There has been a growing chorus of industrywatchers and writers fretting that the current rebound in the housing market is little more than a bubble. While their concerns are valid, the players getting in on the market today should have more staying power than the highly leveraged individual buyers who helped fuel the industry’s last bust.
The housing bubble that helped usher in the 2007 to 2009 recession and deep market correction was fueled by market speculation. While that’s not surprising, it is important to remember who the speculators were—small investors. Often, mom-and-pop investors were leveraging themselves to the hilt, helped along by overly lenient bank policies, in the hope of quickly selling the home to the next “sucker.”
Of course, many buyers were buying homes to live in, too. But far too many bought more home than they could afford, in the belief that the value of the home would rise. When home prices fell, both the home buyers and the flippers were left owning a home worth less than the mortgage encumbering the property. The logical move, then, was to simply get out from under the house by dumping it as quickly as possible or letting the bank take it.
Thus, at the end of the day, mortgage lenders wound up owning a lot of homes. For banks, that goes under the category of real estate owned, or REO. Its not something banks like to have a lot of on their balance sheets, for many reasons. In most cases, the banks simply aren’t designed to handle owning and managing properties, so they sit, vacant. This leads to many ills, including vandalism, theft, and general disrepair. Clearly, as a property deteriorates, its value falls even further.
An Opportunity
Large investors rightly saw this as an opportunity. With The Blackstone Group L.P. (NYSE:BX) among the most vocal and active investors of late. The company’s portfolio is reportedly more than 16,000 homes. That’s a massive property portfolio. The plan at present is to fix the homes and then rent them out. This is the same plan that other big buyers have, too. What happens then, however, is the big question mark.
The Blackstone Group L.P. (NYSE:BX) could use the revenue from the rents to back bonds. This is what many expect to see happen in a big way. However, some early investors in the space have apparently been unimpressed with the potential. This includes hedge fund manager Och-Ziff Capital Management Group LLC (NYSE:OZM). In late 2012, this company informed its partner in a portfolio of about 300 homes that it wanted out.
As Reuters notes: “The decision by Och-Ziff to exit the market after just a year is notable since the hedge fund was one of the first institutional investors to see the large supply of foreclosed homes in the United States as a new asset class that could generate consistent income if operated as rental properties.” Essentially, Och-Ziff Capital Management Group LLC (NYSE:OZM) didn’t believe the returns would be large enough from the investment to make it worthwhile. Of course, with the housing price run up, the opportunity for capital gains could make an exit profitable and timely.
Prescient or Nervous Nelly?
That a company the size of Blackstone is still going strong in the housing space and Och-Ziff is getting out, begs the question of who’s right? That’s a hard one to answer, however the big risk is that home prices fall again and the current raft of buyers look to get out fast, further depressing prices.
Clearly, large sales would depress prices. However, these buyers aren’t mom-and-pops in over their heads, trying to get by on a stagnant salary, or worse, scraping to get by after losing their jobs. They are well-financed companies that can hold on to investments for lengthy periods of time, even if those investments aren’t performing as well as expected. Moreover, if the rental income from these homes is used to back a bond, selling homes one at a time out of the bond deal becomes increasingly complicated. That means that bulk sales would be likely, which would probably be looked at differently than single home sales.
The REIT Option
In addition, selling the homes isn’t the only way out of these purchases. Silver Bay Realty Trust Corp (NYSE:SBY), for example, was created by Two Harbors Investment Corp (NYSE:TWO). The real estate investment trust owns, rents, and manages single family homes. The company came public in late 2012. Silver Bay used the money it got from its initial public offering to buy over 3,000 homes from its parent Two Harbors, with the intention of acquiring additional single family homes to grow its business.
While Altisource Residential Corp (NYSE:RESI), another notable single-family REIT, was set up as a blank-check company to buy homes, which increases the risks for its shareholders, such entities could help stabilize the market. With cash on hand and a need to buy homes, Altisource would be an ideal buyer of single-family home portfolios. As a REIT, however, Altisource would unlikely want to buy homes tied to bond deals. Regardless, Blackstone and other big buyers could easily follow the REIT exit strategy if they want out or find willing and motivated buyers.
There are Risks
Still, there are good reasons why the single-family home, as an asset class escapade, could fail. For example, housing markets change over time. So what was once a desirable place to own can slowly turn into a place where you wouldn’t want to walk alone at night. Also, managing thousands of single-family homes is still an untested proposition. So while Och-Ziff highlighted the return issue, there are many other legitimate concerns here, some of which may have played into the less than desirable return profile the company noted.
Investors looking to get into the single family home rental market should probably avoid Altisource until it actually has a notable home portfolio. Silver Bay, with a sizable portfolio, could be a good option for more aggressive investors. Blackstone, meanwhile, is far more than just a home buyer, making it an appropriate option for more conservative investors. Even if the current home price run-up turns out to be short-lived, Blackstone and Silver Bay probably aren’t going to be running for the exits.
The article Is The Single Family Home Market A Bubble Again? originally appeared on Fool.com and is written by Reuben Gregg Brewer.
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