BiggerPockets Podcast 514: BiggerNews, October: How Small Landlords Can Beat the Hedge Funds

BiggerPockets Podcast 514: BiggerNews, October: How Small Landlords Can Beat the Hedge Funds

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Once the housing market started to slide in 2007, smart investors began buying, and waiting, for rock-bottom prices to kick in. Investors were buying homes in some of the best markets for dimes on the dollar, and have seen massive profits whether keeping them as buy-and-hold rentals, BRRRR deals, or flips. While small investors started buying a couple of houses a year, institutional investors were doing far, far more.

Private equity funds, along with REITs and hedge funds knew that foreclosed homes were a steal, and their economies of scale made it even easier to turn these financially mismanaged properties into appreciation and cash flow kings. As institutional investors began fixing up these homes, listing them for rent, and later selling them, the entire market moved in an upward direction. Now, first-time homebuyers are competing with these economic powerhouses to lock down their first primary residence or rental property.

A man who has been covering this topic for years is The Wall Street Journal’s, Ryan Dezember. Ryan has a keen understanding of what influences the housing market as a whole, why institutional investors are making the moves they are, and what this means for small mom-and-pop landlords. Dave Meyer also joins David Greene on this episode to discuss the ways small landlords can beat Wall Street at their own game.

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Read the Transcript Here

David:
This is The Bigger Pockets Podcast, show 514.

Ryan:
The one thing that really changed was if you were going to buy a house, you might get there and they might say, “Oh sorry, somebody just bought this and paid cash.” Called over the phone. Never going to look at it. Doesn’t matter what the carpet looks like, they’re going to rip it out anyway. It’s not an emotional decision. Check the boxes, they bought it. Sorry. We didn’t even get to put a sign out front. I think that was the big shock to people, is when they went out house hunting and found that there was somebody else.

Speaker 3:
You’re listening to Bigger Pockets Radio, simplifying real estate for investors large and small. If you’re here looking to learn about real estate investing without all the hype, you’re in the right place. Stay tuned, and be sure to join the millions of others who have benefited from biggerpockets.com, your home for real estate investing online.

David:
What’s going on everybody? It is me, your host of today’s Bigger Pockets Podcast, David Greene. Here with my cohost, Bigger Pockets OG, Dave Meyer. Dave, how’s it going?

Dave:
Great, man. I’m actually back in the U.S. at the Bigger Pocket headquarters, seeing where all the magic is made. How are you doing?

David:
I’m doing good. Glad to have you in the states again. You’ve been living in Amsterdam for what, a couple years now?

Dave:
Yeah, a year and a half, which has been a lot of fun. But I’m back in town for the Bigger Pockets conference. So I’m very excited to be going to that next week. I assume you’re going to be there, right?

David:
Yep. I will be there. I’ll be talking on the BRRRR Strategy. That thing’s a blast. If people want to go have a really good time, there’s something about the Bigger Pockets community where it’s just a bunch of nice people. You don’t see a lot of jerks within this community. So everybody gets along really good. There’s not that typical chip on the shoulder, ego vibe that you get at a lot of real estate investing conferences, where everybody’s trying to prove that they’re smarter than the next person or they own more real estate than the next person. I really don’t love a lot of real estate conferences for that reason. But it’s never like that at BPCON. So I’m excited to be able to go have some fun.
I’m also excited for today’s show. So today we’re going to do a state of the market news real estate podcast where Dave and Dave are going to partner with our guest today, Ryan Dezember, who is a Wall Street journalist that focuses on the real estate market. And we are going to dive deep into what’s going on in the overall markets, specifically when it comes to institutional capital, which would be hedge funds, private equity getting into the space that has typically been reserved for the small-time, mom and pop investors like us. So Ryan gives a lot of good insight into where these people are operating, what type of properties they’re looking for, why we see some of the dynamics that we are seeing, like a shortage in inventory or why people are paying the prices they are for homes.
We get into if we should expect a crash or not, and maybe how we should change our investing strategy around that. Dave, what was your favorite part of today’s show?

Dave:
I think the major thing is when you see some of these headlines about Wall Street and these institutional investors entering the market, it seems really doom and gloom, and it can seem a little scary. And we do talk about that, what advantages they have. But I think what Ryan and you and we all talk about that’s really important to note is that you, the small investor, still have a lot of advantages over these big companies, whether you see that right now or not. If you listen to this show, I think you’re going to hear that there are ways to adapt your strategy and there are things that you can still do better than these big institutional investors. And I really just liked talking about that.

David:
Yeah, that’s a great point. We give a lot of advice on ways that we have the advantage and how we can use that advantage to our advantage. And in my opinion, this becomes more important than ever.

Dave:
Nailed that one.

David:
Thank you. Before I say anything cheesier than that, let’s get today’s quick tip.
Today’s quick tip is, at minimum consider long distance real estate investing. Now I’m not just saying that because I wrote the book. I wrote the book because I consider long distance real estate investing. We talk a lot in today’s show about how certain markets are very difficult because you are competing with some of this institutional capital that does have an advantage over you, and has more motivation than you might have. Rather than fighting that uphill battle, go find an area where you don’t have to fight the uphill battle, and put a strategy together to win in that market.
Dave, anything you want to add on that point?

Dave:
No. I think that long distance real estate investing is something that I’ve been long considering. And actually just as a preview for everyone, next show David and I are going to be talking about that a little bit more. But we’ll just leave that teaser out there for now. And instead, let’s jump right in to this conversation with Ryan Dezember from the Wall Street Journal.

David:
All right, Mr. Dave Meyer, Mr. Ryan Dezember. Welcome to the Bigger Pockets Podcast.

Ryan:
Thank you.

David:
Dave, do you want to-

Dave:
Thanks. I didn’t know if I had to reintroduce myself, but thanks. I’m always happy to be here.

David:
Well allow me to reintroduce yourself to the show, since you’re not on all the time. Dave Meyer is … what’s your official title at Bigger Pockets?

Dave:
I am the Vice President of Data and Analytics.

David:
There we go. And Ryan, how do you like to be referred to?

Ryan:
Reporter for the Wall Street Journal. We’ll keep it simple.

David:
And you cover housing for the Wall Street Journal, so that’s a perfect person for us to have on the show today, because we are going to dive deep into what is going on in the overall real estate market. We’re going to bring you guys the hottest news, fresh off the press, and then give our commentary on how we can interpret this to help build wealth through real estate.
So I’m very happy to have each of you with me today.

Ryan:
Thanks for having me.

Dave:
Great. Let’s get to it.

David:
All right, Dave, where do you think we should start this thing?

Dave:
We’ll I’m pretty interested … I know a little bit about this. But Ryan, I know you’ve been covering this topic for a while, so I’m hoping you could just help us all understand the history of Wall Street entering the rental market and how it evolved out of the last recession and the big housing crash from the 2007 era?

