Last month, I wrote a post wondering what financial investors might be thinking and noted that the post was almost entirely speculation:
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.
A reader recently sent me some information that suggests that maybe, the speculation wasn’t all that speculative. I am now reasonably sure that the housing market — especially in SFR (single family residential) — is being distorted by a new breed of investors moving in.
This trend changes how we all should think about residential real estate. Since I’d like to know what I think about that, I wanted to read what I wrote on the subject. So here we are.
The Evidence
This infographic, which is very large, is from John Burns Real Estate Consulting, a firm that specializes in residential real estate:
I count $9.26 billion from this infographic above, but as the footnotes show, a lot of the amounts are equity and can be levered. The Lennar/Centerbridge/Allianz deal alone leads to $4 billion in purchasing power for example. And these are just the largest deals since 2020. I have to imagine there have been dozens of smaller deals that didn’t make this awesome infographic.
John Burns produced a white paper on this phenomenon that they called “Housing Mania 2.0” which you can find here. And there’s a video on that page that is worth watching.
There are some details of John Burns study/take on things that I don’t agree with (for example, classifying market makers like Opendoor as an investor) but I find nothing objectionable in the general takeaway. A few of them from the linked page:
While we are not in an investor-induced bubble today (largely due to low rates), we see the potential for one to emerge rather quickly. Consider the following:
- Investors purchase 20% of all homes sold nationally today (combining resale and new) and are shooting higher in many major markets and numerous secondary markets.
- Investors account for a higher percentage of home sales today than during the speculative subprime bubble years in several top housing markets, including:
- Houston, Riverside-San Bernardino, Los Angeles, Orange County, San Francisco, Seattle, Nashville, and San Jose
- Many other top housing markets are close to matching investor market share peaks during the subprime bubble years.
Their theory is that this investor activity is being driven by a new breed of investors entering the housing space:
Investor activity can fluctuate dramatically due to capital availability, which can quickly surge and then shut off, something we like to call “hot money.” In the last few years, and at an increasing rate during the COVID pandemic, we have seen a plethora of capital seeking investment in US housing for the following reasons:
- COVID pushing institutional real estate investors to the safe haven of US housing
- Investment diversification, with worldwide stocks at all-time highs and bond yields at all-time lows
- Hedging against COVID stimulus inflation risk
- Global yield chasing
- The democratization of rental real estate investing, with new technologies and slick investing platforms gaining popularity among the masses
- Tax incentives and less stringent regulatory hurdles
I realize there’s a good amount of confirmation bias going on here, but yeah… I think these guys have nailed it more or less. Especially the “hedging against COVID stimulus inflation risk.” That was my thesis in my last post about financial investors.
John Burns (the founder & CEO) in the video says that new information technology in real estate is making it possible to conduct research very quickly around the country (“know what the home is worth and what it will rent for”) and then says;
I do think there’s some truth to now real estate moving from an alternative low liquidity asset class into more of an institutional investment, and when you see pension funds moving in, I do think that’s a game changer. I do think that can have the potential and probably is going to make housing permanently more expensive in America.
I can’t help but agree.
Then we have this story from The Real Deal, citing a Redfin study:
Investors dropped a record $77 billion on homes in the past six months, according to Business Insider, citing a Redfin report. That compares to the $55 billion spent on homes in the second and third quarters of 2020, when buying dropped as Covid cases surged and cities imposed restrictions.
I didn’t major in Math, but $77 billion + $55 billion = $132 billion? Since Q2 of 2020 when the housing market started to bounce back hard?
So… what does this mean for the real estate industry as a whole?
Implications
The short answer is, “I don’t know.”
The longer answer is, “I’m going to try to figure it out and make as informed a set of predictions as I can.” The caveat that opinions are like um… noses… and everyone has one applies here. The further caveat that I am not an economist, although I do look like one, also applies. Finally, the obvious caveat that I am not an investment advisor and nothing herein constitutes investment advice applies although one would think that’s pretty f’ing obvious.
With all that out of the way, here are a few implications I believe we will see as a result of this changed dynamic.
