Recently, I’ve been trying to research what is going on with buyers in the residential real estate market. Specifically, I’m curious what is happening with institutional investors. My gut tells me that we’re probably seeing a lot more interest in single family housing units from institutions… but there’s very little data to prove or disprove that.
In that research, I posted a question to my friends on Facebook about whether they’re seeing any investor activity in their local markets. Most seemed to say no, because prices have climbed to such a level that there is no rental yield to be had. This from my friend Jennifer Archambeault, an experienced broker in Austin, summarizes the idea:
It is hard to imagine that most of Austin will continue to drift upward. We have seen some pretty intense hikes case in point two years ago homes that were sellout between $300,000 and $400,000 now fetching $600,000 to $700,000. That nearly eliminates instant cash flow because rental rates cannot keep pace. So how long will an investor hold at a break even? How long will it take to net another $200-$300k return if ever. Granted there are some areas that are still prized to trend upward but most areas becoming an investor makes absolutely no sense.
Of course she’s correct. And since most houses in most markets across the U.S. have seen insane increases in price, becoming an investor makes absolutely no sense.
Yet, every single day, we hear about buyers getting outbid in ludicrous ways. I recorded a podcast with a broker in San Antonio the other day, and he made the point that on a recent property that went for something around $400K, the losing bid was $60K over asking, all cash, all contingencies waived, inspection waived, and with a 10 day close. His comment was, “I’d really like to see what the winning bid was.”
This post then is utter and complete speculation as to what might be happening. I’m not a hedge fund manager, but I know quite a few of them. I think I have at least an idea as to how they might be thinking about things. So let’s explore what such financial investors might be thinking in terms of residential real estate, especially SFRs.
The Dilemma of Fund Managers
The first observation I’ll make is that none of us who are not big fund managers have any real idea of the dilemma they face. But over the past few years, I’ve come to understand a bit of it.
Most investment funds have to generate a return that beats some index, whether that’s the S&P 500 or Dow Jones or what-have-you. Otherwise, your investors will pull their money out and put it somewhere else. The pressure is rather intense. In 2020, the S&P 500 gained 16.26%. So to justify the steep costs of a professional fund (often 2% of assets, 20% of gains), the fund has to deliver significantly better than that. Some of the top hedge fund managers have 40% or better 3 year returns and manage billions of dollars.
They get paid extremely well, but they have to outperform the market… or else. When you read in the papers about some hedge fund losing billions on a short squeeze, it’s because the managers have to chase returns that are better than the market average. They have to take risks, but then figure out how to manage the risks as best as they can.
Second, when you’re managing that much money, it’s not easy to place investments. For most of us, putting $10K into some stock and having it go up by 50% is awesome; we made $5,000! If you’re managing $26 billion (as Coatue Management does), $5K is not even a speck. In fact, $5 million or even $50 million is not enough to move the needle. Remember that you have to deliver better than S&P 500 index of 16.26%. For Coatue, that means more than $4.2 billion in returns in 2020.
There are not that many investments one can make to see that kind of a return. In fact, there aren’t that many investments you can make, period. As one investor told me a couple of years ago, “If the investment isn’t at least $100 million, we’re not interested even if it’s a fantastic investment, because it just doesn’t move the needle for us.”
Public companies stock and bonds are more or less the main investments because few others even need billions of dollars in investment.
The Money Printer Go Brrrr
Prior to 2020, I think a few of these funds played in residential real estate via specialized REITS and other vehicles. We’ve all heard already about Black Rock and Invitation Homes and other big players. But those were based on the idea of investing in housing as rental properties, and taking advantage of the cash flows from rent plus asset appreciation.
I think things changed in 2020. Again, I have no real proof or evidence, but here’s something that I know for a fact that a lot of professional investors pay attention to:
That was in March of this year. Dalio has been talking about this for quite some time.
The two things that struck me about what he said is (1) if you buy the average thing that is inflating at 2% a year, you’re better off than holding cash or bonds, and (2) you need to diversify.
On March 15, 2021, Dalio wrote this on his LinkedIn blog titled, “Why in the World Would You Own Dollar Debt?”
The economics of investing in bonds (and most financial assets) has become stupid. Think about it. The purpose of investing is to have money in a storehold of wealth that you can convert into buying power at a later date. When one invests one gives a lump-sum payment for payments in the future. Let’s look at what that deal now looks like. If I give $100 today how many years do I have to wait to get my $100 back and then start collecting the reward on top of what I gave? In US, European, Japanese, and Chinese bonds an investor has to wait roughly 42 years, 450 years, 150 years, and 25 years[1] respectively to get one’s money back and then one gets low or nil nominal returns. However, because you are trying to store buying power you have to take into consideration inflation. In the US you have to wait over 500 years, and you will never get your buying power back in Europe or Japan. In fact, if you buy bonds in these countries now you will be guaranteed to have a lot less buying power in the future. Rather than get paid less than inflation why not instead buy stuff—any stuff—that will equal inflation or better?