Ryan:
We think of the housing crash as 2007, and maybe into 2008. But it wasn’t really until about 2011 or so that home prices hit bottom. And one of the reasons that a lot of people think that they found a bottom was that Wall Street looked at it and a lot of these financiers who had invested in other classes of real estate saw their way in. They saw homes that were selling for 40, 50 cents on the dollar in Phoenix and Las Vegas and Florida, and all these hot housing markets. And it was irresistible. They had always wanted to conquer single family homes, but it was a very unwieldy thing to do. You have 100 apartments, they have one roof. You have 100 houses in town, they’re all over the place, they have 100 roofs.
So the housing crash gave them not only the opportunity to buy cheaply, but also to buy in scale. And around that time, if you remember, that’s also when the iPhone came out, and this leap in cloud computing. And that enabled these investors to orchestrate this giant house hunt. As most of your listeners will probably know, you can’t go to a foreclosure auction without cash. You can’t look at it and come back and think about it. You got to buy then. So they were able to orchestrate this huge purchase of tens of thousands of homes from the courthouse steps, that they wouldn’t have been able to do without that sort of technology, let alone what that technology allowed them to do after the fact, in terms of efficiently managing these properties that were all over the place.
And the business, for a few years people were pretty skeptical, though that once home prices bounce back and rise they’re going to liquidate these portfolios, they’re going to sell these homes. What happened, of course, is that renting houses in the suburbs proved to be very profitable, especially in this environment of low yields on other investments. So that’s why, come 2013 or so, and you see home prices coming back and the foreclosures have been sopped up. You see these companies, like Invitation Homes and American Homes 4 Rent, Tricon, they’re hitting the open market. They’re bidding with the rest of us on a house, one-off houses in the suburbs.
They deployed a lot of technology, of course a lot of money. They got the minds on Wall Street cranked up to figure out how to mortgage these purchases after the fact. They were having to spend all cash. So how do they take money off the table and put it back into their growth? Well they come up with rent backed bonds, securitization of thousands of different rent streams from these properties into bonds. So they sort of made this industry. There’s technology companies that have algorithms that go and hunt for the house that you want, like a dating app. It finds the house, just like the girl.
So we’ve seen a lot of things get added to this business and built out. And now we’re at this point where the infrastructure is there, management companies, service providers, where now it’s plug and play. So basically anybody on Wall Street, and around the world really, can commit huge amounts of money to this strategy, and buy a lot of houses. And we saw it really ramp up once it was clear that the pandemic wasn’t going to end the world, and once people realized that these people will keep paying their rents. These properties really cater to what has become the work from home class, the people who could still work and want to work at home, and maybe not want to work from an apartment, have a little more space.
So we’ve really seen the pandemic just really accelerate … and it was all because of these systems and this business that was built out of the last crash.

Dave:
That’s a great context. Thank you for sharing that. And I think it’s really fascinating to think about the fact that Wall Street, while we see it as a competitor to smalltime landlords right now, could be credited in a lot of ways for spawning this whole generation of investors that we’ve seen over the last year, because they helped find that bottom back in 2011. David, do you have any thoughts on how they’ve contributed to where we are today with so many people being interested in real estate investing? Do you think Wall Street plays a role in this whole movement we’re a part of?

David:
Well it absolutely did. To simplify the way that real estate works, on a macroeconomic level, is you have to understand the psychology of a buyer. So buyers drive markets. When people want to buy houses, the market is healthy. When they don’t, it’s not. And it tends to increase incrementally through the amount of buyers that are in a market, compared to the number listings. So if there’s two buyers for one house, they’re going to bid over asking price. The price now goes up. There’s an appraisal number that’s set as the value of that property. All the other houses in the neighborhood, theoretically, go up in value. Everybody makes money. People put more money into fixing up their homes, so now there going to Lowe’s and Home Depot and they’re paying all these other people.
More people want to sell their house, because they have equity. Or they want to refinance. That gives loan officers jobs. When they want to sell their house and buy another one, that’s the title rep getting paid and the home warranty company. All these transactions are taking place. The problem is, when homes stop going up in value, everybody as one big flock of birds that all move in the same direction at one time, they all withdraw and they don’t want to catch the falling knife. That’s the phrase that’s going on.
So prices start dropping, and there’s nothing to stop the bleeding. There’s no tourniquet, because all the buyers, me included, just sit back and we wait and see how far is this going to fall. We don’t want to jump in too soon. So what I’m getting at here is price is increase incrementally, but thy decrease rapidly. It just boom. That’s what we saw happening in 2010, 2011, late 2009.
The hedge funds, these really big buyers, were the ones that came in and functioned as the tourniquet when the prices were dropping. They came in and said, “Hey, the debt service ratio looks really good on these properties. We don’t know if they’re going to keep falling. We don’t care. They will cash flow if we jump in and we buy them.” And that’s what they did, they started buying houses. And then they started attending auctions and they started buying foreclosures.
And it’s not just that they … people tend to look at this and say, “Well they sucked up all the inventory and they’ve restored balance to the force.” I don’t think it was so much that. As all the other buyers so, “Oh, you jumped in. Now I got to jump in.” Now it’s safe to jump in. And everybody else came back in. So that’s when we started to incrementally climb our way out of the mess that we were in. So they absolutely played a role in the recovery. And I do think, Dave, it’s a good point that you highlight that. But we fed that beast, and they got a taste of meat. And now they’re hungry and a lot of us are competing with those same people.

Dave:
Yeah. That’s a great point. I do want to talk about what’s going on today. Because, as you said, Ryan, it seems like things are really accelerating over the last couple months. But before we go into that, we say “Wall Street is getting into housing market.” But that is a pretty ambiguous term. Can you tell us a little bit about who is actually in this market and what these companies look like?

Ryan:
Yeah. So to start, these were basically funded by private equity firms, by and large. There were some startup ventures like American Homes 4 Rent sprung from the management team behind Public Storage, the giant self-storage empire. And they were mostly real estate … Like Blackstone. Blackstone was a huge real estate investor. All they did was take funds from a private equity fund and say, “Well instead of buying office towers or shopping malls, we’re going to buy single family homes.”
And the reason private equity started it had a lot to do with the fact that their money’s locked up. A private equity fund holds investors’ money for a decade or more. A hedge fund, you can have a run on the bank. Everything else, the sky’s falling, money’s coming out of funds investors get their money back. Blackstone’s sitting there with billions, I forget how many billions. More than 10, I think, in the fund that they used to start Invitation Homes. They had money locked up and ready to go. So that’s what it started as, private equity funds. Most people would know them more for their corporate buyouts, like a leveraged buyout. But over the past few decades they really branched into real estate investment. And they had conquered every asset class in real estate except for the single family home.
You also had hedge funds, of course, that act pretty much in the same way. And now you have public companies. These companies have become fully formed, fully public, real estate investment trusts. You also still have a lot of private equity funds within the companies that are operating, whether it’s Invitation Homes, Progress Residential. A lot of those companies now are forming joint ventures where some big institutional investor, an insurance company or some asset manager will set up a side pocket. “We’ll buy $1 billion worth of houses with y’all. You manage them.”
So they’re sort of the tip of the sphere, which is these big companies that started up during the crash. And then there’s a lot of money coming from behind. That’s why I used a catchall like Wall Street or high finance. We’re talking global investors, sovereign Wealth Funds, pension funds. Texas teachers are in it. CalSTRS is in it. All these big pockets of money.
And really, lately it’s all a function of okay you have this pandemic. You see that people are still paying their rent, and suburban houses are hotter than ever. Meanwhile, everything else is very uncertain. Are you going to buy an office tower right now in New York City? You want a shopping mall? A lot of big pockets of money have money to do that stuff. And so it’s shifting more to single family homes, and that’s where we’re at now.
But when we talk about big numbers like you see these studies that come out from consultants, CoreLogic, John Burns Real Estate, that say one in four houses in this market are being bought by investors, that’s everyone. That could be a sole proprietor, all the way up to Invitation homes with 80,000 houses. That’s basically anybody who’s not going to move into the house they buy. So we have two different groups, and that’s why I use high finance or Wall Street to distinguish the billions from the millions or thousands. Right?

