Cashing Out of the “Bet on America” Might Get Messy

Housing industry frets about the mega-landlord PE firms

Stephen Schwarzman, CEO and co-founder of Blackstone Group, the world’s largest private-equity firm with $290 billion in assets under management, made $690 million for 2014 via a mix of dividends, compensation, and fund payouts, according to a regulatory filing. A 50% raise from last year.

The PE firm’s subsidiary Invitation Homes, doped with nearly free money the Fed’s policies have made available to Wall Street, has become America’s number one mega-landlord in the span of three years by buying up 46,000 vacant single-family homes in 14 metro areas, initially at a rate of $100 million per week, now reduced to $35 million per week.

As of September 30, Invitation Homes had $8.7 billion worth of homes on its balance sheet, followed by American Homes 4 Rent ($5.5 billion), Colony Financial ($3.4 billion), and Waypoint ($2.6 billion). Those are the top four. Countless smaller investors also jumped into the fray. Together they scooped up several hundred thousand single-family houses.

A “bet on America,” is what Schwarzman called the splurge two years ago.

The bet was to buy vacant homes out of foreclosure, outbidding potential homeowners who’d actually live in them, but who were hobbled by their need for mortgages in cash-only auctions. The PE firms were initially focused only on a handful of cities. Each wave of these concentrated purchases ratcheted up the prices of all other homes through the multiplier effect.

Homeowners at the time loved it as the price of their home re-soared. The effect rippled across the country and added about $7 trillion to homeowners’ wealth since 2011, doubling equity to $14 trillion.

But it pulled the rug out from under first-time buyers. Now, only the ludicrously low Fed-engineered interest rates allow regular people – the lucky ones – to buy a home at all. The rest are renting, in a world where rents are ballooning and wages are stagnating.

Thanks to the ratchet effect, whereby each PE firm helped drive up prices for the others, the top four landlords booked a 23% gain on equity so far, with Invitation Homes alone showing  $523 million in gains, according to RealtyTrac. The “bet on America” has been an awesome ride.

But now what? PE firms need to exit their investments. It’s their business model. With home prices in certain markets exceeding the crazy bubble prices of 2006, it’s a great time to cash out. RealtyTrac VP Daren Blomquist told American Banker that small batches of investor-owned properties have already started to show up in the listings, and some investors might be preparing for larger liquidations.

“It is a very big concern for real estate professionals,” he said. “They are asking what the impact will be if investors liquidate directly onto the market.”

But larger firms might not dump these houses on the market unless they have to. American Banker reported that Blackstone will likely cash out of Invitation Homes by spinning it off to the public, according to “bankers close to the Industry.”

After less than two years in this business, Ellington Management Group exited by selling its portfolio of 900 houses to American Homes 4 Rent for a 26% premium over cost, after giving up on its earlier idea of an IPO. In July, Beazer Pre-Owned Rental Homes had exited the business by selling its 1,300 houses to American Homes 4 Rent, at the time still flush with cash from its IPO a year earlier.

Such portfolio sales maintain the homes as rentals. But smaller firms are more likely to cash out by putting their houses on the market, Blomquist said. And they have already started the process.

Now the industry is fretting that liquidations by investors could unravel the easy Fed-engineered gains of the last few years. Sure, it would help first-time buyers and perhaps put a halt to the plunging homeownership rates in the US [The American Dream Dissipates at Record Pace].

But the industry wants prices to rise. Period.

When large landlords start putting thousands of homes up for sale, it could get messy. It would leave tenants scrambling to find alternatives, and some might get stranded. A forest of for-sale signs would re-pop up in the very neighborhoods that these landlords had targeted during the buying binge. Each wave of selling would have the reverse ratchet effect. And the industry’s dream of forever rising prices would be threatened.

“What kind of impact will these large investors have on our communities?” wondered Rep. Mark Takano, D-California, in an email to American Banker. He represents Riverside in the Inland Empire, east of Los Angeles. During the housing bust, home prices in the area plunged. But recently, they have re-soared to where Fitch now considers Riverside the third-most overvalued metropolitan area in the US. So Takano fretted that “large sell-offs by investors will weaken our housing recovery in the very same communities, like mine, that were decimated by the subprime mortgage crisis.”

