Real estate investors large and small have helped clear foreclosure inventories, supported prices in ailing markets and renovated sizable portions of the nation’s housing stock. However, if their share of the housing stock or debt financing grows, they could pose significant risk to the nation’s financial stability, a new study by two Federal Reserve economists concludes in what is believed be the first study exist on the effect of single-family-real-estate business investor activity on housing markets or other outcomes.
“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,” said Fed economists Raven Molloy and Rebecca Zarutskie in a working paper published December 5.
However, the economists raised alarms that the greater use of leverage, which makes financial distress of the investors more likely, which may force them to liquidate their asset holdings at suboptimal values. “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,” they concluded
The economists urged the close monitoring of the development of markets for bonds backed by rental-income streams for the development of potentially destabilizing structures or concentrated exposures. Last month Blackstone marketed the first security based upon rental income from single family rentals, a 480 million deal employing collateral from rental cash flow from 3,207 foreclosed single-family homes. As many as two dozen private equity firms and real estate investment trusts have been buying thousands of single family rentals with plans to issue securities based on their holdings.
Using real estate transactions data from CoreLogic, they said 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. Preliminary readings suggest that this share remained high in early 2013. While this initial increase was the result of small investor activity, 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.
“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,” they wrote.
Noting the REITs commonly lose money in their first three to five years, they noted that 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.
“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 concluded.