Dave:
Yeah, exactly. I’ve seen data that says about 15% of houses are owned by investors. But that includes anyone from has a single family, one rental property or flipping a house, up into these giant publicly traded companies that you’re talking about. And for years I’ve always seen that the majority, vast majority of them, 12%, 13%, 14%, of the 15%, are smaller time investors. But is that changing?

Ryan:
It is. I think there’s something like 16 or 17 million standalone rental homes in the U.S. And we’re still measuring the institutional investor, the Wall Street, we’re still measuring them in the hundreds of thousands of properties. It’s significant. It looks less significant when you consider the country as a whole. But when you chop it down to the markets that those companies buy in, and the neighborhoods they buy in, it’s highly concentrated. But when you blow it up to the whole country … Invitation Homes doesn’t own any houses in more than half the states in the country. But if you go to certain neighborhoods in Phoenix, they’re going to own a lot of houses, sometimes one after another down the street.
So it’s changing. But again, it’s sort of like two different scales that we’re looking at. The national level, it doesn’t look like much. Drill down, it’s pretty serious, pretty big numbers.

David:
I think that’s a really good point to highlight, that while these institutions are having a very significant impact on the overall housing market, they’re not operating equally in every single market. So when you say in Phoenix they’re likely to own a lot of properties, that’s because the price to rent ratio in Phoenix is very strong compared to what it might be like in California or in New York or in some of these other coastal markets. And the reason that they need a price to rent strong is they need cashflow to pay back the people they’re borrowing money from.
You can kind of interpret what they’re going to do based on understanding their model and how they work. Just like a lot of investors focus on cashflow if their goal is to get out of their job, they don’t want to be there anymore. So as you hear this, don’t become discouraged. You can use this to our advantage, and we’re going to talk about that, how we can buy in markets where hedge funds are operating, and increase the value of our houses. Or how we can find markets where they’re not operating, if we’re looking for deals and we don’t want competition.

Ryan:
Well I was just going to say, you can get a good idea when you look at these companies, particularly the publicly traded ones. If you look at their investor presentations and their quarterly filings, what we’ve seen is, just like what David said, is they bought houses really cheap in California or South Florida. And now those houses have gone back up, they’re not 40 cents on the dollar. They’re full price and then some. Does it make sense to keep renting out a $750,000 house? Probably not, when you can sell it, take the money and buy four in Phoenix that are cash flowing.
So we’re seeing a lot of that. They’ve been pulling out of Chicago, selling and moving out. High taxes, rent’s not growing, population’s not growing. Invitation moved out of Nashville. Interestingly enough, very soon after, property taxes went up across the whole region. So clearly that was a strategic move, to preserve cashflow and put the money elsewhere, where they could do better.
So yeah, just because they’re there now doesn’t mean they’re always going to be there. They’re like oil companies where they’re always trading horses and wells here and there. They’re always optimizing the portfolio.

Dave:
And what are some of the characteristics in markets that you see these companies look for?

Ryan:
Job growth, demographic growth. They don’t want to pay a lot for a house. You don’t want to own a $1 million house and be renting it. They like good schools. Within the markets they want proximity to work. Maybe that’s changing now, since the pandemic still letting a lot of people work at home. It’s like the Sun Belt boomtowns, the smile states. They don’t touch the Northeast. The Midwest, you’ll see Columbus, Indianapolis, some of the higher growth markets. They don’t really touch Detroit, Cleveland, Pittsburgh, and we can talk why. And those are much bigger markets for smaller investors looking to hit it out of the park with one house instead of trying to own 1,000 or 10,000 houses.
Honestly, Wayne Hughes, who started Public Storage and then American Homes 4 Rent, and just died recently, became one of the richest men in the country, probably, on real estate. And when he came up with the idea for American Homes 4 Rent he said, “I don’t want to find the house. I want to find the tenant first. And then I want to find the house that they want.” So he decided the best tenants would be families with kids, because they don’t want to move. You don’t want to disrupt your kids’ social life or education if the rent’s going to go up 5%. You just pay it.
And you want high earners, because high earners can pay rent. If your kid’s sick or your car has trouble, you don’t miss hours of work at a certain level of income and a certain job. You keep paying rent. You miss those tragedies that chip away at lower earners. And other people followed this, is he found the people that he wanted to rent to, generally speaking, a demographic, socioeconomic class, and then bought the houses that they would want to live in.
So you think of that person, that family of four, outside of Phoenix. And it’s the house that’s the all-American three bedroom, two bath, enclosed garage, good school system, a park down the street.

Dave:
And what is happening in these markets? If you are living in this market or you’re investing in one of these markets, how does a big institution investor coming into one of these markets alter the dynamics of that particular area?

Ryan:
We haven’t really seen them come wholesale into a new market in several years. But I did a story a few years back when they found Nashville. Nashville didn’t have a lot of foreclosures, pretty steady. But it was a boomtown, right? And there was a suburb south of Nashville called Spring Hill. I don’t know if you remember the old Saturn car commercials from GM in the 80s? It’s a car town. There’s an auto factory. And that business was coming back. There was a lot of hiring, a lot of people coming from Michigan and Ohio who had underwater houses at home and had to rent where they were moving to work.
And all these big investors, their house hunting algorithm pointed them here’s a place to buy. And very rapidly they bought something like 7% or 8% of all the houses in this town. What was interesting is I called city hall to check my numbers, city hall had no idea. So what did that tell you? That told you, number one, they’re cutting the grass because no one’s going to city hall to complain, or the council meetings. And it really didn’t change a lot. The subdivisions where these houses were concentrated, I found some where 15% of the houses were suddenly owned by three companies.
And they would have meetings and worry about it. And then they’d have a vote like, “Oh, let’s ban any more rental properties.” And they would routinely fail because once people got to thinking about it, well what if I have to rent my house someday. Do I want to cut off a whole segment of potential buyers? And these measures would routinely fail. So really from just the casual observer, you wouldn’t really notice. A lot of them don’t even put signs up, for rent. You never even know. You use an app.
I would say that the one thing that really changed was if you were going to buy a house, you might get there and they might say, “Sorry, somebody just bought this and paid cash.” Called over the phone. Never going to look at it. Doesn’t matter what the carpet looks like, they’re going to rip it out anyway. It’s not an emotional decision. Check the boxes, they bought it. “Sorry, we didn’t even get to put a sign out front.” I think that was the shock to people, is when they went out house hunting and found that there was somebody else.
Now if you were an operator and you had some rental houses in these places, you heard from them right away. They were looking to consolidate. They were buying from other owners.

Dave:
Given what’s going on there, if the normal resident of that city or just people who are home buying are starting to see that, David, what do you think the impact of all this would be on small to medium sized real estate investors? How is this all playing out for them when they’re directly competing against these huge institutional investors?

