In reviewing the year that ends next week, “remarkable” may not be an adequate word to describe the unforeseen events and fundamental changes that have taken place in residential real estate investing. “Awesome” comes closer to reality.
A Look at the Past
Consider the how things stood a year ago. Residential investors were gaining new respect and had moved beyond the status of a temporary fad because they were saving critically ill markets, largely in the “sand” states, from becoming comatose. They soaked up thousands of toxic foreclosures and returned to the housing stock rehabbed rentals and entry level homes while all other buyers were fleeing. In Florida, home to the sickest of the sick foreclosure markets, they sparked a dramatic turnaround in the fourth quarter that would later be repeated in Phoenix and California. As last year ended, leading economists like Alex Villacorta at Clear Capital, Mark Fleming and Sam Khater at CoreLogic and Zillow’s Stan Humphries recognized and began to study and write about the unique and vital role investors were playing.
As 2011 ended, real estate investing entered new territory to become not just at essential element of the real estate economy but an increasingly popular option for any investors seeking a better return than they were getting in traditional securities. Not many noticed when several hedge funds announced plans to enter what would become known as the REO-to-rental business, and those who did viewed the funds’ plans no more than further recognition of the prescience of individual investors.
Major events in 2012
Twelve months later, who could foresee how greatly the world of real estate investing would change? Here are some events that symbolize how much things have changed.
- Investing Moved from the Fringes to Center Stage in the Housing Economy. Throughout the year, investors accounted for about 20 percent of all home sales. Forecasts today anticipate investor reactions to changing economic conditions as much as owner-occupants. When the BiggerPockets.com/Memphis Invest survey was released in September, showing that 65 percent of active real estate investors plan to buy as many or more residential properties in the following 12 months as they did in the past year, the survey generated coverage from BusinessWeek to CNBC. The survey also found that some 3 percent of American adults, or 7 million people, consider themselves to be real estate investors and an additional 9 percent of all Americans own investment property today. As forecasters look ahead to 2013, many are wondering whether rising home values will turn markets into sellers’ markers, encouraging widespread sales by investors, impacting the market. The first BiggerPockets.com Summit in March crated a forum for the emerging investor segment to learn, share and network.
- Single Family Rentals Outnumbered Multifamily. When CoreLogic Economist Sam Khater calculated single family versus multifamily facilities based on the latest Census data and found that single family rentals are $3 trillion business and accounts for 21 million rental units—52 percent of the entire residential rental market. In other words, the number of single family rentals in the market today has surpassed apartments.
- The Hedge Fund Invasion Grew from Trickle to a Flood. While imitation may be the best form of flattery, whetting the appetite of a thousand pound gorilla may not end up well. The trickle of interest from Wall Street money that surfaced in late 2012 turned into a torrent of hedge funds flush with cash, vowing to spend billions on purchasing distressed sales. Eyebrows rose when analysts at investment bank Keefe Bruyette & Woods reported in September that dozen hedge funds entering the REO market have raised between $6 billion and $8 billion for acquisitions, according to investment bank Keefe, Bruyette & Woods. By summer their presence was felt in local markets, often driving up prices of foreclosures already in short supply. Today investors view them with mixed emotions (See Forum topic Hedge Funds: How Are Hedge Funds Impacting Your Market and Business?)
- Foreclosure Supplies Shrank to Multi-year Lows. Like a perfect storm, five factors combined unexpectedly to send inventories of foreclosures to record lows. Despite the signing of the AG agreement in March, the 18 month slowdown in foreclosure processing did not entirely end, especially in judicial states. New laws in several states, notably Nevada, did not help the situation. Today some >1.3 million foreclosures are still in the foreclosure inventory, down only 200,000 from a year ago. Delinquencies and defaults also continued their decline, which began in 2010. Demand mushroomed. In addition to the growth in the numbers of individual investors, hedge funds, as noted above, entered markets in a big way. Owner-occupant buyers woke and realized the train was leaving the station, and sought to get a foreclosure. Finally, record numbers of defaulting owners and their lenders opted for short sales.
- Squeeze on the Foreclosure Discount Cut Profits. Once as high as 34 percent, the foreclosure discount—the difference between distressed sale prices and full-priced homes—fell to as low as 7 percent in some markets. Tight inventories and unexpected demand from hedge funds and owner-occupants as well as individual investors are driving up prices on foreclosures and short sales in many markets. At essential part of the both buy-and-hold and buy and flip strategies, lower discounts could change the feasibility of hedge funds’ business plans.
- Ratings Agencies Put the Kibosh on Securitizing Single Family Rentals Any Time Soon. A number of hedge funds entered the single family rental space expecting to package hundreds of rentals into securities and sell them to institutional investors on Wall Street, which would dramatically speed up their cash flow, create another source of income through managing the properties, and rid them of the risk involved in owning and managing the properties. Unfortunately, all three of the major securities ratings agencies, especially Fitch Ratings, raised concerns about the idea and announced they would need years’ worth of data to rate rental properties, effectively delaying plans to create a secondary market in SFR securities for years.
- The Geography of Foreclosures Changed Dramatically. In the past 12 months, current and pending supplies of foreclosures have shifted from the traditional “sand” states of California, Nevada, Arizona and Florida to the judicial states in the Northeast, especially those struggling with high unemployment levels. The AG agreement exacerbated the differences between these states, which require a court order to foreclose, and the balance, largely in the West, that do not. In judicial states, lenders moved slower to resume processing and starting new foreclosures. By October, the five states with the highest foreclosure inventory as a percentage of all mortgaged homes were: Florida (11.1 percent), New Jersey (7.7 percent), New York (5.3 percent), Illinois (5.0 percent) and Nevada (4.8 percent).
With the Fiscal Cliff still unresolved, it’s hard to foresee what’s ahead for investors, even in the short term. Potential changes in taxes, including capital gains and transaction taxes, have been widely reported. Less has been written about what the Cliff may do to the dynamics that drive the housing economy. Next week, hopefully with the Cliff settled, I’ll take a shot at some predictions.
Photo: Gerlos2012: The Year That Changed Investing Forever by Steve Cook