My fishing pal and hedge fund buddy Scott forwards along an email from an anonymous analyst in Asia, who is somewhat perplexed by the massive “rent to flip” private equity investment in US distressed (or not so distressed) homes:




Take a look at the number of houses for rent in Phoenix.  This is from Silver Bay, one of many Wall Street REO to rental companies, not to mention all the private big and small investors.  The snap shot above was taken today off their website.

The following is the snap shot I took on March 18, almost exactly 4 months ago.




How the hell can they be making money when there are so many empty houses cooking in the desert sun?  How can they possibly generate those double digit cap rates?

Sooner or later, these Wall Street OPM is going to lose interest.  I like to see how Bernanke is going to carry the pump all by himself to inflate this real estate recovery story.


Source: Silver Bay Management

Category: Real Estate, Venture Capital

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

30 Responses to “So You Want To Be A Landlord?”

  1. BennyProfane says:

    Something tells me that there’s going to more than a few PE and hedge fund people who are betting millions on this out of work in a year or two. Mom and Pop landlord are wincing and shaking their heads in disgust.

  2. rd says:

    Maybe they plan to make money off of the fees they can generate when they foreclose on themselves.

  3. VennData says:

    Phoenix rental season starts soon. Don’t worry about this outlier.

    • barbacoa666 says:

      That was my first thought. But zoom in, and you’ll see that there are a lot of rentals per unit area. Much more so than Houston

  4. constantnormal says:

    … looks like an overly crowded market (for landlords) to me … watch for the special-purpose funds from Wall Street that will allow the “little people” to participate in this … with double-digit yields and no guarantees …

  5. wmhalpin says:

    The large increase might be largely caused by the fact that many people move during the summer months when school is out.

    • megamomo says:

      This month is certainly the off-season for Phoenix area rentals. March is still in snowbird season. Spring Training during March would certainly reduce inventory that month. Lots of people rent homes for just the month of March to watch baseball, especially in the Scottsdale area.

  6. Anonymous Jones says:

    This seems to be just one of many (probably-doomed-to-fail) investment strategies. I think multifamily apartments are also extremely overbought. The market fluctuates. Some strategies win. Others lose. It was always thus. Not sure why it’s such a big deal. And not sure what it has to do with Bernanke. Is there systemic risk here I’m not seeing?

    Actually, from the middle class perspective, this seems great. These investors are buying housing units that were unreachable for many family units as ownership plays and thereby increasing available housing supply (thus putting downward pressure on rents). I think Wall Street losing money in this market is a great boon to everyday people. Seems like the near-hysteria about it is misplaced.

    • BennyProfane says:

      “Actually, from the middle class perspective, this seems great. These investors are buying housing units that were unreachable for many family units as ownership plays and thereby increasing available housing supply (thus putting downward pressure on rents). I think Wall Street losing money in this market is a great boon to everyday people. Seems like the near-hysteria about it is misplaced.”

      I agree. These people are saving a lot of homes from slow ruin (or quick ruin, from mold in Florida). Don’t be surprised that they won’t break any sort of anti trust statutes by getting together to fix rents. This is Wall Street money, after all.

  7. capitalistic says:

    Good point. The rent to flip can work depending on the location. For Phoenix, they’re betting on capital appreciation and “rent to own”, and less on actual rental income. In Texas, for instance Austin, it can and DOES work…

  8. Wiggs says:

    Interest has already been lost. All the companies that went public late last year and this year are trading well below their issue prices. However there are a lot of smart people (Blackstone, Colony and GI) that appear to really believe in the model. I can’t make the numbers work but that’s probably why I’m not in PE.

  9. DeDude says:

    Comparisons should be year-to-year since there can be seasonal effects. Alternatively it may simply reflect that this company has greatly increased its market share in that area.

    I seem to remember that rents are up (nationally) so that would not suggest that there is a huge glut of available rentals. Whether or not these investments can make money depends mostly on the purchase price (going up), the rent, and the % vacancy. I am sure there are cities where those things are working out great and other cities where they are not so good and getting worse. I am not sure what the national trend is.

  10. gman says:

    They may not need much for rent or occupancy to hit their number IF they had the properties practically given to them..which in many cases they were.

  11. Mike in Nola says:

    Shows the innate creativity and independence of investment types.

  12. large J says:

    How can they possibly generate those double digit cap rates?

    The answer is really very simple. They go into the market where houses are $75,000 a throw (for example — you can pick any number). They begin to buy homes first slowly then very aggressively. Yup, they drive the prices up by 50%. Step 2 — mark your book — all the houses you own at the new “market price” – Step 3 — call your local idiot — I mean commercial banker and borrow against this new valuation at a 75% loan to value non-recourse basis and you get $84,000 loan per house. Lather rinse repeat.

    When the portfolio collapses because the properties have no tenants — the bank will call you to buy the houses back. God bless 2 and 20.

  13. couragesd says:

    Once the profits plateau in a couple of years because of the low wage increases and low inflation I imagine the days of the company scrip will come roaring back!!!

