About 6 years ago, deep-pocketed investors and institutions gathered at the Megatrends conference. Blackrock CEO Laurance Fink told them something that seemed unconventional in 2015. The two greatest stores of wealth internationally today is [one] contemporary art…,” said the $6 trillion asset manager. “And two… apartments in Manhattan, apartments in Vancouver, [and apartments] in London.”
This helped turn a quiet trend amongst a handful of super-rich investors, into the vacant home epidemic. Millions of homes, in the world’s most important cities, now sit totally empty. Families started to compete for shelter, with global millionaires looking for safety deposit boxes.
Buying a home or two, or whole floors in condos, works if you’re trying to store a few million. Or maybe even a few hundred million. It’s not a great solution if you’re an institution looking to allocate billions though. Billions of dollars in homes requires a much bigger purchase scale. They also can’t sit empty, or politicians will look for ways to ruin the party.
I used to joke that if the institutions thought buying a home was great, they would just buy them. They have access to cheaper credit than you can dream of, and you’d be shit out of luck. Since home prices are volatile, it wasn’t an attractive bet. Then something changed. Debt became ridiculously cheap, and people began accepting bailouts as the norm. Institutions found themselves with more money than they knew what to do with. So… they started to buy the homes themselves.
Institutional Investors Are Buying Hundreds of Thousands of Homes
Institutional investors in advanced economies have been jumping into bidding wars, and scooping up single-family homes. Blackrock has been the headline maker, but they’re far from the only institution doing it.
One article cites a bidding war for a whole neighborhood with 200 investors. Blackstone, Fundrise, and probably your local pension were amongst the bidders. People are no longer just bidding against other buyers. They’re bidding against pension firms, and often the website they found the listing on.
The trend is relatively small, but rapidly growing across the United States. Institutions owned an estimated 276,000 single-family homes in the US at the end of 2020. This is an increase of 38 percent from 2015, which is quite the shopping spree. The trend is still in its honeymoon phase though. It’s existed for less than a decade.
If it works out, expect to see explosive growth in the segment. Especially if monetary policy continues to run along these lines. Put a pin in that for now though. We’ll come back in a sec. I just want to clarify something about Blackrock.
US Single-Family Homes Owned by Institutional Investors
The number of single-family homes owned by large institutions in the US at the end of each year. Numbers exclude iBuyers, like Open Door and Zillow.
Source: Amherst Group Estimates; Better Dwelling.
People frequently confuse Blackrock with Blackstone, often mistaking one for the other. Even journalists. Blackrock is the world’s largest asset manager, with $6 trillion under management. Blackstone is the world’s largest alternative asset manager. The former is somewhat limited in their play for single-family homes. At least directly, for now. The latter one is somewhat of a pioneer for the industry.
Blackstone is run by two former Lehman Brothers execs, who left to start the merger and acquisition firm in 1985. They spun off Invitation Homes, the largest single-family home buyer, with ~80,000 homes in 2020. Blackstone sold their position in the company, but are trying their luck again. Shortly after existing last year, they invested in the Toronto-based Tricon Residential.
Tricon is the sixth-largest buyer of single-family homes. Even though they’re based out of Canada, they have few investments in the country. The ones they do have, are newly minted purpose-built rental towers, like the Selby. This is likely due to rental yields, which are great for purpose-built rentals in Canada. Not so much for secondary rental units, where landlords often have to subsidize the tenant.
Canadians are actually big players in this space though, providing a lot of capital for investment in the US. The country’s Public Sector Pension Investment Board (PSP) is another huge example. The state-owned pension recently invested $700 million into a single-family rental home partnership with Pretium. Pretium recently bought the US-based Front Yard Residential, who owned 11,843 single-family homes in 2020. If you include multi-family, Pretium owns about 55,000 units.
Phew. Glad that’s clear. Now, why the fuck are they buying grandma’s old house?
The Collapse of Fixed Income Rates Has Investors “Chasing Yields”
No institutional landlord for single-family homes operated before 2010. Their clients would much rather buy government bonds with decent yields. After the Great Recession, bond yields paid peanuts. By 2014, Wall Street was chopping up single-family mortgage debt, to sell to bond investors. That’s key to the issue. Institutional investors aren’t buying single-family homes because they want to be your landlord. They’re buying them because they’re chasing yields. Investors don’t care if the yield comes from bonds or your weekly pay cheque, they just want the yield.
Yields, Fixed Income, and Quantitative Ease (QE)
Let’s go over the basics so everyone is on the same page. A bond is a fixed income instrument that acts sort of as an IOU for debt. The issuer (a borrower) takes capital from the bond buyer (lender), in exchange for interest paid. The rate of interest paid is called the yield. Obviously, you want the highest yield possible, with the least amount of risk.
Credit markets are priced the same way much of the market is — by supply and demand. If demand for bonds rises faster than issuers need capital, the yield falls. Excess money leads to cheap rates, because a borrower is competing to lend the money.
It works the opposite way as well. Yields rise if demand from borrowers rises faster than people want to lend money. It’s a self-regulating system, where the market manages risk. It chokes credit when it’s risky to lend money, and provides more to the market when it has little risk. That’s how a free market works, and how capitalism is designed to work.
Quantitative ease (QE) breaks that model, when it becomes worried its stakeholders may lose money. Instead of purging market inefficiencies, they use the unconventional policy tool used to address a lack of inflation. Central banks buy bonds with their access to unlimited capital. This bids up the price of bonds, and lowers the yield paid. They’re essentially flooding the system with liquidity. QE lowers the cost of borrowing below natural market mechanics. This leaves rates artificially low.
