In today’s economy, there are few people whose opinions can drive national economic policy and change the way entire industries are perceived. The highly trained 331 economists who work for Federal Reserve are among them. Their expertise and impartiality give their views on critical issues extraordinary credibility in the halls of Congress, the Administration, the media and, of course, the Fed itself.
Two top Fed economists have just published a new study on investment in single family rentals. Though the focus of their concern is plans to securitize single family rentals, they address ”business investing” broadly. Their findings could help convince policy makers that all investors are a force for economic instability that could, in future, help provide fodder for years to those who would like single family rentals converted back to owner-occupancy.
Rebecca Molloy, a senior economist with a Ph.D. in Economics from Harvard and Rebecca Zarutskie, who got her doctorate at MIT, published Business Investor Activity in the Single-Family-Housing Market December 5.
The authors make passing mention of the lifesaving role investors played during the foreclosure crisis, noting only that investing “has likely aided the recovery in certain housing markets” and “may also have supported house prices in markets where that activity was concentrated.” Hedge funds get more credit for 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.
“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,” they said.
Large Scale Investors Are Introducing Large Scale Risk
They point out that large investors are creating a new dimension of risk. “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… 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,” they wrote.
Investors May Have Overestimated Demand
In summary, they said “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,” they wrote.
Acknowledging there is little risk to financial stability currently because of the relatively small share of homes held by investors , the authors suggest financial stability concerns may become more significant should debt financing become 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,” they wrote. They recommend it will be important to monitor developments in these markets for signs of the potential to destabilize financial markets.
No Studies on Investors Exist
I came away from the piece with the impression that the authors, though expert economists who made some important insights, could have benefited from a more extensive exposure to real estate investing. For example, Only their charts mentioned that institutional investors account for only a fraction of the foreclosures converted to rentals since 2009. Nor did they account for the hundreds of millions that investors of all sizes have spent renovating housing, which does more than make houses rent-ready. They raise property values and improve neighborhoods that otherwise would fester. And talk about instability: Homeowners in California, Arizona, Georgia, Nevada, Florida and elsewhere would have lost many millions more in equity had not investors created price floors that stopped the bleeding and restored confidence in devastated markets in 2009-2011.
Why they did not seem to know these things was answered by a single line in the report.
To our knowledge, no studies exist on the effect of single-family-real-estate business investor activity on housing markets or other outcomes.
Shame on us! As one who has been involved in some very minimal research for Bigger Pockets and others, I know how very little research has been done on the single most important phenomenon in residential real estate.
What difference does all this make? Hopefully, this discussion will have no impact on your business. However, the Federal Reserve, which oversees the national economy and directly regulates the nation’s banking and financial industry, now has real estate investors of all sizes in its cross hairs. Should some institutional investors collapse and their investors lose big time or their tenants are forced out into the street, you can be sure this report will set the tone for the government’s response, and that response could include regulatory moves that will limit investors’ debt and access to financing.
Photo Credit: Gwenaël Piaser