We’ve Resorted to Fighting Over 3/2/2s

Rodney Johnson | Thursday, May 16, 2013 >>

One morning, several years ago, I was running late for a TV interview. I had just finished up a radio interview and realized I had twenty-five minutes to get to the on-location site for the live TV spot.

The topic was housing.

The location was an empty field.

Well, it was almost empty. It was a new neighborhood with streets, sidewalks, and streetlamps… but no houses. I drove (too quickly) to the location, hopped out of the car, walked up to my mark opposite the reporter, pinned on the mic, and the interview started.

After the real estate bust it was clear to everyone that we were not going to simply revert to cheap credit again anytime soon. For housing to rebound at all, something had to change… and it did.

There has been a seismic shift from owning to renting, which was a huge opportunity for those that had the ability to buy property and rent it out. I say “was a huge opportunity” because this play has already been squeezed for the easy profits. What is left behind at this point is the stuff that takes work.

Right now, investors of all sizes are locked in a battle over homes with three bedrooms, two baths, and a two car garage… otherwise known as a 3/2/2.

As the housing market rolled over and foreclosures exploded, there were suddenly a million different coaching classes available on buying foreclosures and turning them into rental property.

Granted, when things were darkest in late 2008 and early 2009, this was a gutsy thing to do, but as the economy stabilized the investment made sense. Banks and other mortgage lenders were convulsing over loan losses and property was being sold at very low levels.

Real estate prices got so low that annual rents represented more than 10% – and often more than 15% – of the cost of the home. During a time of record low interest rates, where else can an investor get that kind of return?

Of course, this situation attracted a lot of small investors, and eventually a lot of really big ones as well…

The investment group Blackstone has spent over $3 billion to buy 20,000 homes, becoming one of the largest landlords in the country in the process. At the same time, Colony Capital has raised more than $2 billion to do the same thing. These amounts are small compared to the size of the housing market, but they show a sizeable trend in how institutional investors are now getting involved in, as well as shaping, the housing market.

From March 2012 through March 2013, home prices in the U.S. were up more than 7%. But rental prices on single family homes were up merely 0.1%.

In many cities, the two measures (home prices and rents) moved in opposite directions…

In Fort Lauderdale, FL, home prices were up 10.7% while rents were down 1.2%. In Phoenix, AZ, home prices shot up by 24.2% while rents increased by a measly 0.3% (less than the rate of inflation). The spread was the widest in Las Vegas, NV, where home prices moved up by 24.6% and rents fell by 1.9%.

Given the two trends of rising sale prices and flat to falling rents, it’s clear that the marginal return of buying a home to rent it out is declining. In short, this is becoming a crowded trade, where everyone is doing the same thing.

At what point do homes become too expensive to justify the buy-to-rent strategy?

The answer is somewhat different for each investor, because everyone’s cost of capital and tolerance for loss and illiquidity is different. I’d imagine Blackstone can take a deeper loss, and suffer longer illiquidity, than most individual investors.

So the key to this market is shifting from merely buying the property right to including a clear exit strategy. The days of buying cheap homes on the courthouse steps and then renting it out while it appreciates dramatically are over.

If you’re in this market, or considering getting in, be very careful of any assumptions made about price appreciation. The housing market has been driven much higher in the past two years by investors both large and small, taking out the easiest profits. Whatever you buy at this point could be in your portfolio a lot longer than you anticipated.


Rodney

P.S. If it’s an easy, but profitable and relatively risk-free investment you’re looking for, then turn your sights away from housing and look at this.

 

 

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Categories: Housing Market

About Author

Rodney Johnson works closely with Harry Dent to study how people spend their money as they go through predictable stages of life, how that spending drives our economy and how you can use this information to invest successfully in any market. Rodney began his career in financial services on Wall Street in the 1980s with Thomson McKinnon and then Prudential Securities. He started working on projects with Harry in the mid-1990s. He’s a regular guest on several radio programs such as America’s Wealth Management, Savvy Investor Radio, and has been featured on CNBC, Fox News and Fox Business’s “America’s Nightly Scorecard, where he discusses economic trends ranging from the price of oil to the direction of the U.S. economy. He holds degrees from Georgetown University and Southern Methodist University.