PE firms have tried to exit via IPOs – which kept these houses in the rental market.

Silver Bay Realty Trust went public in December 2012 at $18.50 a share. On Friday, shares closed at $16.16, down 12.6% from their IPO price.

American Residential Properties went public in May 2013 at $21 a share, a price not seen since. “Although people look at this as a new industry, there’s really nothing new about renting single-family homes,” CEO Stephen Schmitz told Bloomberg at the time. “What’s new is that it’s being aggregated, we’re introducing professional management and we’re raising institutional capital.” Shares closed at $17.34 on Friday, down 17.4% from their IPO price.

American Homes 4 Rent went public in August 2013 at $16 a share. On Friday, shares closed at $16.69, barely above their IPO price. These performances occurred during a euphoric stock market!

So exiting this “bet on America,” as Schwarzman had put it so eloquently, by selling overpriced shares to the public is getting complicated. No doubt, Blackstone, as omnipotent as it is, will be able to pull off the IPO of Invitation Homes, regardless of what kind of bath investors end up taking on it.

Lesser firms might not be so lucky. If they can’t find a buyer like American Homes 4 Rent that is publicly traded and doesn’t mind overpaying, they’ll have to exit by selling their houses into the market.

But there’s a difference between homeowners who live in their homes and investors: when homeowners sell, they usually buy another home to live in. Investors cash out of the market. This is what the industry dreads. Investors were quick to jump in and inflated prices. But if they liquidate their holdings at these high prices, regular folks might not materialize in large enough numbers to buy tens of thousands of perhaps run-down single-family homes. And then, getting out of the “bet on America” would turn into a real mess.

And getting out of the bet on China? China has long frustrated the hard-landing watchers. But maybe not much longer. Read… Housing Crash in China Steeper than in Pre-Lehman America

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  11 comments for “Cashing Out of the “Bet on America” Might Get Messy

  1. mick
    Feb 28, 2015 at 2:05 pm

    2015 is the new 2008, multiplied by 10.

    2001 Crash
    2008 Crash
    2015 Looking very much like a crash.

    Hard to ignore the pattern.

  2. Petunia
    Feb 28, 2015 at 3:35 pm

    In FL where there are large numbers of these homes the rents are so high that the rental market for them is limited. Most families with middle class incomes already own. The rental homes have multiple families or generations living in them to make the rent. Over time the rental homes experience more wear and tear than owner occupied houses because the renters have no incentive to fix or improve the properties. These companies are one hurricane away from big loses.

  3. michael
    Feb 28, 2015 at 6:21 pm

    Pardon me but I hope these “investors” loose their shirts.

  4. Vespa P200E
    Feb 28, 2015 at 7:04 pm

    RE market is cyclical and driven by supply & demand.

    PE’s timing was impeccable in scooping up the houses from the lows littered with lots of foreclosure/short sales while outbidding and SCREWING the folks who were trying a buy a roof over their heads. Made a killing with price appreciation but the rate of appreciation slowed and they may need to pull some capital out for other investing opportunities. Guess next up is to flood the market AKA increase the supply and sucker in the very people who got outbidded with “hot” potatoes.

    Something tells me that some PEs may not fare so well with swelling demand and perhaps dearth of buyers not to mention the bond/equity market about to tank just like it did on last downturn in 2008 as we learn history so as to repeat it.

  5. Mel
    Mar 1, 2015 at 8:43 am

    ” in a world where rents are ballooning and wages are stagnating.”

