You Lost the Bid...to Blackrock

How the Institutionalization of Housing Screws Over First Time Home Buyers Pt. 2

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Walk through a scenario with me. 

You’ve worked your ass off for the last 5 years, living in a shoebox so that your monthly rent payment was low. 

This puts some stress on your life. Your roommate leaves dishes all over the place and brings home a new Tinder date every week.

But it saved you money. You focused on earning more, being responsible with your spending, and made some pretty safe investments in order to preserve your capital.

You bought a couple low-fee ETFs, dollar cost averaging in every month, about 20% of your paycheck. 

This was a hard thing to do, but you’ve finally made it. You have enough money to afford a downpayment on a condo in a major city and you’re on your way to climbing up the property ladder.

Or maybe you don’t mind the commute and are able to WFH (a blessing in disguise), so you buy a semi-detached house in a suburban community that is about a 40 minute drive in traffic away from the city. 

You’re in the clear. Except you’re not. You’re still SCREWED.

When you go to put in your bid, you find that the listing agent has set an offer date one week from today. But the day after, you are informed that there is a bully bid on the table and there are 25 competing offers on this “entry level” plain vanilla home you are trying to buy.

Now imagine you didn’t lose this house to your rival avocado toast-eating millennial, you lost it to a guy named Mr. Rock. Black Rock or something. Wait… What?

Corporate investors in the United States bought 15% of US homes for sale in the first quarter of 2021 as the median price of an American house has increased by 28% over the last two years.

In the first part of this series, we took the approach from a personal finance type of lens (own your home!). In this week’s part 2 newsletter we will unwrap the new concept of the institutionalization of housing in <5 minutes:

  • How Did We Get Here? đź‘‰ Lower Global rates + the Hunt for Yield

  • The Institutionalization of Housing đź‘‰ Pensions and Private Equity stepping in

  • Community Shareholders đź‘‰ Owning equity in a community rather than a single home

  • Technology’s Role in Modernization đź‘‰ OpenDoor, Zillow, Redfin

Let’s get started!

1. How Did We Get Here? đź‘‰ Lower Global rates + the Hunt for Yield

In personal finance, there is sort of a rule that applies when thinking about diversification in your portfolio known as the 60/40 rule. 

So you would weigh your portfolio 60% into equities and 40% in bonds. This historically blended a good mix of risk and return. Bonds were historically more stable in terms of pricing, and pay you a coupon (yield) to keep your money there. Equities had higher risk profiles, but also higher returns in the longer run.

Bonds were also thought to be negatively correlated to equities which would limit downside, but also upside on a 60/40 mix. 

However, there are two problems with this portfolio. The first problem with this is that the correlation between bonds and equities wavers between positive and negative, so it is not always a proper diversification method. 

The second is that yields are historically low, which means you do not get paid a substantial coupon while parking money into bonds. A low yield is not itself a problem if the total return of the bond can outperform (decreasing bond yield = increasing bond price). 

However, in a lower for longer rate environment, this causes problems for big institutions and pension funds that NEED this risk management component in their portfolio. Since there is very little yield to be found in the bond market, a lot of majors have been shifting towards “Alts” or alternative assets that have PE-like qualities (private equity) in their search down market for yield. 

You’re probably starting to connect the dots in your head because you’re thinking:

“Hey, housing kind of has those attributes - Stability and Yield.”

And you’re dead right.

The new portfolio looks more like 60/20/20, with the third category being alternatives. 

We now have a huge list of investors, pensions, and PE firms with records amounts of capital all searching for yield. Add to the pile of existing home buyers armed with the cheapest mortgage financing ever and its a potent mix to drive up prices. 

2. The Institutionalization of Housing đź‘‰ Pensions, Funds, & Private Equity stepping in

In April, The Wall Street Journal reported that DR Horton built 124 houses in Conroe, Texas and then rented them all out. They then put the entire block of houses for sale on the market to the highest bidder as investors and big pension funds were starved for yield. 

The winning $32 million bid came from an online property-investing platform, Fundrise LLC, which manages more than $1 billion on behalf of about 150,000 individuals.

A huge player in this space is an entity that Blackstone (not to be confused with Blackrock which I did on the original piece, apologies!) spun out back in 2017: Invitation Homes (Ticker:INVH). This publicly-traded $23B company deals in single-family rental homes, and has done quite well. 

Back in the early 2010s Invitation Homes (IH) purchased close to 90% of the homes for sale in certain ZIP codes in Atlanta, essentially cornering a market. They typically don’t look for the upscale move-in ready homes, rather they focus on getting an attractive rental yield in an up and coming market with population growth. 

