December 5, 2013
Business Investor Activity in the Single-Family-Housing Market
Raven Molloy and Rebecca Zarutskie
We discuss recent purchase activity by business investors in the market for single-family homes and consider the possible benefits and risks of this activity. In terms of benefits, business investor activity has likely aided the recovery in certain housing markets by helping to clear the inventory of vacant and foreclosed homes, which may also have supported house prices in markets where that activity was concentrated. Investors have also funded much-needed renovations of a sizable portion of the housing stock. Moreover, large investors may make the rental market for single-family homes more efficient by investing in new platforms for property management, marketing, and servicing, and by expanding the number of single-family homes for rent in relatively attractive neighborhoods--at least in some cities.
Nonetheless, investor activity may pose risks to local housing markets if investors have difficulties managing such large stocks of rental properties or fail to adequately maintain their homes. Such behavior could lower the quality of the neighborhoods in which investors own rental properties. Moreover, if an investor suffers financial distress, it may be forced to sell a large number of homes at once or cut maintenance expenditures, which could lower house prices in the surrounding area.
Given the small aggregate share of homes held by business investors and investors' currently low leverage ratios, we think that their activity to date probably is not a significant source of risk to financial stability. However, a future appreciable increase the extent of investor holdings and leverage, or unforeseen difficulties in managing such large single-family-rental inventories, could raise financial stability risks by increasing the odds of financial distress amongst a large number of investors, the institutions providing their funding, and homeowners in affected markets. In particular, it will be important to monitor the development of markets for bonds backed by rental-income streams for the development of potentially destabilizing structures or concentrated exposures.
Business Investor Home Purchase Activity
Information on home purchases by business investors can be obtained by looking at the names of the buyers in records of purchase transactions. Using real estate transactions data from CoreLogic, analysts at Amherst Holdings estimate the share of single-family homes purchased by business investors increased from less than one percent in 2004 to nearly 6-1/2 percent at the end of 2012, as shown in Figure 1. Preliminary readings suggest that this share remained high in early 2013. The most rapid increase occurred from 2007 to 2009, when house prices were plummeting and foreclosures were skyrocketing. This increase was largely driven by small and medium-sized business investors, shown in orange and green. The share purchased by the largest investors, defined as businesses purchasing more than 200 homes since 2000, and shown in blue, also stepped up in those years, but jumped more significantly in the past two years.
Recent business investor activity has been concentrated in certain metropolitan areas (MSAs). Table 1 lists business investor activity in 2012 in the 20 MSAs that are included in the Case-Shiller index. More than 16 percent of all the homes sold in Atlanta in 2012 were purchased by business investors, as were 14 percent in Phoenix and 11 percent in Las Vegas. For the most part, business investors of different sizes tend to purchase homes in the same metropolitan areas.
|MSA||Investor Purchase Share (%)||Large Investor Purchase Share (%)|
Note: Investor purchase share includes small, medium and large business investor home purchase shares.
Source: Amherst Holdings
We analyze the determinants of business investor purchase shares using the data from Amherst Holdings merged with metropolitan area data, as well as by reading the financial reports of publicly traded investors and reading news and other reports on private investors. Our analysis suggests that investors have been drawn to certain metropolitan markets in part because of their low price-to-rent ratios. Such markets appear to offer a higher potential return to buying a home and renting it out. As shown in Figure 2, metropolitan areas with lower price-to-rent ratios in 2011 tended to attract larger investor purchases in 2012. Indeed, the five metro areas with unusually large investor shares of home purchases, shown in red, all have fairly low price-to-rent ratios. The two metro areas with the highest purchase shares, Atlanta and Phoenix, are located significantly above the trend line, suggesting that other factors also influenced investors' decisions. One of those factors appears to have been the availability of foreclosed homes because business investors tend to buy properties at foreclosure auctions, where they can purchase homes at distressed values.
The five metropolitan areas with a high level of business investor activity had a larger ratio of properties for sale at foreclosure auctions to homes for sale than in the U.S. as a whole. For example, the ratio of foreclosure auctions relative to homes for sale in 2012 was just over 5 in Atlanta and just under 6.5 in Phoenix, compared to an average ratio of 2.6 for the U.S. as a whole. Many investors also cite the outlook for economic and employment growth, which is, for example, more positive in Atlanta and Phoenix than in Detroit or Cleveland, as an important factor in determining investor home purchase shares within metropolitan areas. Within metropolitan areas, investors also reportedly seek out homes in family-friendly neighborhoods with good schools, and they have typically purchased homes with three to four bedrooms in the $100,000 to $200,000 price range.