1. Housing Will Be Permanently More Expensive
While I agree with John Burns that housing will be permanently more expensive going forward, leading to #renternation, I do think it’s more useful to look at it slightly differently. As I suggested in my previous post, I think it isn’t that housing is more expensive, but that the dollar is worth less. From that post:
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.
More and more mainstream observers, analysts, and random yahoos are starting to realize inflation/hyperinflation is on its way.
If it is true that we have printed 25% of all dollars in existence since the beginning of 2020, then it seems reasonable to think that home prices will stabilize at 25% higher… or more, since demand curve has changed, and inflation expectations are driving investor activity. But even when investors are satisfied, home prices will be higher simply because the dollar is lower. I expect to see all asset prices higher as a result, and housing is an asset.
2. Size Will Matter, But Not All Sizes Matter
Real estate is famously a fragmented industry, with 1.4 million REALTORS out of some 3 million licensees. Real estate is hyperlocal, and many markets are dominated by small boutiques. Even if there are large brokerages, each agent is a 1099 independent contractor who is essentially running his or her own small business.
That works extraordinarily well to serve families who come from every walk of life, who are facing unique circumstances and unique considerations. Families are moving from one neighborhood to this other neighborhood for personal reasons, for life circumstances, and whatever else.
That doesn’t work all that well to serve hedge funds and pension funds. Large institutions prefer to work with other large institutions, simply because that reduces the administrative overhead. I mean, say you’re in charge of managing $1 billion portfolio of SFR properties. Would you rather work with ten very large property management firms who have brokerage capabilities, or a thousand small property management first as well as ten thousand agents across the country?
So I think companies in real estate will have to get larger in order to work effectively with these larger clients. And that entire dynamic will look more like commercial real estate (where relationships are between institutions) than residential real estate (where relationships are between individual agents and buyers and sellers).
Important note: size will matter, but only if that size comes with control. That means franchises (RE/MAX, Keller Williams, Realogy, etc.) and traditional brokerages (Realogy, Compass, EXP, etc.) won’t have the traction because they won’t have the control. True companies like Opendoor, Zillow, most property management companies, and agent teams will have far more opportunity for growth.
3. All Fees Face Downward Pressure
Closely related is the prediction that all fees will face pressure. Real estate commissions are the obvious, but if the buyers and sellers are dominated by large institutions, then all fees will face pressure because the volume will be so high.
We have long understood that institutional investors, who are buying thousands of homes, will often offer 1% commission rate. We have long known that REOs will offer less to agents, because they’re sending them so much business. That’s normal. We know that Glenn Kelman of Redfin has openly said that he wants to drive commission down by publicizing the commission rates as the NAR-DOJ settlement allows them to do.
But if I think about growing importance of institutions in residential real estate, I can’t help but think that we should see all fees get pressure. Those who are willing to accept such lower fees will win huge amounts of business… but that means they have to be far more efficient, which means operational control… so see above about not all size mattering.
4. A New Kind of Brokerage Emerge… and Looks A Lot Like…
Given all of the above, I have to think we’ll see a new kind of brokerage emerge. Maybe they won’t be the dominant model, as most buyers and sellers will remain individuals and families. However, as institutions grow in importance as both, I have to imagine that we’ll see a more optimized type of brokerage emerge. What would it look like?
I have to think it’ll be something like Redfin + property management + asset management. Having W2 agents is critical to have the kind of control that institutional clients expect and will demand. I think the property management piece is important as financial investors (unlike more traditional operating investors) will want a one stop shop who can squeeze out some income from the inflation-hedge investments. The asset management piece is an important advisory/consulting piece of the puzzle that the funds, who are investment experts but not real estate asset experts, will find valuable. Maybe the W2 piece is not strictly necessary, but control will be.
What does that future brokerage look like? Doesn’t it look a lot like CBRE or Jones Lang LaSalle? Doesn’t that look a lot like a horizontally integrated commercial real estate firm? A professional services company that can help clients acquire properties, manage them for income, do the analysis to determine what to do with them, then sell/exchange those properties for maximum return on investment. For residential, some mix of iBuyer type of service could be useful, not because the institutional clients need the money, but the people they want to buy from or sell to do.
