It may be time for institutional investors to exit the single-family home rental industry in some markets, according to a recent report from RealtyTrac, a provider of housing data and analysis. Surveying the single-family home sector in December, the firm found that for properties purchased in 2012, investors could realize returns ranging from 38 to 43 percent if they were to sell out in the coming months, while many of the markets they’ve invested in would be facing much lower price appreciation in 2015 and beyond. Below, RealtyTrac’s Vice President Daren Blomquist explains the findings and what they may mean for bulk investors.
NREI: According to RealtyTrac’s most recent report, the homes purchased by institutional investors during this market cycle have appreciated in value by double digits. Do you expect further gains in 2015?
Daren Blomquist: I think we’ll see appreciation slow dramatically in 2015. We’ve already seen that in the second half of 2014 in many of these markets. The reason is that prices are reaching a ceiling for these investors in terms of where they make sense as rental cash flow-producing properties. When these investors go in and buy a home, in order to produce the types of returns on rentals they are looking for, it has to be at a certain price point or below, and in many markets we are hitting a ceiling on that. This is a very broad look at it, but the general price range I believe they are looking at is under $200,000. That’s a property that, broadly speaking, in most of the country, you can rent for $1,500 a month. That’s going to give you a gross rental return of about 9 percent a year, which is right in their sweet spot. But once you get above $200,000, those returns go down. In a way, institutional investors become a victim of their own success—by buying up properties, they push prices up very quickly, but that makes it difficult to acquire.
NREI: Where you are seeing that happen?
Daren Blomquist: In terms of the markets where we are seeing the appreciation slow most dramatically, I would put Phoenix at the top of the list. For the last six months, it has seen single-digit appreciation. A lot of California is in the same boat, where appreciation has dropped from double digits to low single digits. Atlanta is slowing down, the Sun Belt. Florida is still pretty strong, but I think we will also see it go down in 2015 to single digits.
NREI: Do you think we will see institutional investors dispose of a significant portion of these properties in the coming months? Or do you think they may opt to hold onto them for the long term?
Daren Blomquist: I think we’ll see them start to sell off some of their inventory in 2015. I would suspect it will be fairly gradual. They’ll be analyzing their own portfolios, and the properties that are performing very strongly, in neighborhoods that are performing really strongly, they are going to keep those. These are properties with strong rental returns, low vacancy rates, low occupancy expenses. They are going to separate the wheat from the shaft and sell off some of the poor-producing properties that have gained in terms of price appreciation.
And the other thing is that [with] the bigger operators, it’s not just that they are going to sell, but they will put that capital into another market that they think is better and buy rentals there. I think we are already seeing signs of the next wave of buying being in the Midwest, [the] upper Midwest specifically—places like Ohio, Michigan, where home prices are still extremely low. Texas is going to be another hot place for them to buy in 2015.
NREI: Who would be the most likely buyers for these assets—will it be other institutional investors, local investors or end-users?
Daren Blomquist: I think the most likely buyer is going to be the smaller, regional investor in those markets who is still going to keep the property as a rental. It’s just an easier transaction for these players to sell to another investor. But I certainly think that you’ll see some of this being marketed to end-users as well. And the advantage of the end-users is that, depending on the market, they may be willing to pay more for the property than an investor.
NREI: What, in your view, are the biggest challenges currently facing institutional investors in single-family homes?
Daren Blomquist: I think the biggest challenge, [from] talking to some of these guys, has been the day-to-day management of these properties. And that includes not just the maintenance, but dealing with vacancies, dealing with turnover and all those expenses and the headache that goes with being a landlord. I think that has been the really unpredictable part for these guys, and the toughest. That’s what Warren Buffet predicted in explaining why he wasn’t going to invest.
NREI: Do you think that institutional ownership of single-family properties is a trend that’s here to stay? Or are we witnessing a very unique moment in the history of the real estate industry?
Daren Blomquist: That’s the million dollar question. I think it’s here to stay, but save for a few select players, it’s going to be a niche industry. It’s not going to take over the world in terms of the housing market. I think we are going to continue to see the majority of housing owned by mom and pops and smaller regional investors. I would say it will be 50/50. About 50 percent of the big hedge funds and private equity money that’s come into this sector will exit and 50 percent will stay for the long term.