What will solve the housing crisis? The Keynesians think it's a government bailout and the Hayekians think it will ultimately be the invisible hand and spontaneous order of supply and demand that will ameliorate the underwater single-family home sector. Well, could it both? In other words, the government steps in to structure a private sector solution?
On the heels of Bloomberg reports that Blackstone Group, the private equity giant and the country's biggest buyer of real estate, has spent more than $250 million this year buying foreclosed single-family houses with plans to put them up for rent, we have more indications that large, yield-hungry Wall Street firms may provide the answer (or one of them) to the housing crisis.
The National Association of Realtors' Investment and Vacation Home Buyers Survey reports that investment-home sales soared a whopping 64.5 percent in 2011, with investors purchasing 1.23 million homes compared to 749,000 in 2010.
"In the next five to 10 years, you'll see tens of billions, if not hundreds of billions, of dollars of private equity" pouring into the single-family rental business," says Justin Chang, principal of investment firm Colony Capital. In the past six months, Colony has bought more than 1,000 homes to turn into rentals. Most are in Arizona, California and Nevada, though Colony expects to expand into Texas, Georgia and Florida. In the next year, it will invest at least $1.5 billion in single-family rentals, Chang says. According to Forbes, "the concept is catching fire on Wall Street and with good reason: While a 10-year Treasury note yields little more than 2 percent, economists at Goldman Sachs calculate that rental property investments yield more than 6 percent on average, nationwide."
Blogging on the real estate website, GlobeSt.com, Ernst & Young's Howard Roth stresses the importance of geography: "The places attracting the most attention from rent-to-buy investors are all cities that, although hard hit, have good long-term fundamentals and strong rental demand, such as: Las Vegas, Miami, Phoenix and, in California, the Inland Empire and Sacramento. Homes in Phoenix, for example, have appreciated 15 percent to 20 percent since the start of the recovery, a trend that is expected to carry on if investors there continue to absorb supply from the market. Already, there is less than a two-month supply of homes to be sold in Phoenix, compared to a one-year backlog a year ago."
The most coveted investment play today for the high-cap private equity player is to bulk buy REO (bank-owned) homes. As Forbes explains it, "the largest holders of distressed assets are the Government-Sponsored Enterprises Fannie Mae and Freddie Mac. Together the two mortgage giants own roughly 180,000 foreclosed homes." In February, the Federal Housing Finance Agency announced the launching of a pilot program that puts 2,500 of Fannie Mae's homes in eight locations, valued at $320 million, up for sale. On July 3, the FHFA announced that the winning bidders in the REO to Rental initiative had been chosen and transactions were expected to close early in the third quarter. Investors were evaluated on the basis of several factors, including financial strength, asset management experience, property management expertise and experience in the geographic area.
Even with big investors entering the space however, the housing problem remains outsized: Nearly 650,000 REO properties sit on the books of the nation's banks and 710,000 more are pushing through the foreclosure process, according to RealtyTrac. Still, the entry of institutional and private investors into the housing space does raise several promising notions: a higher professionalism in the management and operation of the assets; a portfolio strategy that can raise the value of more challenged assets; and ultimately a way for renters to re-enter the home ownership by saving and re-building their equity while they rent. Could it be that Keynes and Hayek are both right?
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A good analogy is what happened in commercial real estate. In 1989, the market hit bottom because of the Savings & Loan crisis. S&L’s made hundreds of billions of dollars worth of loans on commercial real estate and saw asset prices freefall after Black Monday. Between 1989 and mid-1995, the government stepped in under the guise of the Resolution Trust Corporation which closed or otherwise resolved 747 thrifts with total assets of $394 billion. At the peak in early 1990 there were 350 failed savings and loan institutions under the agency's control. Just like the GSEs today, they organized bulk sales of commercial buildings and loans. Who bought them? Large Wall Street firms. It was an enormous transfer of wealth, no question, but it also brought a new professionalism to the industry – portfolio-level strategy, transparency in pricing and underwriting, a new skill in operations, managing supply and demand, and accurate reporting. Our industry was transformed. By the late 90s, asset prices shot back up and reached record levels. In 2007, when the recession hit, the industry was affected but far less than it would have been had it not been for how it had evolved. We simply didn’t have the levels of overbuilding that we did in previous recessions. And, incidentally, Wall Street allowed the person on the street into the industry.
To go back to the investment firms, remember that part of the strategy is to avoid evicting people from their homes. In the best of circumstances, these homes would be rented to their former owners who would also have an opportunity to acquire the home as the exit strategy. Each of these firms has their own strategy but I’ve spoken personally to private equity firms that are making a good faith attempt to prevent people being ejected from their homes for a simple reason – it’s preferable and cheaper than having to re-lease these homes. What are the alternatives? We could let the bad loans sit on the books of financial institutions which can cripple the credit system for years or decades (that’;s what happened to Japan in the 1990s); or foreclosed homes can end up being acquired piecemeal in one-off or small auctions which isn’t efficacious in bringing back an enormous market. The argument to be made is that the Wall Street may be that critical intermediary step before the consumer sector is ready to take back the housing market.
A few addenda to the article: Part 1
I agree that there are pros and cons to this program. The clear source of popular resentment is that the equity lost by homeowners as their home values plummet will be recaptured by large investors when they go to flip the assets once asset prices start to stabilize. Given the low cost of leverage and the low acquisition prices, the large-cap investor wouldn’t have to wait for prices to get back to par in order to make their targeted returns. So, is there another way? Well, yes. Homeowners could stay in their homes. That’s why the Obama administration created the Home Affordable Modification Program (HAMP) which has saved approximately 802,000 U.S. homeowners from foreclosure as of April 2012 – a worthy achievement but far from the 4 million expected and not enough to make a dent in the housing problem. HAMP was tempered by the lack of lender participation in the program. Of HAMP’s $30 billion budget, thus far it has only spent $3.23 billion.