  14. as.value says:

    Barry I think the market is already pricing in skepticism.

    Silver Bay, has no leverage and a book value per share of $17.52 vs. a share price of ~$16. The selloff in Silver Bay occurred despite massive appreciation in housing related stocks since Silver Bay had its IPO last December.

  15. Livermore Shimervore says:

    How about Wall Street just a) stay out of residential mortgages and leave it to the 3-6-3 guys (aka the olden days)? b) tax anyone with more then 10 properties — that are not primary residences — 50% carried interest tax.

    Otherwise couples buying starter homes, seniors who are downsizing (aka regular folk), etc. who decide to pick up homes in hard hit foreclosure states are simply buying into yet another pump and dump scheme, also known as ‘left holding the bag’.

  16. AGMichaels says:

    I’ve been doing this (buying houses at auction or REO to rent or flip) in Atlanta for the last 5 years with a partner who has been in the business for 15. In that time, we have seen our net yield available at auctions go from approximately 20% down to 6 or 7 tops. This is exclusively a function of the institutional rush to put money to work. As a “mom/pop” investor, we have a very clear view of the quality of the house, the amount of work likely required to bring it into appropriate condition, etc. Given the due diligence we do, we have been rarely surprised by the inside of a house, and have never had a problem getting a tenant inside in a short period of time at market rents.

    Even in this current environment, with a seemingly endless supply of rental houses, we have had no issues rolling or turning over leases. Our neighborhood quality is in the B/C range. We stay away from high crime/gang-y areas, but are in middle to lower middle income areas. Essentially none of our renters have a chance of getting a mortgage in any foreseeable amount of time. The supply of families needing to rent because they are not able to buy is enormous, and growing, and I dont see anything on the horizon at the moment that indicates that this is going to change dramatically for some time. The number of houses available for rent in our areas has not affected rental prices in the least at this point.

    So, I don’t agree with the premise of oversupply of rental homes, but I do agree with the notion that the likely returns on these institutional structures are pretty low. I have gone to as many of the Colony, Blackstone, SBY presentations that I can, and I chat with the executives for as long as they will let me. They are quite sharp and know the business well, but I still do not like their models.

    We cant get direct leverage on our properties, but they can. Even if we could, borrowing up to 60% of the value of the house at current rates would allow us to have rents drop over 30% before we would even start to worry about cashflow. So even moderate deflation isn’t that scary to a model using reasonable leverage. Why doesnt everybody do this? Because it is a pain in the ass business and it requires an extreme amount of diligence, particularly and most importantly at the point of purchase.

    So what is the problem? First, they are paying too much. Second, the level of due diligence is worrisome. They have third parties who do most of the bidding at the local level, and their knowledge of neighborhoods or familiarity with the property itself is (generally) severely lacking. Pricing for houses that they are largely unfamiliar with now exceeds what you can find on MLS. That’s crazy. At auctions, we are told they do this because the path to ownership is cleaner at auction, which is true. But some are willing to pay more for houses at auction than they are for turnkey assets. We are making good yields on our holdings, but we would be happy to sell it today for a 7 cap. Bids from these guys for rented/low maintenance are in the double digits cap range. Doesnt make a lot of sense, but I think as the ability to keep doing size at auctions continues to shrink, they will come our way. Until then, we are clocking quite acceptable yields.

    Another big issue is that these models have rent increases built into them, which combined with asset appreciation makes for large theoretical returns. I really hate seeing future pricing in a RE model. It’s a lot to buy into, in my opinion. Great deals can still be had buying REO from fannie/freddie and via carefully researched NPLs, and if you can find properties this way, it is still a pretty safe investment if you are willing to do the work. But I think these stocks and dedicated PE funds, while unlikely to be huge disasters, are going to have a real tough time generating long term attractive returns.

    The public equities are also some ways away from generating any significant positive GAAP income, so divs truly reflecting the economics of the business are still in the somewhat distant future. I think for most the divs will be disappointing, and the growth of that dividend may be hard to come by. At one point I thought that some of these 7+ year funds would have a problem when they need to get cash back to their investors. If they turn into permanent capital via IPO, selling pressure goes away. But now that the shine is off some of these, like Colony, at least at the moment, I would love to see a flood of these hit the market. Unlikely, though.

  17. b_thunder says:

    “How the hell can they be making money when there are so many empty houses cooking in the desert sun? ” – But with ZIRP it doesn’t cost them much, does it? Can amortization be used to offset other cap. gains?

    ” I like to see how Bernanke is going to carry the pump all by himself to inflate this real estate recovery story.” – Beyond Dec 31 it’s not his problem. He provided ZIRP – it’s going to be up to the next Fed chair[man|woman] to spike the punch again

  18. getgo says:

    Not sure why there is such negative edge to most coverage of this strategy. First, it’s not really a massive play if you consider around 30% of ALL rentals right now are single-family homes. Huge market. just that it is dominated by mom-and-pops. Last number I saw, there were around $10 billion in institutional commitments to this [BR: At Sheila Bair’s distressed housing conference Summer 2012, its was ~$25 Billion]. Even with leverage that would buy just the tiniest sliver of the overall market. Though there have been concerns over the volume of appropriate homes to feed this beast. If the market was allowed to clear in a more traditional way, I think there would be plenty of well-priced assets to choose from.

