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Here come the mom-and-pop REO-to-rental investors!

Institutional interest in the asset class peaks

April 25, 2014
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Much has been written and discussed over the past year or two regarding the new asset class: REO-to-Rental.

While attending the MBA Single-Family Rental Summit held in Arlington, Virginia on April 22nd, it struck me that there is already a shift taking place in this market.

This was natural due to the emergence of institutional investors such as American Residential Properties, Blackstone, Starwood Waypoint Residential Trust, Colony American Home Rental, and others that bought thousands of REO properties in well-publicized transactions.

But, according to several panelists who spoke at the summit, large institutional participation in this market may well have peaked and is giving way to smaller investor groups and individual investors.

This one-day, first of its kind seminar held by the MBA provided attendees with a wealth of information from industry experts, including representatives from the Federal Reserve and FHA, lenders, investors, industry analysts, and more, including a representative from Moody’s Investors Service. And while there truly was a great deal of useful information shared, the one point that I focused on was the above-referenced market shift.

The shift from institutional investors to smaller groups and the oft-referred to “mom-and-pop” investors, in my view, based on comments made by panelists here and considerable material I have read was precipitated by the shrinking availability of REO properties in key markets, such as Arizona, California and Nevada.

Finding appropriate properties to purchase for rentals in these states is getting more difficult and more costly to acquire.

While there remains significant foreclosure activity in judicial-foreclosure states, like Illinois, Massachusetts, New York and others, the scale of activity of these large groups has retreated considerably in other major markets. Another contributing factor is diminishing yields. California is a bit of an anomaly because property “values” have been artificially increasing substantially due to rising demand and decreasing availability of properties.

This does not make for increased confidence that prices will continue to rise, however, primarily because affordability issues are forcing many first-time buyers out of the market, which impacts all the home prices up the food chain at some point. Despite the belief of some experts at the summit that affordability ratios are nowhere near critical mass in California, there are enough new reports that the so-called housing recovery is stalling that large investors might be leery to continue buying up properties.

The advent of “REO-to-Rental” is certainly new, but the reality is that the single-family rental market has long been a major part of the housing industry.

In fact, single-family rentals today make up over 30% of the rental market in America. With so many households preferring to rent a single-family home rather than live in an apartment building or apartment community, it is understandable that the single-family rental market will continue to make up a large segment of the overall rental space.

Institutional investors, however, may not continue to participate.

Adding to the reasons for diminishing home ownership is the fact that although hundreds of thousands of homeowners have been able to secure loan modifications rather than go through foreclosure, there are far more who did short sales or were, unfortunately, foreclosed upon. Many of these households are among those preferring to rent a single-family home rather than an apartment.

Another reason for diminished home ownership is a change in attitudes toward renting, rather than owning, particularly among Millennials. Panelists agreed that many Millennials prefer mobility and flexibility in terms of where they work and live. They do not have the same desires for home ownership that previous generations had aspired to.

Other factors that could be influencing a decrease in acquisition activity by the institutional investors may be that it is still too early to predict the actual yields on investment to be derived from these investments. One panelist made it clear that this is still a “growth phase” and is potentially “volatile.” While some panelists said it is clear that this practice is no longer considered to be a “trade,” and is a business, there remains doubt as to whether or not it is a “good” business for large investors. Some participants even wondered aloud if the business models of the institutional investors would prove to be sound, or not.

The truth is that there isn’t one “housing market” as all real estate is a local. Therefore, while large institutional investors might not want to play in this space in massive ways going forward, smaller investor groups and individual investors in many markets will continue to view the single-family rental market as a positive investment.

One panelist even stated that with so much uncertainty out there regarding retirement accounts, the practice of buying homes to rent out might be a sound retirement strategy.

That advice is geared specifically to mom-and-pops and not the investment community — proof the buyer base is shifting in the asset class.

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