Note Buyers and Investors – Recognizing the Peak of the Housing Market

Hardly anyone was surprised by the news earlier this week that property values had climbed 6.8% from December 2011 to December 2012, according to the S&P/Case-Shiller index.  Phoenix led the group — where 19 out of 20 cities saw value increases – by gaining 23% over that 12-month period.  Note buyers, real estate investors, and formerly underwater homeowners have rejoiced over the trend.  The media and economists see nothing but sunny skies ahead for housing and believe that real estate will help pull the economy to greater heights.  Some of the more skeptical investors and note buyers may wonder how genuine the housing recovery is going to be.  An example of well-founded skepticism is that Georgia, with one of the country’s highest foreclosure rates, still experienced year-over-year price increases of 5% (per Salon, 2/7/2013).

Digging more deeply into the details, we find that a much smaller percentage of traditional homebuyers are participating in the home buying spree than has happened in the past.  Rather, Wall Street private equity firms and hedge funds, aided by the Fed’s full participation, are buying a lot of the foreclosed homes and turning them into rentals, thus fueling the increase in values.  Most of Wall Street survived the huge housing bubble that they helped create a few years ago and now wants to make fresh profits from the newest bubble.

A hot trend in the financial sector is REO-to-rental, in which the firms raise huge amounts of capital to buy foreclosed and otherwise distressed homes, rent them out, and resell them at appreciate prices.  A JP Morgan Chase report states that at least $10 billion has been raised for REO-to-rental – enough to buy 15% of all bank-owned homes.  The financial firms offer up to 10% returns to entice investors to jump in.  Blackstone Group alone is spending $1 billion just in Tampa, Florida for foreclosed homes (New Republic, 2/12/2013).

Money down the drainThese firms are sometimes partnering with large property management companies that do minimal renovations to damaged properties and have little interest in keeping rents reasonable or tenants happy.  At least one of these companies has signed an agreement with credit-reporting company Experian to more promptly do credit reporting on renters.  Worst of all, Wall Street has begun exploring the securitization of rental income, much as they did with mortgages.  We all know how that turned out!  With new REITs and investor types entering the market, the increased speculation is almost certainly leading to another bubble.

How will we know when this housing bubble is about to burst?  When these private equity firms and hedge funds decide to start exiting the market, the sheer size of their holdings will magnify individual actions.  Any hiccup in the economy that threatens more vacancies or hits to home values will send those companies scurrying for the exits like scared rats (an apt metaphor).  Phoenix is a good candidate to see what happens as its home values experienced a meteoric rise, a harrowing fall, and a huge climb again.  Some investors have already pulled out of that market.

So, keep an eye on the financial firms.  Some of them may use alias names, so a large spike in inventory could signal problems.  When they do decide to jump ship, expect another crash shortly thereafter.