American Housing Prices: Bill McBride on Institutional Investors

by JT McGee

I think Bill McBride is undoubtedly one of the best economic forecasters and reporters in the United States. His blog, Calculated Risk, is one of the most popular macroeconomic blogs around, especially for real estate trends.

Like McBride, I think housing is one of the world’s most important economic indicators. Through 2007, the expanding real estate bubble in the United States contributed 75% to America’s GDP growth. Home equity begets more consumer spending, which in an economy where 70% of economic activity is simple and pure consumption, home equity is everything. That’s why I’ve always said we all work for the real estate industry.

In a recent post, McBride shares his view on recent investor interest, which anyone should read. Some interesting tidbits: investors are displacing owner-occupied demand, and investors are making up a greater share of the buying spree in higher value homes. In higher-priced markets like the Bay Area, investors purchased a whopping of 27.3% of all estimated sold homes, up roughly 10% from the year-ago period.

Real Estate Investors Going Nuts!

The market for real estate could not be hotter. Existing home inventory is falling rapidly as owners who are still underwater cannot bring their homes to market and those who are currently holding onto their homes don’t want to sell at a bottom.

Months of supply only modestly increased to 4.7 months in March due to a slightly slower sales pace. Here’s a chart of unadjusted housing inventory:

I think it’s interesting to compare the performance of single family homes to financialized real estate – public REITs that turn a business into a pure investment. Whereas buying your own homes requires work, buying real estate as a REIT requires much less work to find individual properties. Basically, REITs remove the impact of your own labor in the economics of real estate deals, so cash on cash returns are lower.

I don’t own REITs, so when I saw this snapshot of the best performing asset classes from 2009 to the end of 2012, I was shocked:

REITs, as measured by the NAREIT U.S. All Equity Index, have trounced every single asset class from 2010-2012. Furthermore, REITs beat every single asset class in total returns from 1993-2012. In the last 20 years, the best investment was…yup, real estate.

Obviously there are a few macro realities that gave real estate a winning boost:

  1. Falling rates – Real estate is, in some sense, a perpetual bond. Finance 101 says rising or falling rates have the most pronounced effects on long-dated fixed-income investments. Perpetual is forever. Thus, real estate valuations are buoyed the most by falling rates.
  2. Cheap capital – One of Amazon’s biggest advantages – yeah, I’m going on a tangent – is that its investors love seeing the company compete on price. Amazon raises extraordinarily cheap equity capital that it uses to slaughter rivals on price. REITs have the same advantage in raising cheaper and cheaper capital. Thus, REITs that have a low cost of capital can buy, buy, and buy away, driving up prices as they find plenty of investors willing to participate in secondary offerings to buy more properties.
  3. Institutional delay – REITs find it very easy to raise new debt and equity capital. Private real estate investors won’t be getting a bank loan for $100 million any time soon. However, institutional funds are raising multi-billion portfolios for new acquisitions, even in single family homes.

What excites me most about real estate is that it will soon be very transparent, and perhaps more liquid, than it has ever been. A recent spin-off, Silver Bay Realty Trust Corp. (SBY) is still in its infancy, however, as its portfolio matures, it will provide a public proxy by which we can gain insight into the biggest real estate markets in the country.

In due time we’ll know average rental prices, cap rates, vacancies, and capex costs from its portfolio of single family homes around the country. I’m impressed by the company’s financial reporting as it breaks out, in very good detail, the status of its portfolio in its quarterly filings. I really think the data gleaned from a mature Silver Bay portfolio will completely change the game for how we look at and value single family homes since it’ll be the first true pure-play with years of data from several locations around the US.

That kind of detail should only continue to bring more and more investment capital to American real estate. Based on historical norms, real estate still isn’t all that costly. The price to rent ratio is back in line with the pre-bubble levels from the very early 2000s, but still slightly higher than in the 1990s.

This is only just the beginning of a whole new bubble. Here we go again.

{ 3 comments… read them below or add one }

Darwin's Money April 22, 2013 at 21:53

I agree we’re seeing some strength even if areas that aren’t considered “hot” but I don’t think we’ll see the days of double digit annual gains on a sustained basis for many, many years, perhaps not during our lifetime. The economy and jobs are not supportive. New household formation isn’t happening, lending standards would have to become lax again which would lead to yet another crash.

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American Debt Project April 23, 2013 at 10:57

So you’re usually not that interested in investing in real estate, but now, with a greater amount of information available on the financials of a single deal, you would consider it and are more likely to invest in it?

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PK April 23, 2013 at 10:59

Huh, price to rent not looking that bad. I guess that means (if you see the price raises everywhere), renters must be coughing up a bunch more than a few years ago.

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