    Sure, rents were ballooning; that was part of the plan. Too bad about the wages were stagnating part. Damned externalities! A scheme to amass great wealth by renting houses to broke people is a dumb idea. It was dumb a year ago and it’s dumb now. The way out needs a Greater Fool, it’s the only hope.
    Whether an IPO sells shares in the wreckage, or some derivatives securitize the alleged cash-flow. Or they convince Congress to declare the Vampire Squid an endangered species, then change the wording between the committee and the votes so as to be paid a huge pile of money. It’ll have to be something creative

  6. Mike R.
    Mar 1, 2015 at 9:18 am

    I hope everyone realizes that this Private Equity buy up was all a planned effort courtesy of the highest levels of our government. Early in the housing crash, banks were shell shocked and started dumping properties right and left. I have personal knowledge of such. Suddenly that changed and all the foreclosures and soon to be foreclosures got pulled back off the market. We have all heard numerous cases of people living “rent free” for years in their to be foreclosed house. We also know many of the houses sat empty for months and years.
    Why did the banks stop the foreclosure process? They were instructed to do so. I’m sure Geithner and others realized that if this was left to the market, housing prices would undershoot on the low side; further worsening a bad situation. And of course the banks would have taken huge losses.
    Along came the PE’s. Remember the story line? Buying up to be mega-renters. Now I don’t know about you, but I didn’t buy that for a second. First they had no experience in this arena and second, the profits appeared to be slim compared to what they were used to.
    What really happened is that Blackstone and others did a “national service” buy selectively buying up and ratcheting up house prices; first in the hardest hit housing areas and later in secondary markets like here in Charlotte where I live. The early stages of buy up were easy. There was no supply (the banks had pulled back) and everyone else was underwater. The very limited supply was easily bought up with artificially increasing prices. Just like the early days of the stock market after the crash. Large and steady price increases with little money involved.

    The PEs were selected to do this because of their smarts and because of a need for a cover story.

    Everyone is right that they squeezed out the average guy looking to buy while this price increasing was in process. That was not the primary goal. The primary goal was to raise the overall price level of housing, thus helping may who were underwater and restoring “confidence” in housing and prices.

    Did it work? Well yes they got the prices back up…..but; the real question going forward is who will be able to afford this price level? Certainly it has opened up a good amount of stalled buying. In Charlotte, we’re back into a little mini-boom; particularly in desirable close-in neighborhoods. Infill has ramped back up with people tearing down older, smaller houses and building biggies. These people obviously have purchasing power/good jobs, etc.

    The price raising also allowed many folks to sell and make a move they wanted to. Parents retiring to be near their children or elsewhere. Some folks looking for a relocation due to career change. etc.

    But in spite of this mini-boom in housing, I think the overall housing big picture can only go down from here. Sure, there will be a luxury/high end market that continues in all the desirable locations; however, the vast bulk of average and older houses will see declines in price over the coming years. They have to. The cost structure is simply too high for the vast majority of Americans.

    • Petunia
      Mar 1, 2015 at 11:00 am

      I agree, all those families doubled up and tripled up just to pay the rent don’t have any savings to buy. Most of the extra income in those households is sitting in the driveway.

    • Mark B
      Mar 1, 2015 at 11:15 am

      I think it may be a bit more of ‘taking advantage of government stupidity’ than collusion. Here in Oregon, the legislature pushed through tough foreclosure rules and initially the banks resisted, then they went quiet. I think they realized they could take advantage of the situation as Mike R. points out, but I don’t know if they actively pushed for the rule changes. From the articles I read locally, they sure seemed against the rule changes….. at first.

  7. Tim
    Mar 2, 2015 at 7:49 am

    Was this supposed to be a veiled attempt at toilet humor?

    “They are asking what the impact will be if investors liquidate directly onto the market.”

  8. Michael Gorback
    Mar 2, 2015 at 7:56 am

    The PE players are too smart to not understand that managing thousands of individual rental homes is extremely difficult compared with multi-unit rental properties. They never intended to hold these properties long term.

    The idea has always been to gather these houses together into a “rent-backed securities” scam for the yield-seekers and flip the houses as REITs to retail investors. What’s next? Credit-card-debt-backed securities?

    With the flops experienced by the initial IPOs and one or more cancelled/delayed IPOs it looks like they miscalculated the number of greater fools available for exploitation. I hope Blackstone has to eat this mess itself.

    • Mike R.
      Mar 2, 2015 at 1:30 pm

      The PEs involved with this charade are all backstopped by the Federal government. You and I just don’t know about the details. They may lose money in their filings, etc. but trust me, they will not lose behind the scenes.

Comments are closed.