    Of course, it is an unproven business model and the success depends a lot on aggregating enough properties ($150k valuation +/-) for the right price, hitting the right level of improvements and getting the right rent expectations. So there are challenges. Though I don’t know too many sectors where institutions didn’t eventually do a better, more efficient job at managing assets than mom and pops. Some of the comments, and the tone of the post itself, suggest few have even glanced at any of the research reports available on this. There were similar doubts expressed when multifamily and hotel industries were being institutionalized. They are different assets, of course (scattered housing more difficult to manage, for example), but the conditions have never really been like this for rental single family sector. Especially the fact that few people demanding this type of housing will be able to buy a house for the foreseeable future (no down payment) and the opportunity for PE and others to buy em up, at least in the beginning, for 30-50% off peak. The early movers (Och-Ziff and early Colony and Blackstone) were clearly getting mid-teen caps, now less than half that, but they are (aside from Colony and Blackstone who will probably go public wth their portfolio) just aggregating to sell as a portfolio to publics… Once they are in a REIT (if they can stabilize the portfolio) no one expects teen yields. OPM investors have been tripping over themselves over the last couple years to grab 3-6% yielding multifamily.. so if these are stabilized and can yield something more than that… who knows. Whether this will eventually be a good investment for REIT investors, not sure.

    And for such a great, data driven site, this post should at least include some simple data… like the actual vacancy rates for comparable residential in the area pictured. The balloons all resting on each other might be misleading.

  19. stonedwino says:

    BR: stuff like this is why I love your well moderated comments section…

    AGMichaels said: “Essentially none of our renters have a chance of getting a mortgage in any foreseeable amount of time. The supply of families needing to rent because they are not able to buy is enormous, and growing, and I dont see anything on the horizon at the moment that indicates that this is going to change dramatically for some time” Bingo…it seems however that institutional investors are less savvy than Mr. Michaels – Kudos!

  20. Sun Tzu says:

    I actively invest in the dfw area and have been constantly outbid in the past year. I went back and looked what they sold for and was baffled at the winning offer. In many instances the purchase and estimated rehab exceeded market values. They are also having a hard time filling vacancies because they over charge the rent and under rehab the homes. I think they are using section 8 rent comparables as a baseline but section 8 has always been higher than market to entice landlords to participate.

    These guys are not idiots, quite the opposite. I wonder what their exit plan is. My guess is some kind of REIT to sell on the secondary market so when things hit the fan somebody else (pension funds, mom and pops, retail) is left holding the bag.

    • DeDude says:

      I am not sure how these things are structured. But is it possible that they already have “handed the bag” to someone else, the way hedge funds do it. If they harvest big fees and salary up front with none of their own skin in the game, then the whole walled off structure that legally own the property may be 100% with the investors. Control fraud is the business model of modern predatory capitalism.

  21. DiggidyDan says:

    In Florida right now, PE investors are making the market. They outbid all wannabe buyers on distressed properties buy flashing the cash vs mortgage, while at the same time jacking up rents to sky high rates. Rents are through the roof and builders can’t recover fast enough to fill the supply side of non-distressed homes. I have heard of 4 friends of mine getting their rent increased in the last 3 months because of the influx, but many can’t close on properties they are looking go buy to get out of the renal game right now. Little guy loses on all sides. (except for us suckers with underwater mortgages probably).

  22. tdotz says:

    It’s the music that’s playing the PE world. And hey, IBG, YBG – and I’ll take my salary/2% with me, thankyouverymuch! After all, I’m not personally responsible. Actually, I’m not responsible at all. That’s for the little people.

  23. jbegan says:

    I’ve been a long term landlord and a professional manager. The buy to rent flip is reaching a peak in many areas. But when the real estate market went belly up, I told everyone I could that if they could, they should buy now! What i saw, and what many didn’t was people losing their homes, flippers buying them up and renting back to the very people that lost their homes..often at higher rent than their original home payments and without the homeowner’s tax deduction.

    My neighborhood in Sacramento peaked at $235,000 for a 1968 3 bed 1 1/2 bath single family home. Within months that same home was selling in the $60s and $70s. Even today, the same home can be purchased for $120,000. With an 80% mortgage, taxes & insurance, total payments are about $630 per month. Rents for that home are $1100 to $1200 per month. Real Estate Flippers will sit on that home until it’s back in he $190,000 range (about 5 more years) and sell.. Rents will be in the $1300 to $1400 range. The real estate collapse was the greatest rip-off and transfer of wealth from the Middle Class that the average American will ever experience. And the same people that lost homes are scraping by, paying taxes and renting bailed out the banks that led to this mess.

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