David:
Well that’s a great question. That’s why we wanted Ryan on the show. Because this is the carbon monoxide that’s affecting your investing that you don’t see or smell or know is coming. It just is affecting you. And most people don’t want to talk about this because it scares people. And we don’t want it to scare you. We want you to take this information and use it to your advantage. I think the average, the small to mid sized investor needs to understand is most of them go to the same place to find properties that they might want to buy. They’re going to Zillow, Redfin, Realtor.com, these portals that make it very easy to look at inventory that’s out there. They’re basically portals into an MLS, and their job was to help you avoid having to go to a realtor to see what’s out there. But you’re just looking at what realtors are seeing.
They’re also looking for the same thing. Most investors are looking for some degree of cashflow. Now appreciation and tax advantages, those all play a role in people’s overall strategy. But I would say the meat and potatoes of why most people buy houses is they want them to cashflow. They want cashflow and they want an easy way to find properties. Now the danger to the small or mid-sized person is now you put yourself into competition with the big dogs.
So this is why we’re talking about this same thing, is you may need to zig where other people zag. Or you may need to understand that the meat and potatoes of what you wanted, let’s say it was cashflow right off the bat, if you’re going to a market and you’re looking at the same houses that everybody else is seeing, you don’t understand that there’s people behind the scenes that are getting access to those homes before they ever make it to the MLS. That’s the scary thing. A lot of wholesalers are out there operating. And investors used to love wholesalers, because they’d bring me the great deal. It’s a better deal than I can find on Zillow. A lot of those wholesalers are not bringing you that deal anymore. They are selling it directly to the hedge fund who’s going to pay way more than you, and you’re not seeing the inventory from the wholesaler that you used to see.
You’re not seeing the inventory from the realtor that you used to see, because a lot of these people, like Ryan said, are doing business without a sign in the yard. They’re finding tenants for their properties or they’re selling their property without ever even taking it to the realtor. So while the average investors listening to this and saying, “I want to learn how to analyze a deal,” and, “I want to try to find a deal way below market value,” hedge funds are paying over market value because they’re playing a five year game or a 10 year game. They want to know what that property’s worth five or 10 years from now.
We’re all trying to find the deal of the century and waiting for the market to crazy, and I think that a lot of people don’t realize that they’re shooting themselves in the foot, that that carbon monoxide is operating behind the scenes. Big institutions are buying a lot of houses. And it should change our strategy. Now I can say what I’m doing, and I don’t want everyone to think that my situation is the same as all the rest of them. But I’ve become more aggressive with what I’m buying. I’m looking at will it cashflow, is it in a strong market, many of the things Ryan said. Are the schools good? Is the area good? Are jobs moving to that place? Very similar to hedge funds.
And once I find that, I’m not asking myself how low can I get this deal. They’re not going to take an offer $100,000 less, we’ll I’ll just shoot out another 50 offers. I’m saying someone else is going to buy this house in seven days if I don’t, it makes a lot of financial sense for me to do it. That’s good enough. I’m buying it and I’m setting up my own financial situation so that five years down the road this looks like a great deal. I don’t think you want to stretch to buy a house that you can’t have a bad month or two. If that’s your financial situation, those are not properties that you should be going for.
And then the last point I’ll make as far as how this affects the small and the mid-sized people is if you’re going to Phoenix because you really like the cashflow there, and the hedge funds are competing with you and you just can’t get that deal, you might want to find a market where they’re not operating. Can you go to the Northeast, like what Ryan said, where they don’t want to touch those properties?
And if you’re going to buy in Phoenix, can you find houses in that area that a hedge fund might not want? Something where the house is too expensive for the rent to keep up, so the hedge fund’s going to pass it up. But you can rent it out by the room, because you can put the time into managing it that they can’t, because they’re doing big things. You’re looking for those little spots that they’re missing when they’re combing over the entire area. And you can still be successful there. And you should enjoy the appreciation from buying in that market that the hedge funds are helping create because they’re limiting the inventory.

Dave:
That’s a really good point. And I do want to point out two things. First, I think that we are talking all about Wall Street and all these advantages that they have. But there are serious advantages that small investors have over these big companies. And we’re going to get back to that in a minute. But I do want to press on some of the advantages that Wall Street has so that we can just really understand what they’re doing. And then we can look at what they’re not doing and use that to fuel our own individual strategies. So Ryan, I read something the other day that said these institutional finance companies are getting loans at as low as 1.5%. Is that correct?

Ryan:
It could be. It could be. Invitation Homes just sold a bunch of bonds that I think were 2%. They’re using those to repay rent backed bonds that encumbered the houses they were cash flowing, the rent payments into the bonds. They can repay those and then unencumber the homes and then sell them or whatever they want to do with them. That could very well be the case.
Now you look at Tricon is probably a top four or five company. They’re tied to a private equity real estate firm in Toronto. They just got essentially enough money to buy $5 billion worth of houses over the next few years. That’s with a sovereign wealth fund over in Asia, the Texas teachers pension, and I forget the other one, another big, global investor. I think the cash in its like $1.5 billion, and then they leverage, they get a big bank loan. And they’re paying very low rates.
The point I would want to make is that when a company like that gets money like that, that sort of money, they’re not going to not buy houses. They’re going to put that money to work. Think about if you went to a stock broker and you gave them a bunch of money and said, “What should I invest in?” And they said, “No, the market’s not good. Take your money back.” Never going to hear that. These managers, they’re asset managers. They’re managing properties, but deep down they’re asset managers. They’re not going to not buy houses. So they’re going to be aggressive. And the aggressiveness might not be paying more, it might be willing to accept a lower rate of return.
Because again, like David said, they’re not trying to hit a home run with every house, like an individual might. They’re going to probably buy 18,000-some houses with this $5 billion, over the next few years. When you have 18,000, you can have some clunkers, you can have some that lose a few for a few months. You’re just spreading it out. So they’re going to have to be aggressive in terms of probably lowering their standards, in terms of yield and things like that, cap rates. The advantages, with a regular buyer, is they have the cash up front. They’re not having to go to financing.
One, there’s no emotion in it, which there’s emotion even if you’re an investor buying one or two houses. There’s probably some emotion that they don’t have. They don’t care what it looks like inside, because they’re going to gut it. They give that certainty when they make an offer it’s going to close. It’s a no-brainer to take their … all things being equal, you’re going to take theirs. There’s no risk of an appraisal knocking a deal off course. So they have advantages there that they can work.
I think what we’ll see is that they’ll probably come down. Not necessarily come down to market, but come back in their math on what they find an acceptable return to be. They can’t get a return anywhere else, so 5% still beats the heck out of the treasury at under 2%. When you’re thinking on the big level, you have to think like that, like what else are they going to do with the money.