Couple that with Dalio’s observation that in every case in history, governments print money in a debt crisis:
Then, when the printing of money and the central bank’s buying up of financial assets fails to get money and credit to where it needs to go, the central government—which can decide what to spend money on—borrows money from the central bank (which prints it) so it can spend it on what it needs to be spent on. In the US the Fed announced this plan on April 9, 2020. This approach of printing money to buy debt (called debt monetization) is vastly more politically palatable as a way of getting money and shifting wealth from those who have it to those who need it than imposing taxes, which leads taxed people to get angry. That is why in the end central banks always print money and devalue.
Now, look at this graph from St. Louis Fed:
From January of 2020 to December of 2020, the M1 money supply went from about $4 trillion to $17.8 trillion. That number has gone up to $18.6 trillion in March of 2021. Given what the Biden Administration has already announced, I expect we’ll see that number go higher still for a while.
Lots of reasons why the Fed did this, and COVID was and is a big part of those reasons… but fact is, we have printed, are still printing, and will be printing a lot of money for the foreseeable future. That means the dollar will be devalued and on purpose.
Fund Managers are Brilliant
So let’s return to the men and women who manage these funds. They are among the best in the world in finance. They understand money in a way that most of us simply do not. They don’t get those jobs managing billions of dollars of other people’s money if they weren’t.
I think they see what is happening to the Dollar and saw that long before the public did. They don’t want to be holding cash, and they don’t want to be investing in bonds. But they have to diversify as much as possible, and they have to find something in which they can invest not millions of dollars, but hundreds of millions of dollars. Yes, they’ll put that money into equities, they’ll invest internationally, but at some point, they start to run out of investments to make.
Enter real estate.
I think what is happening is that there are at least some investors now in the housing market who are not real estate investors as we traditionally think of them. These new financial investors are not as worried about rents and yield and cap rates as actual real estate investors are. They’re more concerned about real estate as a storehold of wealth, of buying power, in the face of devaluation.
As Dalio said, just buying something, anything that increases by the 2% a year of inflation is better than holding cash or investing in bonds. So how much better is it to put money into something that is increasing by 14% a year as American residential real estate is?
Even if the mania calms down, and home prices only go up by 2-3% a year, that beats the hell out of what bonds are offering. Even if you make zero rent the entire time you own the home, it’s not a terrible storehold of wealth. If you do manage to rent it out, even if the actual yield doesn’t pencil out, that’s better than nothing, isn’t it? If you take big losses, oh well, that’s a tax writeoff for your profits from the other parts of your diversified portfolio.
A billion dollar fund might put 10% of its assets into housing purely as a hedge against inflation/dollar devaluation. They don’t need that housing to generate a single dime of rent. They just need it to appreciate above and beyond inflation. That seems like a reasonable bet… and 10% of a billion is $100 million. Who cares if you’re paying $60K over asking price, so the home is $360K instead of $300K. Who cares if it won’t appraise; a hedge fund isn’t looking to finance that anyhow. Who cares if you waive all contingencies; the fund isn’t looking to live there or even to rent it out. It’s just a storehold of wealth. And they have a lot of wealth they need to store…. not that many places where one can park $100 million safely… 300 single family homes might fit the bill very nicely.
I say this because a friend who is a fund manager recently told me that he put a big chunk of his personal assets into crypto. Not because he believes in crypto necessarily, but because he needed to diversify, and he didn’t believe in the Dollar or in any fiat currency. And he’s one of the smartest minds in the world when it comes to finance and investing.
Why wouldn’t people like him make similar decisions for their funds? And don’t forget that these are funds that have to generate above market returns, or face investors fleeing.
Are We Seeing Financial Investors in Housing?
What we don’t know, of course, and why this post is pure speculation is the extent to which financial investors are in the housing market. Maybe there isn’t a single one like that. If there are, maybe they’re very limited in their activity and only in certain highly desirable markets today. Or maybe, they’re everywhere and throwing money around not because they want to chase yield but because they need to store their wealth in something, anything, that will beat inflation.
As Jennifer said: “So how long will an investor hold at a break even? How long will it take to net another $200-$300k return if ever?” What if the investor doesn’t care about netting another $200-300k return? What if the investor only cares that the $700K house he bought in Austin appreciates by more than inflation for the next 5 years? Any rental yield is just a bonus on top of that primary objective?
Doesn’t that change the calculus some?
-rsh
