- RealEstateEconomyWatch.com - http://www.realestateeconomywatch.com -
Are Hedge Funds Blowing Bubbles?
Posted By Steve Cook On March 13, 2013 @ 8:33 am In Commentary, Foreclosure Situation, Investment Activity, Investment Watch, Opportunities, Performance | No Comments
Last month the New Republic published a provocative article on hedge funds and real estate investing (Your New Landlord Works on Wall Street) by former TV producer David Dayen. He said out loud what many people have been whispering.
Dayen argued that Wall Street hedge funds, backed by billions from wealthy investors, are turning the once sleepy business of renting and managing houses into a festering real estate bubble that’s bound to burst and blow up everyone standing nearby, from tenants to hedge fund investors to homeowners to the entire national real estate economy. “It’s the next Wall Street gold rush, with all the warning signs of a renewed speculative bubble,” he said.
Another Bubble Brewing?
The essence of his case is that the billions hedge funds are pouring in the REO-to-rental business will jack up prices for distress sales far above their value as an asset. Home values will follow and artificially inflate home prices once again, only to crash once more. Two bubbles in less than ten years. “There’s far less excuse for such nonchalance this time, coming just a few years after we saw the precise consequences of the bubble, and the means by which it grew,” he concluded.
In the interim, the funds will do a poor job rehabilitating the foreclosures they buy and make life miserable for their tenants, especially when compared to the “typical owner of a single-family property for rent is a local mom-and-pop business with a stake in the community who manage properties as a primary vocation.”
“For the most part, they have partnered with large property management companies to deal with day-to-day operations. The houses they purchase often come to them in substandard condition. And the management companies, with thin profit margins of their own, tend to renovate as little as possible before seeking renters,” writes Dayen.
I quibble with a number of the author’s assertions:
Viva la Effervescence
However, there’s more than a kernel of truth in his central message. Hedge funds are definitely having an impact on foreclosure prices and inventories, not so much on a national basis, but in the less than 5 percent of real estate markets where they active. They may or may not be creating local bubbles, there’s definitely some effervescence at work, as my partner David Lereah used to say.
At about the same that that the New Republic published its article, I interviewed Rick Sharga, formerly with RealtyTrac, now with Carrington Mortgage, and asked him whether small investors will survive the hedge funds.
“There are over 3000 counties in the country. Institutional investors right now seem to be focusing on about a dozen. There are opportunities for individual investors across the country, especially in markets that are off the radar of the bigger guys,” he said.
Sharga’s right about the localized impact of hedge fund acquisitions:
Consequences and Contingencies
Some of the consequences of the hedge fund incursion have been positive. The funds are contributing to the overall investor demand, which has been the single saving grace throughout the housing crisis. Investors built bottoms on spiraling markets and saved homeowners and the nation at large from losing even more home equity than it did. Just like individual investors but more so, hedge funds are buying and renovating distress sales that would otherwise lower home values, blight neighborhoods and increase the numbers of underwater homeowners. They are also housing tens of thousands of families, many of them foreclosure victims looking for a new start.
Already “investors have begun to pull out of one of the leading edge markets, Phoenix, as most of the foreclosed properties worth purchasing have been snapped up. The big run-up in prices there could collapse as demand collapses, depressing prices and putting the recovery in jeopardy. And any economic downturn would increase rental vacancies and send this entire market reeling. We may not only have a bubble, but already the beginnings of a bust,” he writes.
Aside for the fact that in Phoenix neither is demand showing any sign of collapsing or nor are prices depressed (they’re up 24.64 percent year over year in February), it may be the first place hedge funds pull out in earnest. After all, it was the first place they all chose to land.
“We got to a point in Phoenix where we said these prices don’t make any sense. It’s mind boggling to hear an institutional investor say that their model is based on buying a property, holding it and then flipping it as prices appreciate and then buying a property for 25 percent over list price. It makes sense. But that’s not our model so we’ll let everyone else do what they want,” Sharga told me in our interview.
Now, if the funds would just move away from overworked markets like Phoenix and turn their sights on metros still plagued by large foreclosure inventories, places like Philadelphia, New Jersey, Cleveland, Detroit, Chicago, greater New York City they might find better discounts, better quality properties and large markets for rentals. And they would be doing those markets and the national real estate economy a real service by soaking up the remaining volumes of foreclosures that are depressing local housing markets.
Whimper or Bang?
Dayen is right the Hedge Fund Incursion won’t last. Fewer bets are more certain than the withdrawal of a number of the 50-plus funds and REITS in the REO-to-rental business. The Foreclosure Era has only two or three years left before the flow of defaults dries up and the front end of the REO-to-Rental model?acquiring properties at a significant discount ?disappears. Investors who were sold on quick returns of 8 percent or more will tire of paying more than they expected for properties and waiting three, four, five years, maybe more, maybe never, for securitization to produce a payday. Like most things in life, it’s just not as simple as it looked.
One of the catalysts for the Hedge Fund Incursion and the push to securitize single family rentals was the void for institutional investors created by the meltdown of private label mortgage backed securities in 2006. As the economy picks up, institutional money may find new opportunities, including the return of a viable private label mortgage market that is a priority for both the big lenders and the federal government as they seek a private sector alternative to Fannie and Freddie. As time passes, the private money behind the hedge funds may also realize there are better opportunities elsewhere can be doing a lot better elsewhere. They’ll unload their assets quickly and quietly, selling to other funds that that are sticking it out for the long haul or, on a limited basis, dumping them on the for sale market. The great Hedge Fund Incursion will end with a whimper, or the sound of air escaping from a balloon, not a bang as Dayen expects. Left will be a few survivors, who may realize some of their initial goals-securitization, massive numbers of rental units, management economies of scale?but only if the SFR rental market remains strong.
Future demand for SFRs is another question mark. In light of the findings of the single family rental survey that we released a week ago, I’m increasingly confident that with time SFRs will become a more accepted option, and develop a stronger market than it has today, which is doing just fine. However, the homeownership lobby sees a potential new home buyer in every SFR despite tough lending standards that aren’t going to change any time soon, skimpy for sale inventories and the emotional baggage of the housing crisis that has left an entire generation wary of the homeownership risk.
In Dayen’s scenario, the surviving hedge funds would “make life really miserable for renters,” which would be an extremely foolish thing to do. In fact, their success will largely rest on maintaining the lowest possible vacancy rates, which will call for excellent property management skills. In our single family rental survey we found that real estate investors, predominantly individual not hedge funds, are doing a much better job of management than multifamily owners. The big guys will need to learn from the little guys or they’ll be out of business in a heartbeat, their rentals empty and their securities worthless.
Article printed from RealEstateEconomyWatch.com: http://www.realestateeconomywatch.com
URL to article: http://www.realestateeconomywatch.com/2013/03/are-hedge-funds-blowing-bubbles/
Click here to print.
Copyright © 2009 RealEstateEconomyWatch.com. All rights reserved.