David:
I like what you said that their aggressiveness might be being willing to take a smaller return. So around 2012, ’13, when I was first getting into heavy real estate investing, I would tell people I look for a 12% cash on cash return. That was the criteria that I looked for. And that made a lot of sense because prices, we didn’t know what they were going to do and they were kind of just slowly ticking up. Well was more people are buying homes and the inventory’s being limited, you can see that prices are being forced up. There’s no other way for them to go.
So that 12% number becomes less important to me because appreciation is just baked into what I’m buying. So what I’m willing to accept becomes more aggressive as far as cash on cash, which means I will buy properties that have a lower cash on cash return. So the person who’s clinging to that 12% number is just getting passed up. And smart institutions are weighing this into their decisions. And I think a lot of the people that we want to get the homes, the people listening to this. Blackstone’s probably not listening to Bigger Pockets Podcast to figure out what to do. I want them to understand, it’s okay to do this within your means. This is why Bigger Pockets has Bigger Pocket’s money and a lot of their financial independence resources, so people learn how to manage their own home and their own household so that they can reduce how much they may be getting cash on cash, because they’re living beneath their means.
In an article from CNN Business that was titled Wall Street is Buying Up Family Homes. The Rent Checks Are Too Juicy to Ignore, there’s a line where they mention even before the pandemic hit institutions already heavily invested in commercial real estate, side note, Ryan was just talking about that. And were looking for ways to diversify their income streams. Residential real estate provided an obvious alternative and one that has only become more attractive since the pandemic.
And if you think about it, retail space, business space, a lot of those commercial areas, where typically these big REITs and hedge funds were buying, have become much more risky. You don’t know if businesses are going to be operating out of retail spaces. Everybody wants to work from home. People are doing the Zoom thing. So it makes sense that that money would shift its way out of those big commercial spaces and into the residential spaces that are safer, because people still need a place to live.
Now traditionally it’s been very difficult for them to get into our space that we like to operate in, the residential space, because management was a pain in the butt. You did not have software that was available to manage properties. You didn’t have the demand and thirst for it where you could hand pick the best tenant. A lot of the time that the world’s been spinning, if you managed residential real estate you had to be really good at marketing your property to get the tenant to want to live there. Well supply has become so low and demand has become so high, that isn’t as much of a factor. Most people are making really good money managing properties right now. So that opened the door to let them come in, and they are coming in hot.

Dave:
Yeah. They definitely are. So what I’m hearing from both of you is that these companies have a handful of advantages over smalltime real estate investors. So I’m hearing their ability to take a lower yield is one of the main things. We talked a little bit about financing, the ability to make all cash offers and bid out people who don’t have that opportunity. And there was something else that you mentioned quickly, Ryan, that I want to talk about, is that they don’t care what the inside’s like because they’re going to gut them.
And I think something we haven’t addressed yet is that these companies are targeting the exact type of deals that a lot of us smaller investors see as huge opportunities because there’s upside in renovating them. So whether you’re doing a BRRRR deal or just fixing up a more traditional property, these companies are looking for that. They’re not going to be taking deals that were just … Some of them are buying just flipped homes. But you see a lot of them targeting these things, and that’s because they can renovate them at a much better scale and for cheaper than a lot of investors can, because they are huge and they can hire an entire team of contractors, full-time on the payroll, and just churn out these renovations and increase the value of the properties all on their own through forced appreciation.
So I’m curious, Ryan, do you see that as a key part of their strategy? Is that something that’s also expanding during this post-COVID run up in housing prices?

Ryan:
Well I think you hit the nail on the head. Invitation Homes and some of these big operators, they’re buying flooring and faucets by the train car load. They’re getting a good deal, better than me and you could get at Home Depot, even if we got one of those discount cards. So you have that. They standardize them, right. When you have 18,000 or however many houses Invitation Homes has around Atlanta … I don’t know if you’ve ever been to Atlanta, but getting from one place to another can take all day sometimes, with the traffic they have. And that’s the case in a lot of these cities.
So you don’t want to send your maintenance person out there for the call about the drippy faucet. And the traditional way to fix a drippy faucet is you go there, you look, you say, “Okay. This is it.” You take the washer or the stem out. Then I go to the hardware store and I get that one. Then I come back and I put it in. They already know, when they pull up, and before they even go, what that faucet has, what size washer. So they can fix that right away, in one trip. So by standardizing everything they’ve made management much more simple. And that’s one of the reasons why they just go in and do it their way at the onset, and why they don’t fuss about the carpet or whatever.
What’s really been interesting lately is that they’re buying a lot of houses straight from builders now, and from the Opendoor, sort of these programmatic house flippers that don’t really … they’re not a fix and flip. They’re not knocking down walls or things like that. They’re not removing lead paint. They’re sprucing the place up. Think $15,000 and less or work sort of situations. They’re buying a ton of those houses. And again, that’s probably more a function of the money coming at them and how they have to put it to work.
There is a big home builder out of Texas, LGI. They report earnings. They report a segment called … I can’t even say it, wholesale home sales. It’s a tongue twister. But think back, five years ago you wouldn’t think that a home builder would have a wholesale unit. You sell a house at a time, right? The rich among us might have a couple houses. But you didn’t sell multiple of them. I had an anecdote in a story from April where D.R. Horton, the country’s biggest home builder … they build these cookie cutter houses all over the country for the middle-class, the starter homes.
They built a subdivision outside of Houston. There was 115, 125 homes, something like that. They filled them up with tenants, then they put the whole thing on the block, “Who wants to buy this cash flowing subdivision?” It attracted a who’s who of big investors, real estate companies. And the company that actually bought it and won the auction was a firm called Fundrise that crowd sources individual investors. I forget what they paid, it’s in the article, but D.R. Horton made, I think it was a 50% return, gross margin, or something like that. They made basically effectively twice what they would’ve sold on margin selling those to individual buyers.
So you have this whole thing evolving where you’re building brand new houses straight for that channel. And at a certain point the buyers may weigh in, “Okay, we want all Moen faucets like this. Paint them all this certain color, Sherwin Williams, whatever the color that everyone’s doing now. Paint them like that.” So they are starting to buy. And I think that’s a component of that willing to come down. Somebody else is getting paid for making that house turnkey, ready to move in. And they’re starting to do that.
So that sort of bleeds into where we’re talking about because of the money they have to work they’re willing to come down. They’re not really looking for that deal where they say, “Well if we can get all the junk from this hoarder out of here and get rid of that smell, we can really do something with this house.” They probably still do those, but I think that’s where the sole proprietor can still make their money and find those houses, sort of off the grid, where the big money, they have to … now that they’ve got the infrastructure set, it’s plug and play with houses all day long, so you can afford to lose a little on the elbow grease. But I think that’s where we’re seeing the individuals and the smaller investors.
And David, you’d probably know, that’s probably where … When I talk to people in Phoenix who are still doing it on their own, that’s what they’re doing. “I just bought a hoarder’s house. It’s going to take me $40,000 to fix it up.” But that’s what I’m going to get. You’re going to have a hard time competing on the open market.

David:
Assuming they’re even getting to the open market. Because like you said, now some new home builders, that no investor was ever going to look at homes, we’re getting to a point where they might say, “Hey, I only sell to those guys. I build for them.” And at what point does Blackstone say, “We’re going to buy that home builder. And now we’re going to build houses that we are going to get for ourselves.” There’s a lot of things that are happening that are way different than the market has looked for a really long time. And it’s that carbon monoxide where it’s not being talked about but the effects are still happening when it comes to the people like us who just want to find what we call a deal.
There’s an article I have here from Slate that says, “Investment firms aren’t buying all the houses, but they are buying the most important ones.” And they talk about Invitation Homes, which is a $21 billion, publicly traded company that was spun off from Blackstone. We mentioned them earlier, the world’s largest private equity company, is buying in Atlanta. And it’s saying, “That while normal people typically pay a mortgage rate of 2%-4% these days, Invitation Homes can borrow money for far less. It’s getting billion dollar loans at around 1.4%.” And because of that, in some zip codes in the Atlanta area, around 2010 they were buying 90% of the inventory in those zip codes.
So if you lived in Atlanta and you were like, “My god, why is real estate becoming so expensive?” They’re able to borrow money at 1.4%. They then go make a cash offer, which is cheaper than your financed offer that you’re getting at 3%-4%. They get all the homes. They wait for them to appreciate. And they’re basically BRRRR-ing. Now they come in and they refinance that whole portfolio at really cheap money. They can take that 1.4% they’re paying, that’s their down payment. They can go borrow the majority of money from somewhere else who gives them a really good rate because they’re operating in high volume. And they move onto the next area, kind of like locusts that will soak everything up.
So it’s just one more example to highlight what you’re saying here, Ryan, and give some credibility to it. This is exactly what we see happening in many of the markets that investors have typically been trying to find deals in throughout the country.

