Last September, one of the original institutional investors in the housing-to-rent strategy, multi-billion hedge fund Och-Ziff called it quits on the landlord business. The reason: “the New York-based hedge fund is looking to sell now because the returns it is generating from rental income are less than expected and it is looking to take advantage of a recent rebound in home prices in northern California.” As a reminder, the REO-to-Rental subsidized investment program, which led to an epic surge in demand for multi-family housing, i.e., rental, units was, together with offshore investors parking their cash in the US for safekeeping (taking advantage of the NAR’s anti-money laundering check exemptions) and the big banks Foreclosure Stuffing, the key reason for the recent, stimulus-fuelled and quite transitory bounce in house prices in assorted markets.
Still, OZ’s exit of the business did not spook too many of the other remaining investors who simply had no better investment options, and in a world of POMO and FOMO, they saw no choice but to become ever bigger landlords.
Today, another one of the original “big boys” has called it curtains: “We just don’t see the returns there that are adequate to incentivise us to continue to invest“, according to the CEO Bruce Rose of Carrington, one of the first investors to use deep institutional pockets (in this case a $450 million investment from OakTree) and BTFHousingD.
Rose’s assessment of the market? “There’s a lot of — bluntly — stupid money that jumped into the trade without any infrastructure, without any real capabilities and a kind of build-it-as-you-go mentality that we think is somewhat irresponsible.”
Of course, one can say exactly the same thing about virtually every other market where those gambling with “other people’s money” have no choice but to ride the tide and dance as long as the music emanating from the Fed is playing. However, it is rare to see one (technically, another) voluntarily step out even as others are still locked into a market where the returns are no longer worth the effort.
One such gambler is Blackstone:
Blackstone Group LP (BX), the largest investor in single-family rentals, has spent $4.5 billion to amass more than 26,000 homes and continues to buy, according to Eric Elder, a spokesman for Invitation Homes, the rental housing division of the world’s largest private equity firm.
Blackstone’s net yields on its occupied houses are about 6 per cent to 6.5 per cent, Jonathan grey, the firm’s global head of real estate, said during a May 3 conference call with investors. That’s before using leverage from a $2.1 billion line of credit the private-equity giant arranged in March from a lending syndicate headed by Deutsche Bank AG.
While about 85 per cent of Blackstone’s renovated homes were leased, grey said, “we’ve got an awful lot of homes to continue renovating.”
Blackstone can have its homes: it’s a different question if it will have the rental cash flow also needs to make these investments a reasonable investment. According to Carrington at least, the answer is a resounding no. And if people think the bottom will fall out of the market when the Fed pulls the curtain, just wait to see what happens to housing when the day comes that Blackstone announces it is shifting from the net buyer to net seller.
Back to Carrington’s rationale:
Carrington, which started in 2003 as a mortgage investment fund and has managed almost 25,000 rental homes for itself and others, has been joined by hundreds of institutional and international investors buying single-family homes after prices plunged following the housing crash. The firms are building a new institutional real estate asset class from the 14 million leased single-family residences that are worth an estimated $2.8 trillion, according to Goldman Sachs Group Inc.
Even as demand for rentals rises amid a falling homeownership rate, yields are declining and companies formed to buy the homes that have gone public haven’t yet been profitable.
Funds are buying property now, including homes sold by Carrington, for rents that yield 6 per cent to 8 per cent a year, before costs such as insurance, taxes and vacancies, according to Rose. Carrington’s model called for mid-single digit net returns on annual rents on an unlevered basis, according to Rose. While returns would vary by market, they would generally be in the mid- to high teens over the duration of the holding period, with the profit from home price appreciation.
Others’ experience justifies the logic:
Colony American Homes Inc., a division of Thomas Barrack Jr.’s Colony Capital LLC, has found tenants for only 51 per cent of the 9,931 homes it bought for $1.4 billion, according to a filing yesterday with the U.S. Securities and Exchange Commission.
American Residential Properties Inc. (ARPI), a Scottsdale, Arizona-based real estate investment trust, and Silver Bay Realty Trust Inc., a New York-based single-family REIT, both reported losses in the quarter ending March 31. Owen Blicksilver, a spokesman for Colony Capital, declined to comment. Silver Bay CEO David Miller was unavailable to comment, according to Tricia Ross, a spokeswoman at Financial Profiles Inc. American Residential CEO Steve Schmitz and President Laurie Hawkes didn’t reply to e-mails seeking comment.
If nothing else, everyone now knows where the incremental “bubble” demand for housing has come from: not from the distressed end user of thes properties, for whom as we showed yesterday, the disconnect between real income and new home sales has never been wider: it was all large institutions who invested OPM, and chased any upward moving price with the fervor of a rabid dog.
But all things come to an end:
“All the people who made money during the gold rush in California, they were selling the buckets and shovels,” Gordon said. “I think there is gold in them there hills, but you’re going to have to dig deep. And hopefully you’re going to need more than one shovel.”
Carrington may start buying rental homes again when other large investors decide to sell after learning they can’t make returns that justify the prices they paid, Rose said.
“We’ll sit back in the weeds for a while and wait for a couple of blowups,” he said. “There’ll be a point in time when we’ll be happy to get back into the market at levels that make more sense.”
If the Chairman is serious about tapering, or even hinting of tightening at some point in the future, those blowups won’t take too long. And so will the blowup in the illusion that the housing market is “recovering” on anything more than yet another cheap-money fuelled bubble afforded to a select few who now have no choice but to “hot potato” properties amongst each other first on the way up, and soon, going down.