does not pay for itself. (Car is not paid for by driving the car.) Suburban housing becomes an unaffordable luxury.

    Keep in mind, when fuel prices decline it is because of increased poverty effecting ability of users to meet fuel costs. The outcome here is less fuel available on the market because of high production costs cannot be met.

    High real fuel prices nailed America’s sprawl cities in 2008 and ready to smash the same places again (and again and again until they are abandoned). Where can this fuel price dynamic be seen right now? Europe. Greece is destroyed, it is on its way to being a failed state like Yemen. Next up is Spain then France (!). Auto infrastructure is stranded by high prices, cost of both fuel and infrastructure have been met with massive amounts of debt that cannot be repaid. Booyah!

    The entire sprawlville enterprise is a currency trap that the gullible cannot perceive largely because they don’t want to look. To perceive the trap is to acknowledge peak oil and the consequences. Speculators here are drinking the Kool Aid while hoping against hope the media mouths business shills are not lying about ‘abundant fuels’.

    The first leg down destroyed bank credit (and annihilated shadow banking and the repo markets in the bargain). The next leg down will suck circulating money out of the economy … along with an equal-ish amount of debt on account of deleveraging. This in turn will cascade as the speculators will be desperate to recoup.

    Don’t bother looking to the Fed, they have shot their credit bolt and have no more credibility. Don’t believe me, look at crude chart after QE(x) last month. Crude has declined $10 as customers are going broke around the world. The Fed cannot even manage a dollar carry trade toward China any more.

    Unless tenants have independent means — which they won’t because they will be out of work — there are no returns for the speculators, their cash is gone and no markets for their useless houses.

    1. Yves Smith Post author

      These are not “second tier speculators”. They are institutional investors. The takeout for many of these deals is an IPO. They figure a portfolio of 10,000 homes with stabilized incomes is big enough.

      You are missing that these guys have ALREADY DONE IT. They’ve already bought homes and placed lots of tenants in them. There is more to come, but the people I’ve seen talk this up (at a conference that had 5 panels on different aspects of this development) are talking about their experience so far and what they plan to do going forward.

      Now there will be more entrants, but the point is this is not a trend about to start, it’s already well out of the gate.

      1. Bert_S

        Here’s a timely article about how we just had an apartment building boom and finished units are now hitting the market.

        Apartment Demand Ebbs; ‘Avalanche’ of Units Open
        http://finance.yahoo.com/news/apartment-demand-ebbs-avalanche-units-151346988.html

        So someone could be walking face first into a buzz saw.

        Granted there will always be people that prefer single family over apartments, but my feeling on that is they historically always made apartments too small, and if they do try to target families, they could do better – especially when you get the pool, greenbelts, and dog walks.

      2. Susan

        Yves – I think you miss Steve’s point. I suspect Steve may be reading Kunstler’s Clusterfuck Nation or The Automatic Earth. Or maybe he’s following the monetary policy discussions that are calling for the sovereign currency creation a la Kucinich’s NEED Act or Michael Hudson’s historic overview of how we have created all this ficticious capital. I’m just guessing.

        While I appreciate Naked Capitalism’s coverage of the economy and specific topics therein, these issues do not live in a vacuum. The suburbs you seem to describe will be dead – vacuous vacant zones when the price of a commute to work becomes too high. They may find that they have sunk lots of cash into no man’s lands. Can you ride a bike on the freeway to get from your suburban enclave rental home to the 1990s office park where you push paper or to the warehouse where you tote boxes for Walmart or Amazon?

        It is important to consider, as Steve seems to point out, that trying to fetch an 11-14% ROI by purchasing newer homes in late 20th century cul-de-sac neighborhoods indeed makes these investors “second tier speculators” who may get caught in the intersection of peak energy (EROEI declines) and the credit crunch.

        It is reassuring to know that, as you report, these investors/bulk buyers are unlikely to visit my old historic inner ring suburb, both because of the age of the houses and because of the poor job market drivers. One less concern to keep at bay. I’ll sleep better tonight. Thanks.

        And Steve, the fuels are abundant, but energy companies have been sucking all the money out of their businesses for years. Rather than reinvesting some of the massive profits into finding safe ways to provide energy at a cost the world can afford (both in terms of climate change and personal income expenditures on average), they have been swilling those profits in champagne glasses aboard their yachts. I imagine they all know they’ve hit the iceberg, but extend and pretend is the current endgame for energy as well as for bankers. The deleveraging, when it comes, will be painful all round.

  8. Leon

    I have been hearing institutional investors are looking to use yields as a way to extract maximum values from buying these undervalued rental homes. Because current prices in many markets like Vegas, Phoenix, inland empire are so low, net income often yields above 10%. By aggregating all these homes into a REIT and pricing the REIT to yield 5% (in other words, doubling the price they’d sell for), they can extract a tremendous value on the resale. And if they get backed by the government, the returns are going to be astronomical! Meanwhile, small investors like us end up losing good rental homes to these institutional investors because they can afford to bid up house prices up as long as they can get even a 7% yield. Kind of messing up the market in my opinion. Glad to hear the program is being stymied.

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