Dave:
All right, so that makes total sense. And we’re seeing basically these big advantages. But Ryan, you touched on something really important, that small investors still do have some advantages. You already pointed out one really important one, which is that they’re not looking at these hoarder homes. David, what do you think some of the other advantages that small to medium sized landlords have over these big institutional players?

David:
Okay. So here’s a big piece of it. When you’re an institutional investor looking at a house, you’re not necessarily looking at a house. You’re just looking at an income stream. Their minds process this information the same as they would look at buying stock in a company, buying bonds, making private loans. It’s all just what return can I get based on the price to rent ratio. Which means they will look at a property from a lens that misses out on a lot of the value. And I know this because I’ve sold to them before. The people who are making their decision are getting paid acquisition fees based on how much they pay for the property. They’re not experts in understanding real estate. They are experts in making relationships with people that have homes to sell, and soaking them up.
So if there’s a property that’s worth significantly more than the other houses around it, but maybe the rent doesn’t keep up with it, their radar will miss it, like the Tyrannosaurus Rex that theoretically can’t see something that’s not moving. If you just stand still, they won’t eat you. Those houses will not show up on their radar screen. But if you know that market or you’re working with an agent who knows that market, who can come and say, “Look, houses in this neighborhood rarely come up for sale,” or, “They appreciate a lot. The schools are amazing here. And this has a lot of square footage or it has an ADU.” The hedge fund’s not noticing that it has an ADU. They’re not even going to put the time in to looking to see that. They’re just looking at whatever this Zestimate says of this, and how much rents are for the other houses around it.
So anything specific to an area that other people might not see is huge. One of the things that my team does is we look for houses that have more square footage than show up on the MLS. Lots of people finish basements, added bonus rooms, took a sunroom and turned it into part of the house, did an addition and they didn’t report it to the county because they didn’t want their property taxes to go up. So if you’re looking at it individually, through an agent or yourself, and you can find hey that house has 3,000 square feet not 2,200, hedge funds won’t see that. They’re only going to see the big macro picture. So you can find opportunities there.
There’s also the way you use the house. I like to buy really big houses, 4,000 square feet, 5,000 square feet, and then figure out how can I turn this into smaller units, how can I rent it by the room, how can I split it into different pieces, how can I convert a garage. What angle can I use to make this work so that I can make it cashflow and I can make it rent out for more? If they see a 4,000 square foot house, all they see is, “Yep, our payment’s going to be $6,000. The rent’s going to be $3,000. That’s a hard no. I’m just going to pass it.”
Whereas we can take that $3,000 rent and turn that into $8,000 rent, depending on doing it right. And these are California prices. I understand if you’re listening in Indiana you’re like, “Where does this $8,000 number come from?” It’s all relative, right? Adjust it to whatever your market looks … It could be $800 in your market. But I think that’s what we have to do.
And this is why Bigger Pockets is constantly pounding the table saying, “You’ve got to become an expert. You’ve got to learn how real estate works. You can’t look for the quick fix.” One of the things that I have been just railing about … this is a side note. I’m about to rant here. That drives me nuts about the investment community the last 5-8 years, is the tech world basically promoting laziness where they say, “Look, I just want software that will scrape Zillow and scrape Redfin, and find where the best house is and where the numbers work the best. And then I’m just going to go buy it. I don’t want to have to learn how this thing works.” They want to treat it like a stock. And that will really come and bite you in the keister at this point because, A, that’s the same data that all these institutional investors are looking at. They’re probably smarter and more resourced than the average investor would be. And B, you miss out on where the gold is. You have to be able to find those nuggets and find those properties that work better.
Like you were saying, Dave, that’s the advantage that the little guy has, is they’re willing to put in that work.

Dave:
I couldn’t agree more. I, for a living, look at and train algorithms. And I feel like people see that these big institutional investors, they have these advantages over people and they know exactly which houses they buy. And that’s just not true. I think these algorithms have a lot of ability to look at markets on an aggregate level and say this market is really great. Like the one you pointed out, Ryan, in Tennessee earlier. But what they cannot see is what a house looks like, what the curb appeal is like, what you can do, how you can alter the use, like you just said, David. There is no way for a list of data to be able to do that.
And so while I … I’m the biggest proponent of looking at data in the world, also accept that there are limitations to what data can tell you about your investments. And you have to use your own two eyes and your own effort to do that. And just like you said, you, as a small investor, can know your market better than any algorithm actually can. And you care more about any individual deal than these hedge funds do. To them it’s one of 10,000 purchases they’re going to make in a year. And so they can miss a lot of stuff. They can afford to miss. But if you’re a smalltime investor and you care more, you can do a better analysis on that one deal than they’re going to do on their 10,000 deals, because it matters more to you. And therefore, if you’re just willing to put in that effort to try really hard, you’re going to be able to find more home runs than they are able to, using just their data and this huge scattershot approach that they’re taking towards the housing market.

Ryan:
When I talk to people who are in the same business and in the same markets, some of them have used the arrival of this buyer to their advantage. So they’ll go and they’ll find the house. There’s one guy I’m thinking of in particular, a guy named Bruce who does a lot of work in Atlanta, the Carolinas, and Tennessee. He’ll go and find a house and make that big third bedroom into two bedrooms. He’ll put in the wall. He’ll do the work. And then it looks better to the buyer, it fits their metrics better. They call it a buy box. Really it’s like a dating app and they said no a bunch of times, and so the thing knows what to serve them up. They don’t like any of these things, so this doesn’t have any serve it up.
So there’s probably a lot of opportunities for your listeners to find those houses that they can make appealing to those buyers, that might not hit their radar but if you put a little bit of work into them maybe they do.

Dave:
Ryan, one of the other advantages, in addition to be able to do exactly that and treat each deal as a unique opportunity, rather than a cookie cutter approach. One of the advantages I personally like to think that I have at least is being a good landlord and being there for my tenants and making myself available, and really genuinely caring about if they have a good experience living in my properties. Do you talk to any tenants who live in some of these homes? Do you have any idea what the experience is like for them?

Ryan:
I do. And honestly, it’s skewed negative because you only hear from people who are having a bad time.

Dave:
Fair enough.

Ryan:
I’m renting in New York. I never call my landlord like, “Hey. Good job.” They only hear from me when there’s a problem.

Dave:
That would be nice though.