Since credit markets compete for capital, the cost of borrowing falls for most things. Great if you need to refinance your debt, but it sucks if you’re a bond buyer. A buyer with unlimited capital is willing to lend money for lower than inflation. That often means committing to lose money in real terms, which really sucks. Institutional investors are left with two choices — lose or move the money.
From Bond Buyer To Bond Issuer: Institutions Are Dumping Fixed Income For Alternative Investments
Low interest rates do three important things that are worth remembering:
- Lowers the cost of borrowing. It’s cheap to borrow. Really cheap, sometimes. This makes it easier to have profitable outcomes in a debt-financed business. It’s also why interest rate shocks funnel money to the super-rich, who have access to much more credit.
- Allows larger amounts of debt to be carried. In an ideal world, home prices stay the same and it becomes cheaper to buy a home. In reality, it allows buyers to more easily absorb high home prices.
- Crushes fixed-income investors. These investors, largely institutions, now have to risk losing to inflation, or invest elsewhere.
Now, let’s put that together. You’re an institution (congrats btw). You no longer get decent yields lending people money, because it’s so cheap. However, you now have access to debt cheaper than any regular person can get, and home prices are primed to rise. What do you do? You buy the fucking homes before regular people can.
The lower interest rates have dropped, the more institutions have had to reallocate. Fixed income and cash were about 50 percent of the allocation for institutions in 1990. By 2019, that amount dropped to just 30 percent. Allocation to alternative investments went from 7 to 29 percent over the same period. It absorbed the shift out of fixed income to alternative assets. Hey, you just learned about the world’s largest alternative asset manager. Look at you.
U.S. Pensions and Endowments Move to Alternative Assets, 1990-2019
Source: Morgan Stanley.
A Small Amount of Money Can Have A Big Impact
So they’re buying homes to replace their fixed income investments, and “chasing yield.” But it’s too small of a buy to actually impact home prices, right? They might be very large institutions, but it’s a small portion of single-family homes. That’s a popular take from journalists these days. Instead, they blame everything from your intelligence to your neighbors. It’s a bad take. Much like money laundering, the purchase size is less relevant than how it’s applied.
The number of homes they’ve purchased is small relative to the single-family housing stock in the US. That much is true, and you would be right if they were purchasing across the United States. But they aren’t buying across the US. They’re buying in very specific cities.
Institutions are a large part of buying activity in the cities they operate. From 2019 to 2020, institutions were 14% of Atlanta home purchases. Similar observations are made in Charlotte (7.4%), and Phoenix (7.3%). These cities also have some of the fastest-growing US home prices a year later — Atlanta (11th), Charlotte (5th), and Phoenix (1st).
It’s not a coincidence. Algorithmically buying every home under a threshold is going to push prices higher. Having a buyer take 15% of inventory is also going to push home prices higher. Everyone understands supply and demand, until they don’t like what it shows.
Share of US Single-Family Homes Bought By Institutional Investors
The share of single-family homes bought by large institutions from 2019 to 2020 in their most active target markets.
Source: Amherst Group Estimates; Better Dwelling.
Why those cities? Why not New York City, San Francisco, and other places with more expensive real estate? That’s because this is about yields, not about home prices. In New York City, the cap rate for a single-family home is estimated to be ~1.37%, below the rate of target inflation. In Atlanta (2.42%), Charlotte (2.38%), or Phoenix (2.43%), you at least beat inflation. If Blackstone was looking for a third home where they can catch a Broadway show on the weekend, they would pick NYC. If they want a replacement for their bond allocation, they would pick the smaller cities.
These are also cities where affluent big city folks are looking for “cheap” housing. While someone that grew up in Atlanta might think $2,000/month is a ripoff to rent a single-family. Someone from San Francisco may wonder how many other dudes are renting with you. Increasing yields, and/or the potential for higher home prices makes it a win-win. These firms have also been disposing of homes with rapid appreciation as well.
This is also likely why so many Canadian firms haven’t tried the play at home. In Toronto, almost half of secondary market investors were negative cap years ago. That means the owner isn’t collecting rent, but actually paid so much, they subsidize it. It’s a negative yielding asset, bought entirely to speculate on rising home values. For institutions to jump into that game, rents would have to soar, or prices would have to crash.
Traditionally residential real estate was seen as too volatile. Home buyers are emotional, and this can often lead to exuberance, which leads to price crashes. It would never compete with the security of government bonds. That changed after the Great Recession.
Unprecedented bailouts didn’t teach investors a lesson. It taught them capitalism and risk are dead. Asset prices are now thought to never fall, and interest rates will never rise — even in a risky environment like a global pandemic.
The combination has investors looking at residential real estate in a different way. The decline in value is backstopped politically by other homeowners. Since homeowners are the majority of voters, it’s thought to be a solid bet the government will try to prop up prices. Everyone’s tax dollars, including future generations, can be used to preserve value.
Does that mean home prices will forever rise, with institutions buying the dip? This has only existed for a decade, so we don’t fully know what issues are forming. Institutions are increasingly willing to bet that’s the case though. If they’re right, they collect rental yields higher than fixed incomes. The government will also try to prop up home prices. If they’re wrong, they collect your taxpayer-funded bailout.
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