But the even bigger advantage that IH has is its borrowing cost. While typical individual mortgage rates in the US are between 2-4% these days, IH can borrow at around 1.4%. This translates to an average increase of buying power from $5,000-$20,000 per home. That amount is typically what a bidding war comes down to in a hot housing market. 

If you look at major housing markets, what these investors are doing is depleting major inventory to growing cities with good-paying jobs. According to Redfin, corporate ownership in emerging cities goes as follows:

Atlanta = 22%

Charlotte 22%

Phoenix =20%. 

Many individuals will buy a home because the alternative of renting is more destructive to wealth creation. Institutions, however, look simply at the return of the underlying asset. 

When an individual makes a purchase decision it’s usually according to their job, proximity to family, and something they are familiar with. Investors, however, have amassed a large amount of data (both proprietary and third-party) that power their buying decisions to optimize return. 

The more and more institutions move in, with a lower cost of capital, the more unaffordable the neighbourhood becomes. 

Now, let’s check in with our Outrageous Chartered FinMEME Analyst Dr. Patel!


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3. Community Shareholders đź‘‰ Owning equity in a community rather than a single home 

I came across an interesting concept that I wanted to cover here as thinking outside the box in terms of ownership. 

Community Equity Investment.

This idea dawned on me as relevant especially today as more and more assets are fractionalized and decentralized (stocks, NFTs, etc…). 

Instead of owning a single family home on your own, the concept extends equity ownership to a neighbourhood that one wants to participate in. There is then essentially a buy-in agreement whereby you the individual shareholder participates in the growth of the overall community. 

This lends itself to the famous concept of “skin in the game” whereby you have an active interest in making the community that you live in much better off. 

One example of this framework is cooperative ownership. Cooperative ownership includes collectively owned businesses and utilities like credit unions, farm purchasing arrangements, manufacturing businesses, mutual insurance, rural electric providers, and others. 

Cooperatives are also used for commercial real estate and offer community equity investment an ideological framework for democratic governance. Whether they are worker, housing, or agricultural-processing cooperatives, all cooperatives are member-owned, democratically controlled business enterprises. 

Several community equity investment initiatives draw on this model by empowering resident investors in the governance of the initiative (and some directly use the cooperative structure). 

To me, this can tilt a bit too much towards the ideology of socialism and communism, but there are studies that show how an edited version of this model can limit inequality and may make sense in some scenarios. 

Definitely some interesting concepts in there that may be able to solve issues in some communities.

4. Technology’s Role in Modernization đź‘‰ OpenDoor, Zillow, Redfin

Buying a house is one of the worst and most archaic processes in existence. This is particularly concerning because it is also the single most important financial decision that the average North American will make. 

Technology has always come around to make processes much more efficient, and real estate is finally being disrupted. 

Opendoor

Opendoor Technologies Inc is an online company for transacting in residential real estate. Headquartered in San Francisco, it makes instant cash offers on homes through an online process, makes repairs on the properties it purchases and relists them for sale.

Could this be furthering the over-demand problem? Or is it just a gap to flip nicer houses?

Redfin

Redfin is a full-service real estate brokerage. Redfin's business model to undercut competition is based on sellers paying Redfin a discounted fee, either 1.0 or 1.5% to list the seller's home. 

Zillow

Zillow is the most-visited real estate website in the United States. Zillow and its affiliates offer customers an on-demand experience for selling, buying, renting and financing with transparency and nearly seamless end-to-end service.

Wrapping Up…

In a low-interest rate environment, the hunt for yield is really starting to squeeze those first-time home buyers out of the market. Does the run in asset prices in houses look extended? Absolutely. But getting in on the property ladder is vital to climbing it. 

When you’re forced to hold this asset longer term, from a behavioural perspective, the mortgage payment acts as a forced saving mechanism. 

As always - do the math, do the work, and get in the game (I finally did this year!)

Until next time. Always Yours. Incessantly Chasing ROI,

-Genevieve Roch-Decter, CFA

P.S Somebody just paid $1.3 million for a picture of a rock.


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Sources:
https://www.wsj.com/articles/if-you-sell-a-house-these-days-the-buyer-might-be-a-pension-fund-11617544801
https://slate.com/business/2021/06/blackrock-invitation-houses-investment-firms-real-estate.html
https://www.urban.org/sites/default/files/publication/103341/new-models-for-community-shareholding_0.pdf

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