Ryan:
Yeah. And also, at the Journal we’re looking at finance. We’re looking at the big picture. To us, the tension is more on a high level of American’s since World War II rely … middle class Americans predominately rely on home price appreciation to gain wealth. We’re not really earning any more money than we used to in the 50s, because of inflation and slower wage growth. The middle class has held its share of the pie because we’ve owned homes and they’ve appreciated in value. So we look at the tension and frame it like. So if people don’t own homes, where do they get money for retirement? That’s the big picture tension.
Now, for living in homes, I can tell you, having spent time with the people who run these companies, they are very tuned to their ratings on … I don’t know, Google, whatever the Yelp for landlords is out there, any place people can complain. They are very concerned about that. The CEOs will get, “Give us all the reviews that have come in this week,” and they’ll read through them. For the same reason that you’re able to find a place to live on your phone, you’re also able to find out a lot of things about your landlord or your perspective landlord. That is an issue.
But I want to make another point, I’ve owned a home that I had to rent out. I bought high in 2005, wasn’t able to sell it for almost a decade. I had to rent it out so I could move for work. I would never raise the rent on this tenant that was staying in there. I never even met these people, but for some reason I felt bad. Now if I’m a company and I’m just making numbers and my fiduciary duty is to my shareholders, I don’t have that concern, so I might be more aggressive. Now, I try to think well if there had been big companies renting homes in my neighborhood and they were pushing rents, I would’ve probably raised rent. I would have followed them higher, without that human nature like I don’t want to squeeze these people that live in my house. I don’t want to make enemies. So there’s some tension there, for sure.
And you’re going from a system where … if you rented a single family home in America two decades ago, you knew your landlord. You might’ve gone to church with them or your kids went to school with them. You’d bump into them at the grocery store. You don’t bump into Invitation Homes. You can listen to their quarterly earnings call to find out what’s going on. But you’re going to a call center. And I’m not making this anything about them. I’m just using them, because they’re the biggest, as an example. But that’s a pretty dramatic change in the experience from a homeowner.
Now, on the same side, if I have a corporate landlord I’m probably getting the faucet fixed that day. I know from experience with a smalltime landlord here, things just don’t get fixed. They don’t care. So there’s a little bit on both sides. I don’t know if they’re better or worse.

Dave:
Because I’ve heard the opposite. I have a lot of people who come to me who rent some of my properties, saying, “I live in this big apartment building and yeah they have an app for submitting requests, which might be more convenient than calling me, but it just goes to the bottom of the queue,” and maybe they wait a while.
You might have a different experience than I do, but I hear sometimes the opposite and that people want to rent single family homes or these small two, three unit things that I own because they know that if something’s truly wrong, if the heat is messed up, that I will treat them like a human being and actually make sure that it gets fixed as quickly as possible, and it’s not just going to the end of this queue that these maintenance people have to slog through in a day. And I can just make sure to preserve that relationship as good as possible, and make sure that they know that I am genuinely trying to make their renting experience really good.

Ryan:
That’s a good point. The caveat is that I live in New York, and everything’s weird and different here. That would be a lot different than if I lived … I’m from Ohio, and if I called … I’m thinking of my dad. He would be right over. But to your point, some big corporation, okay you have a dripping faucet. Is it dripping into the sink? Not a problem. If it’s dripping down the back, they’re probably going to bump you to the front of the line because you’re going to cause water damage. I’m sure the same sort of technology they’re applying to find the houses and find out how much rent, they’ve probably applied stuff to who gets the maintenance call first, in order to preserve the property and to not cause other problems.
So yeah, you’re probably absolutely right in that, and I should’ve caveated it like I live in a, as far as real estate goes, on a separate planet from most of America.

David:
But that’s how real estate works, is different markets work differently. You hear about a lot of slum lords in New York type of a deal. But in other markets, if you’re a slum lord, you get a terrible review, no one’s going to rent from you. So regardless of it’s the hedge funds giving better service or the small person giving better service or different in different markets, what we should take out of it is that there is competition.
And at a certain point, probably not right now, but years in the future, when a tenant wants to go make a decision on where they’re going to rent, assuming we’re building more homes and the supply catches up and we get some kind of equilibrium, there’s some balance to the force with supply, they’re going to want to know what’s the experience like renting from this person versus that. There will be a Yelp for what my landlord is like. I promise you. In fact, if you’re listening to this and you go make that, you’ll probably make a whole bunch of money.
So the people listening that own one, two, three rental properties and they manage it themselves, maybe you’ve been getting a little lax with your service. Maybe you’ve been like, “Man, I don’t want to bother with that. I bought this property to go live on the beach. I don’t want to have to manage it now that I own it.” There are funds that will be trying to beat you, that will be trying to give better service than you so that they get the tenants at a certain point.
And so what I like about this conversation is that it just sort of opens your eyes that hey that person you’re dating has other options. Now’s not the time to get really sloppy and stop brushing your teeth and wear sweatpants all the time. You need to be on top of your game when it comes to this, because we will be competing over the same tenants.

Dave:
All right, make sure to stay away from David if you dated him for a while, because he’ll stop brushing his teeth apparently. Sorry, Ryan.

Ryan:
But also, if you know your landlord and something’s wrong but maybe it’s like, “Well, I’m moving in a month. I don’t need to mess with that.” And it’s some big corporation, I’m like, “Whatever.” But if it’s some guy, Bob, and I know Bob and I’m like, “Bob, there’s something going on with your …” You can probably engender a better relationship with your tenants, and therefore they would probably, just knowing what we know about human nature, treat your property better, clue you in to things that might be going on that might not warrant a maintenance call to a big corporation. But you might want to tell the guy next time he comes by to pick up the rent or the next time you see him in the grocery store or whatever. So that’s another place where you can have advantages.

Dave:
Totally.

Ryan:
And you have eyes on the property all the time. When I had a house that was 1,000 miles away, I heard every three months the property manager would take a look. And it turned out I had people selling drugs. I had people living there that I didn’t know about. I had all kinds of problems. And if I was living in town, that wouldn’t have happened. I would’ve known about those things. I would’ve heard about it from neighbors, things like that. Where the distance, even though I had a manager who was getting paid a good chunk of the rent to look after it, it wasn’t the same. So I can imagine that once you extrapolate that nationwide instead of just in a local market, that you could have the problems compounding.

Dave:
All right, well this has been an awesome conversation so far, and I’ve learned a lot here. I’m curious, Ryan, what do you think happens from here with these institutional investors? How do you see their behavior changing over the next years? And if you have any advice for how small to medium sized landlords should adapt to their next moves?

