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2014: issue 9
Investors leaving housing high and dry For the better part of this year, investors have been slowly trickling out of the home buying market, but in August they apparently cut off the cash flow in a big way. Sales of existing homes fell an unexpected 1.8 percent from July, according to the National Association of Realtors (NAR), but more dramatic was the drop in investor sales. Investor activity in 2012 and 2013 was the main driver behind double-digit price gains. Just 12 percent of August purchases were by individual investors, down from 16 percent in August; investors had been making up nearly one-third of home purchases during the worst of the housing crash nationally, and in some markets they accounted for well more than half. "Investors are concerned with a potential rise in interest rates," said Lawrence Yun, chief economist for NAR. "It makes it less attractive in a rising interest rate environment." The drop has been long expected. Home prices jumped dramatically last year and are still higher by nearly 5 percent from a year ago, while the supply of cheap, distressed properties fell. When calculating for potential returns, the math simply doesn't work as well anymore for investors. "The reduction in appetite from investors has put a temporary lid on home sales that has yet to be offset by the first-time home buyer, which is more interested in renting than buying," wrote
Peter Boockvar, chief market analyst with the Lindsey Group. "Faster income growth, slower home price gains and more of an easing in credit standards is what is needed to bring them back." First-time home buyers made up just 29 percent of August buyers and do not appear to be picking up any of the slack of investors. The first-time buyer share is historically around 35 to 40 percent of the market, and it usually increases in the fall, when large families move out of the market. First-time home buyers tend not to have children yet. Realtors are hoping the decreased competition from investors will bring first-time buyers back to the market, but this younger cohort is still facing high levels of student debt, weak employment and income growth and soaring rents, which keep them from saving for a down payment on a home. Some of those who are more fiscally sound are still choosing to rent, especially as the single-family rental market has become more popular. This is why investors, while not buying many more homes, are not rushing to sell the ones they already have, either. Rents are up over 3 percent from a year ago nationwide. "We are really happy with our portfolio of homes," said Aaron Edelheit, CEO of Atlanta-based The American Home, in a July 2014 interview with CNBC. "Our demand for rental properties is strong. We have 95 percent rented." American Home invested in distressed properties.
Edelheit, who operates mainly in the Atlanta and Charlotte, N.C., markets, said he is not buying any more homes. The company currently owns about 2,400 single-family rental homes, which it manages through an in-house network of property managers, rental agents and technicians. "This is maturing into every other type of industry," noted Edelheit. "You will have consolidation. Business is going to be about execution and operations. It will be all about operations. We have an attractive company with attractive assets. Like anything else, it's about
operating and running this business." Others, however, are still buying, albeit shifting their strategies. Justin Chang, CEO of Colony American Homes, which was a huge player early on in the Phoenix and Southern California housing markets, said his company continues to buy, although at a reduced rate. "The contours of the buying and the geographies are shifting, as one might expect," said Chang. By Diana Olick CNBC.com
The question is: are we building too many houses? Construction of single family homes and multifamily apartments fell by over 14 percent in August from July, a far more striking plunge than analysts expected. Single family housing starts are running at about half the normal, prebubble pace, and single family building permits, an indicator of future construction, are flat. So how is it that some claim we are building too many houses? "We're still building single family homes faster than we can fill them," argues Trulia's chief economist Jed Kolko. Using new numbers released this week from the U.S. Census, Kolko makes the following points: • The vacancy rate for single-family homes was 10.7 percent in 2013, up from 10.6 percent in 2012 and near its 2011 peak of 11 percent. That's far above the vacancy rate during the bubble (8.6 percent in 2005) and before (7.4 percent in 2000). • In 2013, household formation was just 321,000, much lower than the 1.2 million baseline implied by current population growth. The number of owner-occupied single-family homes actually fell by 184,000. • At the same time, the multi-unit vacancy rate continues to normalize,
dropping for the third straight year to below its 2006 level. Despite all the new multi-unit construction, apartments are filling up. To put it simply, there are plenty of vacant homes, no new owner households are being formed, and there's not enough demand to necessitate building more new homes. Why then do real estate agents claim there is not enough supply to meet demand, and why are home prices continuing to rise? The answer is that certain segments of the market are thriving while others are stalled and certain locations are thriving while others are stalled. "There are always people who want new. Also, income growth at the high end helps boost demand for the larger new homes now being built," Kolko acknowledged. "But if new construction weren't keeping up with demand, and household formation were strong, more of the vacant homes out there would get occupied—but they're not." On the flip side, multifamily rental construction, while down for the month, is running at quarter-century highs, and the units are filling up fast. At the same time, there are 14 million single-family homes currently occupied as rentals, and those renters appear to be staying. There were just 11 million single-family
rental homes as recently as 2007. "It's proving that households are finding renting to be much more appealing than they ever thought it might be, and they're sticking with those rental homes longer than we expected," said Buck Horne, an equities analyst at Raymond James. Horne added that Kolko "makes a fair point." Horne, however, focuses on particular markets, particular builders and price points. "If you look at the big job producing markets like California, Texas and Florida, [housing] demand there is very strong," he said. "If you're looking for first-time buyers, you'll find them in Texas." First-time buyers nationally, however, are the weakest segment of the market, as younger millennials were hardest hit during the recession. That is why some builders, like Lennar and Pulte, are focusing on move-up models rather than cheaper, entry-level homes. Lennar reported strong third quarter earnings this week, but the Miamibased builder has been focusing on prime locations, higher-priced homes, and did not overestimate demand. DR Horton, however, announced it would have to use incentives to sell its homes. It last reported it had 10,000 unsold homes, 3,100 of those already finished.
"Other builders are sitting on more than that," Horne noted. "That's a lot to be speculating with, especially after the spring selling season." Pulte, meanwhile, is also steering away from entry-level product and, according to Horne, is willing to give up market share as long as it means optimizing cash returns on a per-house basis. As of last quarter, Pulte had less than 1,000 spec homes in all of its combined communities. "That's one the industry's lowest ratios of spec homes," Horne said. Home builders large and small are having to re-evaluate today's tricky market. Some, like Lennar are diversifying, getting into the multifamily market, while other smaller builders are turning to townhomes in more urban settings. "We're constantly having our expectations pulled out from under us because we think that the market might finally be in a more permanent recovery, and now we go into a slowdown again," Stephen Paul, executive vice president of Maryland-based Mid-Atlantic Home Builders, said on CNBC's "Squawk Box." "It's hard to figure out and plan." By Diana Olick, CNBC