Large Investor Business Model
We next describe features of the business models for the largest business investors in single-family housing markets based on publicly available information, such as financial reports, and news reports about large private investors. Large investors are typically funded by private equity. Most large investors also maintain credit lines with large banks, which they tap to acquire and renovate properties. These large investors purchase the majority of homes with cash, rather than obtaining mortgages on a home-by-home basis. Paying with cash gives investors a competitive advantage when bidding for homes because cash sales are not subject to the uncertainties of the mortgage loan underwriting process. This is especially true for the very largest investors, who are able to raise the cash cheaply in the capital markets.
Importantly, the largest investors have also invested significantly in building new platforms for the management, marketing, and servicing of their rental properties. Thus, a major aspect of their strategy is to combine scale economies with information technology to "professionalize" the rental market for single-family homes.
Many large investors say that they plan, in time, to sell their entire portfolios of houses and the associated management platforms to entities that will continue to manage them as rental properties, rather than selling homes one-by-one on the owner-occupied market. Some of the largest investor portfolios may go public as real estate investment trusts, or REITs, in order to tap into a broader investor base, which includes both individuals and institutions such as mutual funds and pension funds. Indeed, three large investors, American Homes 4 Rent, American Residential Properties, and Silver Bay Realty Trust, went public as REITs in the past year.
As public REITs, these three institutions now publish financial reports. All three REITs reported negative net income for the second quarter of 2013. Negative net income is common for private-equity investments in their first three to five years. Private-equity investments typically provide a so-called "j-curve" of returns as investor cash flows turn positive several years after the initial investments are made. Leverage ratios at these REITs, defined here as debt divided by total assets, ranged from zero to 19 percent, indicating a fairly limited use of debt, especially when compared to typical leverage ratios for apartment REITs and general private-equity investments, both of which currently average around 55 percent. However, investors' use of debt may rise over time as revenues increase and stabilize, and net incomes become positive. In addition, the ability to securitize rental-income streams in the form of bonds, a new financial innovation introduced recently by Blackstone and Deutsche Bank, may also lead to greater use of leverage to finance the buy-to-rent model.1
Potential Benefits and Risks of Investor Activity in Single-Family-Housing Markets
To our knowledge, no studies exist on the effect of single-family-real-estate business investor activity on housing markets or other outcomes. We qualitatively discuss the potential benefits and risks of this activity.
On the positive side, these investors are deploying capital to purchase and renovate houses that otherwise might have remained vacant for a long time. Tight financing conditions in the primary mortgage market have likely limited the ability of some potential owner-occupiers to purchase and renovate these properties themselves. Another advantage of this activity is that institutional investors are increasing the supply of single-family rental houses at a time when the demand for such housing appears to be high.
Despite these benefits, the large-scale rental of single family homes is still a new business with a short track record and, thus, carries significant risks. Investors may end up having overestimated the demand for rentals in a particular neighborhood, or may have invested more in improving, leasing, and maintain houses than they recoup through rental payments. Neighborhoods may suffer if a particular investor has difficulties managing large numbers of rental properties or ceases operating and cannot find a new investor to buy out their positions. In this case, a large number of homes that are left vacant or put up for sale on the owner-occupied market could cause a drop in house prices in the area and thus negatively impact other homeowners.
Given the relatively small share of homes held by business investors and low investor leverage, right now there appears to be fairly little risk to overall financial stability. However, financial stability concerns may become more significant should debt financing becomes more prevalent or if the share of homes owned by investors in certain markets rises significantly further. Greater use of leverage makes financial distress of the investors more likely, which may force them to liquidate their asset holdings at suboptimal values. To the extent that public markets develop for bonds backed by the underlying income or assets of investor portfolios, there is greater risk of the development of shadow banking activities based on these securities or derivatives referencing them.2 It will be important to monitor developments in these markets for signs of the potential to destabilize financial markets.
1. The offering, named Invitation Homes 2013-SFR, is worth $479 million. It will be backed by over 3,000 single family houses and their rental income streams, and will be divided into six tranches. Return to text
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