Ryan:
Well I think it’ll be really interesting if they can put all this money to work that’s come their way since the pandemic. And we’re talking tens of billions that can be leveraged into more billions. That’s number one. Will they keep buying the same sort of house? They have the same problems everybody does, not enough inventory. So how do they get around that?
The other thing that’ll be interesting to see is, when we do have prices that stop going up or maybe even go down, whether they go down differently … whether that floor is there in markets where they operate, compared to where they don’t, and to see what happens, if anything.
The other big thing these companies are going to have to contend with, and all investors, we’ve had home prices just soar. Well you know what comes next? David knows what comes next. In a year or two, the property tax bill is going to go up. And that’s the number one fixed expense for the big companies, and probably for a lot of the … because they don’t have really any financing on the houses. It’s all about property taxes. So that’s going to be a big issue coming forward, how do they grapple with that. Right now, the ability to push rents is covering a lot of problems. Lumber soared, and they’re building new houses just to rent. You can cover that up with the rent increases we’ve seen. Double digit percents year over year on new leases. We’ve never seen anything like that. Those are the things to look forward to.
There was an interesting lesson. Right before the pandemic, I followed around a woman who flips houses and does a lot of turnkey stuff in Cleveland. And Cleveland caught my attention, not only because I’m from there, but I noticed that it was in a group with a few other cities in the Great Lakes region of places where the gross margin on flips, so any house that was bought and sold within … sold within a year of a previous sale is how these were measured. People were doubling their money. Now that doesn’t account for their expenses or anything. But those markets, that has largely held up in those markets.
And I followed this woman around to see what she does. And it was sort of like she’s not going on the MLS. She’s finding a house that’s beat up, and putting a lot of work into it to renovate it. And then we’re at one that she’s doing … And she’s buying in this neighborhood that looks really bad. But she knows that the hospital there is doing a billion dollar expansion in the neighborhood, so that neighborhood’s going to be a lot better soon. So that’s that local knowledge of where to buy.
But while we’re at this one house that’s being finished up, she goes and walks around the block, or drives in this case. I think we walked to this one. And sure enough there’s an old beat up house with the kind of sign you’d put in a car, the orange and black signs, house for sale. Three different numbers scratched out. That’s the house she’s going to get. That’s the one that no one on Wall Street is going to find. That seller doesn’t even know what to do. It’s like somebody’s got this thing, they want to get rid of it. And these are really hairy projects. There might be lead, there might be all sorts of other issues. But that was where you could really make a lot of money either flipping the house, fix and flip, or fix and rent. And then flip to somebody who wants the cashflow.
And she was putting them out as fast as she could find these houses and get them fixed up. To buyers in California, a lot of them, who were selling a house that they had bought during the crash that had appreciated tremendously. They sell it, and to avoid the taxes, the 1031 exchange, they put the money to work in other cash flowing properties. And they would look far afield to where they could buy a few of them for the cash flow. And that was places like Fort Wayne, South Bend, Indiana. Detroit, Flint, Kalamazoo, Cleveland, Pittsburgh, Akron, the Rust Belt/Great Lakes.
That was just one story, but it was pretty eye opening that there was a lot of ways to get deals and to do this sort of work where other places that stuff had already been combed through pretty well.

Dave:
That’s great advice. I think that really shows a lot about what hustle and effort and local knowledge can do for real estate investors, even in the face of this increased institutional activity. David, what about you? Where do you think we’re going from here? And what would your advice be?

David:
I’ve got four points that I would make on what I think was an excellent discussion today. Thank you very much, Ryan, by the way, for the information you brought. That was very helpful. The first is that if we continue on the path we’re on, it’s safe to say that institutional investors in these funds will become a much bigger player in who owns real estate in America. Based on the track record that I see of what happens in politics, going after people like that will be the same as going after the rich.
So what I think we’re going to see is a lot more taxes being levied on people who own real estate, because as institutional funds become known as a person who owns real estate, it becomes okay to go after them. And a lot of the small mom and pop people are going to get rolled up in that same mess. And so I would expect to see, as this continues, a lot of the tax advantages we’ve had, like being a full-time real estate professional, the 1031 like-kind exchange, the stuff that’s made it easier for the small person to be able to build up their wealth. I would expect to see that stuff disappear. I don’t want it to happen. I’m planning on that being a case that will happen at some point.
Number two is that I think that short-term rentals is the next frontier for these big institutions. As they chase cash flow and they start to see a lot of people are doing really good with short-term rentals, they will go in and start buying those. And part of the reason that’s possible is that improved technology like Airbnb and VRBO and a lot of the ways that we automate everything, which we love, it also decreases the barrier to entry for bigger players. So while we’re like, “Oh, this is great. I have a short-term rental. I don’t have to do anything. It’s all automated.” That just opens up the door that these big giants can come in and kick you out.
So as they start to soak up the majority of the short-term rental market in the future, what we’ll start seeing is timeshares coming back. They own all these properties. They split them up into little pieces. And now you can buy a part of their fund through a timeshare or you can rent it out and it will be similar to them owning a hotel. Just that hotel is spread out across the country. So those properties will be much more difficult to find and we’ll see a lot of appreciation in those markets in the future as they step into it.
I think that we should be very aware that as technology improves and they make things easier for people, it is tempting to say, “Hey, it’s automated. Thank god for tech. I can rest on my laurels and I can just enjoy my leisure,” instead of thinking that lowered barrier to entry is making it easier for my competition to step in and take what I have. And they have a 1.4% interest rate when I have a 4% interest rate. They have teams and teams of people that can solve these problems quicker and faster and better than I can at a small level. So now is not the time to say, “Hey, I’m 27 years old, I got a couple properties. I should take it easy.” I just think that there’s going to be a big, mean bully. Mike Tyson’s coming to take your lunch money and you need to start preparing for what that’s going to look like.
And actively look for ways to invest in real estate that are not easy. I know this is different than what every other podcast tells you. It’s go after the easy stuff, right? And retire at 28 years old and just sit on the beach drinking Mai Tais. I don’t think that that is sound advice right now. I think that you should be actively looking for ways that it is more labor intensive to own real estate, because that makes it harder for these other bigger players to step in and take what you’ve done.
And then the fourth point I just want to highlight is that these hedge funds are not buying everywhere, specifically because of barriers to entry. So if you don’t live in one of these big markets that we’re talking about, this is almost a non-issue for you personally. So don’t freak out. Do not sound the alarm. Do not go stick your head in the sand and say, “I can’t make this work.” Most of the country is still an area where hedge funds are not buying. So people like me, I’m buying more in California. Hedge funds are not coming in here and taking these away. We’re going to talk a little bit more in future episodes about how I-buyers are affecting markets like that, and the threat that they pose to investors.
But as far as institutional capital, that’s not the case in many different states. So check out my book, Long Distance Investing. Check out a lot of the information that Dave Meyer’s putting out about what’s happening in different markets. Find a market that will work for what your goals are, and plan your strategy around that rather than just walking into the mouth of the beast and trying to compete with these companies that are soaking up all the homes.

Dave:
That’s awesome advice. I do want to also mention that if you are looking to invest in different markets, the next episode, David and I are actually going to be talking all about how to identify markets that fit your specific strategy. And David is probably going to take us all to school on how you can actually logistically pull off this feat that seems really challenging. So definitely check that out in the next couple of days.
All right guys, this has been an incredibly conversation. I’ve been really having a lot of fun talking to both of you. Ryan, thank you so much for coming. David, as always, thank you for your knowledge. Anything else you guys want to add before we part ways?

David:
Ryan, I just want to take a minute to thank you personally for coming on and doing the show with us. Your wisdom was much needed and very much appreciated. A lot of what we talk about on the podcast is our opinion based on what we see in our own experiences. But I loved getting this objective source that we have in you, that really is sort of sitting in the crow’s nest and looking at the entire market, and is an expert in these things that we talk about. So thank you very much for coming on and sharing some of the things that you’ve been paying attention to. I really appreciate it.
And Dave, as always, thank you very much for supporting all those points with the Bigger Pockets insights information for bringing some objectiveness to a very subjective industry of real estate investing. So thank you both very much. Everybody, please check out the next episode of the podcast where Dave and I dig into how to find the market that’s right for you, as well as the strategy that’s right for you in that market so you can start taking action.
This is David Green for Dave Meyer and Ryan Dezember. Signing off.

Speaker 3:
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In This Episode We Cover:

  • Why home prices dropped to the lowest point in 2011
  • How the pandemic gave institutional investors more buying power
  • Who are the “wall street buyers” that are buying thousands of single-family homes?
  • Why you should “find the tenant” before finding your next property
  • The “carbon monoxide” of investing that most investors aren’t paying attention to
  • How institutional investors use economies of scale to rapidly rehab homes
  • What small investors can do to beat institutional investors at the closing table
  • And So Much More!

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