We’ve been skeptical of the private equity land rush to snap up single family homes for rentals. They’ve been a big enough force in the housing market nationwide to lead some commentators to question how solid the housing “recovery” is. Yet the combination of rising enthusiasm for housing and a richly-valued stock market is leading a raft of PE firms to ready IPOs as a way to take profits and establish valuations for their profit participations.
Now bear in mind that real estate is ever and always local, and PE guys have figured out that for operational reasons, they needed to concentrate their buying in certain markets, meaning, say, 200 homes on one side of Atlanta as opposed to 200 homes in 30 states. So it’s possible that some operators who got in early, or otherwise bought well have solid portfolios.
But then we have hot money stories like Las Vegas. As Reuters reported last week:
Local real-estate broker Fafie Moore says private-equity firms and hedge funds have largely “crowded out” local buyers like Marchillo. That’s because the investment firms have broadened beyond their initial focus – buying homes at foreclosure auctions. Now, they are also bidding for homes listed by private owners and banks. In a sign of how freely the money is flowing, Moore notes around 60 percent of all sales are in cash these days.
Fellow broker Trish Nash says she has seen cases where a home gets listed and quickly draws a dozen bids, many in cash. Realtors are talking about a mini-bubble forming here.
“There is an artificial appreciation in our market,” says Nash. “I know (the big investors) say they aren’t going to be flippers, but for them it is all about the bottom line.”
The article describes why the “recovery” may have been pushed beyond sustainable levels by hot money:
Cracks are showing in Vegas and beyond. Here, rents on single-family homes were down an average of 1.9 percent in March from a year ago. In other regions targeted by institutional buyers, such as Phoenix, Southern California, Atlanta and Florida, rents are either falling or flat, according to online real estate service Trulia.
Now mind you, the falling rentals story is an even bigger deal than you might think. At a real estate conference at which I spoke last year, one institutional investor who was on the receiving end of PE pitches for single family rentals sniffed that many were forecasting 5% rent increases for several years running. That’s wildly optimistic given high unemployment and continuing weak wage growth.
And of course, as we pointed out in earlier posts, the very activity the PE landlords are engaging in is bound to undermine their market. Tight rental markets have resulted from many homeowners losing their house through foreclosure, as well as the properties themselves being removed from the market via the foreclosure process. Buying and converting formerly owned homes to rentals increases rental supply which reduces landlords’ ability to maintain high rental rates.
What is particularly interesting about the Financial Times report on the IPO plans of various PE funds is their eagerness to go to market now:
A handful of companies that rent houses to single families are preparing to launch initial public offerings on the US stock market as their private equity and hedge fund owners take advantage of investor interest in the US housing recovery.
Colony American Homes, backed by investment firm Colony Capital, is expected to be among the largest in what is becoming a new area of the US publicly listed property sector.
Others looking at a listing include units of investment fund Ellington Management; Fundamental REO, whose fund received a large investment from Goldman Sachs; Waypoint Homes Realty Trust; American Homes 4 Rent; and Barry Sternlicht’s Starwood Property Trust, according to industry insiders and analysts.
The most popular view I heard last fall was that an exit via an IPO, with the rental business as an operating company, was the easiest and cleanest route. A portfolio of 1000 houses would be large enough to make for a decent-sized deal. But interestingly, back then, the assumption was that the portfolios would also need to have reached “stabilized yields,” meaning they were rented up and had seen a fair number of lease renewals so investors would know the turnover, vacancy rates, and costs associated with both making homes ready for the initial rental and freshening them up when a lease expired. That would take two to three years. We are well short of that timeframe. That means that investors will be buying a pig in the poke.
So why does this move make sense now? All you have to do is look at the continuing-to-defy-gravity stock market. I happened to be on the treadmill in a gym on Monday of the sort where like it or not, an individual monitor goes on when you work out. It was on CNBC and I didn’t bother changing it since I was reading. Even so, when Jim Cramer came on, it was interesting to observe how attention-getting his arm-flailing is even with the sound off. And via captions, his message was clear: The market is super! Even though earnings suck, it’s blown off the bad news. He ever professed to be mystified in how many companies in a a big range of sectors had disappointing earnings. So don’t fight the tape, just enjoy it and find a way to make money.
In other words, investors are so confident that the Fed won’t let them lose money that they are insensitive to fundamentals. That makes this a terrific time to launch questionable investments that tie into perceived uptrends in the economy. So as usual, caveat emptor.
Update: I neglected to include another reason to be skeptical: servicers are still holding back a lot of inventory via attenuated foreclosure timelines. Lysa flagged a choice tidbit on p. 21 of this report from LPS: “The average time of serious mortgage delinquency before foreclosure starts is now up to 492 days nationally, while the average days delinquent for those already in foreclosure is 834 days.” Even though the report discussed how the number of delinquent homes is falling, the attenuated timetable suggests that, as observers in some markets have indicated, servicers still have a lot of product in the pipeline.