In fact, is it really unreasonable to think that the big commercial firms expand into residential to serve their institutional clients? CBRE came out of Coldwell Banker, after all — that’s what the “CB” in “CBRE” stands for. Those guys have so much money, so many resources, and are unlikely to want to let hedge funds and pension funds develop deep relationships with residential firms.
5. MLS and Associations
One thing that is completely unclear is how that future might impact the fundamental infrastructure of residential real estate: the MLS and REALTOR Associations.
I do think that more MLSs will need to start thinking harder about property management, as I believe the future of the country is #renternation. Gen-Y (Millennial) homeownership rates are unlikely to break 50% on current trends, and Gen-Z homeownership rates will be even worse. The economy is simply not setup to support homeownership for younger people, and society has truly changed too much to expect that the majority of them will become homeowners.
Just to cite one example, Morgan Stanley is estimating that 45% of all women between 25 and 44 in the U.S. will be single in 2030. That’s… a change. And marriage drives homeownership. From the story:
Women who have never married are the largest-growing segment of the group, while more women are also adding to the singles population by getting married later in life or getting divorced after age 55.
I’m just not seeing Gen Z reversing this decades old trend and eagerly tying the knot.
So #renternation is coming. Brokers and agents will of course be around, but it isn’t clear how many of them will be around if the structure of the housing market changes to where more than half of the houses are owned by investors, and more and more of those investors will be large institutions. I think that changes things for the MLS. At the same time, property management will become more and more important to housing, and the MLS today is simply not setup to handle that.
REALTOR Associations might still be important for the ethics and lobbying and whatnot, but I don’t know that I’ve ever met a property manager who thinks it’s important to be a REALTOR. I know I haven’t met a single hedge fund manager who thinks it’s important that his agent be a REALTOR.
General Interim Kinda Sorta Conclusion
Obviously, this is merely the first step in thinking through implications. So it’s difficult to form any real firm convictions.
At the same time, reading back over what I’ve just written, I think the theme that emerges is something like this:
- Ownership is consolidating: property ownership is transferring from individuals and families and small investors to large institutions.
- That drives service provider consolidation. The traditional mom-n-pop brokerage, small local property management company, small mortgage broker, etc. lose value if customer base (buyers and sellers and landlords) consolidates. Big companies want to work with other big companies.
- #Renternation also drives horizontal consolidation. The full service one-stop shop company needs to be redefined if the owners are not families but hedge funds. At a minimum, I think brokerage + property management + asset management become the target. Mortgage, title, escrow, and iBuying services (either market making or bridge loan model) may be beneficial.
- Current residential industry structures are not well suited to this kind of horizontal consolidation. The MLS is narrow, brokerages are narrow, and everybody is fragmented. That setup doesn’t serve large institutional customer base particularly well.
- More and more institutional involvement in residential means companies and organizations in residential real estate will evolve to look more and more like their commercial real estate cousins.
That’s where I end up.
Obviously, none of this is reality today. None of this may become reality, because politics of housing is tricky to think through. On the other hand, the difference between a black swan event and a grey goose event is that the former comes completely out of the blue, while the latter can at least be seem through the glass darkly.
I now believe institutional ownership implications are grey geese, not black swans.
Plan accordingly.
-rsh
PS: I’m replacing my normal accompanying music video with this….
1 thought on “The Implications of Financial Investors in Real Estate”
ROB,
IMO, without a healthy and liquid housing index to trade (hedge) these new institutional buyers may be a “dark-grey swan” for the iBuyers as more well capitalized buyers means more price competition (same buy-box?).
Be careful what is wished for as I’m not sure anyone involved in this sector of the business now is prepared to wake up and compete against Bridgewater, Citadel, Blackrock, B of A, Goldman etc. etc. in a numbers game.
As for how the transaction brokerage fits into this? It won’t be pretty if this buying/investment strategy becomes a larger scalable endeavor.
We’ll see 🙂
Thanks,
Brian
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