Housing is currently seen as being on solid footing with strong loan quality and high demand
The rapid rise in institutional investors buying residential property is reshaping the US housing market
Concerns are rising that any instability with institutional investors could lead to a housing crash
Lessons Learned Since 2008
Many aspects of the mortgage industry were evaluated and regulated after the housing crash of 2008. Today mortgage loan quality has never been higher and default rates remain incredibly low, leaving many homeowners and economists to believe US housing is now safe from harm.
However, headwinds such as spiking rates, waning new construction output, and a slowing economy are starting to surface. There is now a more concerning systemic risk that wasn’t present in 2008 — institutional investors. These entities comprise both buy-and-hold and flip investors who buy, rent and sell homes by the tens of thousands. With their ample resources, they are quietly crowding out individual buyers and reshaping the entire landscape of US Housing.
Buy and Hold Investors
Major buy-and-hold investors include players such as Progressive Residential and Invitation Homes boast residential portfolios of 70,000 to 80,000 single-family homes, each. These investors most often rely upon credit lines lent by big banks, global investment firms, venture capital firms, and hedge funds to acquire large quantities of residential real estate. Their buying binge has not only driven up prices and driven out family buyers, but by creating more ownership by fewer entities it also creates a systemic risk.
There are two specific risks to be concerned about with these investors:
Stability: If these investors get into any financial trouble, which could be sparked by the loss of funding or a rapid increase in borrowing costs, they could be forced to fire-sell thousands of homes. That level of inventory hitting the market simultaneously could cause widespread price cuts and potentially prompt other investors to follow suit, causing home prices to spiral downward.
Opportunity Cost: It’s been easy for these entities to secure cheap funding in the past few years when rates were historically low, investment returns were limited, and inflation fears – real estate has long been seen as an ideal inflation hedge – were brewing. However, as inflation fears wane and better investment opportunities appear, the major firms bankrolling these entities may look to reallocate funds elsewhere, with little notice. People need shelter, investors don’t. Major investors can liquidate or shutter credit lines the moment a better opportunity presents itself.
In fact, we’re already seeing this take shape: the “cap rate” used to evaluate rental income returns is starting to inch downward near the 10-year US Treasury yield. Imagine that … an investor can make a similiar return with either option, but one relies on US renters to never miss a payment while the other is fully guaranteed by the US government!? This is a perfect example of opportunity cost and the risk facing institutional investors who rely on outside funding.
Flip investors use similar funding mechanisms as buy-and-hold investors, but they have much shorter duration plans. Typically they plan to only own the properties for 30-180 days, enough time for sellers to vacate, conduct minor repairs, re-list the property, and close the sale.
Perhaps the most well-known institutional flip investor is the preeminent online listing service Zillow, but in late 2021 they exited the flipping sphere after taking a $304 million write-off because their inability to properly forecast prices lead to them purchasing homes over market value. Zillow’s exit left other companies, such as Opendoor, to gobble up market share. Entities like Opendoor will buy your home with cash and let you rent back while you pack up and find a new place. It’s an enticing proposition, but it’s also a potentially flawed model with significant risk.
Instead of logically buying at a discount, which was nearly impossible with demand at ultra-high levels, Opendoor often bought homes at or above market value. This is only profitable if prices continue increasing; even the slightest downward shift in prices could lead to outsized losses. In fact, Opendoor’s stock price has cratered by nearly 90% from its high in 2021. Worse yet, online listing services suggest Opendoor currently owns nearly 10% of all homes listed in the Phoenix area. This is a perfect example of potential systemic risk.
We are greatly concerned about the impact of these institutional investors on individual homeowners, but near term, we feel their systemic risk is potentially greater. They undoubtedly have intriguing models and, with enough capital, could reshape the US housing market permanently. However, any time only a few players carry outsized influence – in any industry – they create potential systemic risk.
In 2008 it was a systemic risk that caused a financial crisis that permeated the globe. While that 2008 systemic risk appears to have been rooted out and regulated (hard to say they were eliminated forever when “too big to fail” institutions are now more powerful than ever), a new systemic risk could pose a similar challenge.
Let’s hope our regulators are monitoring these institutions closely and have solutions ready.