Investor Home Buying Crashes 46%. Firesale Coming in 2023?
A new report from Redfin confirms that real estate investors are abandoning the US Housing Market. And that the era of Wall Street buying up single-family homes could be coming to an end.
The report explains that investor home purchases declined by a whopping -46% in Q4 2022 compared to a year earlier. That's the biggest annual decline in US History. Even bigger than the declines in 2006 that preceded the biggest Housing Crash ever.
Buying Real Estate is a Bad Investment
Why are Real Estate Investors abandoning the US Housing Market? Because buying real estate is a bad investment right now. The combination of declining prices, falling rents, and surging interest rates means there's a good chance an investor who buys right now will lose money.
The best way to understand this is by comparing the Cap Rate to the Mortgage Rate. The Cap Rate measures the profit % an investor receives from buying and renting out a house in America. The Mortgage Rate measures their cost of capital.
When the Cap Rate is above the Mortgage Rate, like from 2015 to 2021, it makes sense for investors buy. Because the earnings from their rental are greater than the interest costs to finance the purchase. They make a profit after paying the bank.
But over the last year we've entered an entirely different situation. Where the Mortgage Rate (6.4%) has vaulted way above the Cap Rate (4.7%). Meaning that an investor who finances their purchase with debt could be paying more in interest costs than they will receive in income from the property.
Cities with the Biggest Decline in Investor Purchases
Ultimately fundamentals rule the day, and if investors are losing money on new acquisitions, they will stop buying. And that's exactly what happened in Q4 2022.
But what's interesting is that the decline was heavily concentrated in specific cities. Redfin identified Las Vegas, Phoenix, Atlanta, and Charlotte as metros where investor purchases declined by more than 60%.
I mean - chew on that for a second. Las Vegas had a 67% drop in investor demand. 2/3 of the investor buyers left. No wonder inventory in Vegas has surged to the highest levels in years and prices are dropping fast.
The same can be said for Phoenix, where there was a 66% drop in investor buying. As a result, sale prices in Phoenix are down by 12% since peak and inventory has nearly tripled over the last year.
The Southeast markets are more investing/complex. Home Prices in metros like Atlanta, Charlotte, Jacksonville, and Orlando have held up fairly well despite the drop in investor buying. Why is that?
Because regular buyers stepped into these markets in late 2022 to support demand. These markets haven't felt the same migration slowdown that the Mountain West areas of America have.
But they will. More on that in a future post.
But wait...I thought Investors Purchase in Cash? Why do they care about Mortgage Rates?
A common point of confusion about real estate investors is the notion that they "purchase in cash". And thus don't need to worry about increasing interest rates.
But this isn't entirely true. Because while an investor might make an offer in cash, most of the time the source of that cash comes from a debt instrument. This is especially true for Wall Street buyers, who commonly use the Mortgage-Backed Security ("MBS") market to finance their acquisitions.
During the pandemic, from mid-2020 to 2022, these Wall Street buyers had a field day raising money from the MBS Market. To be exact, buyers like Progress Residential, Tricon, Starwood, CoreVest, and Cerberus Capital raised $32 Billion in MBS to facilitate their home purchases.
All that capital, raised at artificially low interest rates, enabled these investors to go hog wild buying up homes in 2021 and early 2022.
But then WHAM. The MBS market for single-family rentals ground to a screeching halt in the second half of 2022. And in the last three quarters the Wall Street buyers have only been able to raise a meager $3 Billion.
Wall Street is running out of Money
Which means that Wall Street Homebuyers are running out of money. Which sounds crazy to say. Because all we've heard over the last two years is just how much money is "sitting on the sidelines" waiting to be invested.
But the MBS data doesn't lie. If there was still major investor appetite to fund single-family home purchases, we would see new MBS issuances. But they aren't happening.
And the few that are happening are going poorly.
Progress Residential, the 2nd largest homeowner in America with 70k homes owned, just did an MBS raise last week. The only one of 2023 so far. Their request from the MBS Market was $343 Million at a 5% interest rate.
But the MBS investors didn't want anything to do with that. Progress Residential had to take a haircut and ended up raising $271 Million at a 5.75% rate.
Investor Firesale Coming in 2023?
But these Wall Street Buyers still want to buy homes since their business runs off acquisition fees. They need to keep buying and earnings fees to keep the lights on at the corporate office.
So how will they fund new purchases in 2023 if they can't raise debt to do it?
Well, one option is to raise equity. But that's even worse than raising debt since the cost of capital in equity these days is north of 10%.
Another option is to sell homes in the existing portfolio to fund acquisitions in new markets. Specifically, to sell homes in higher-priced metros areas like Phoenix and Las Vegas. And to take the proceeds from those sales to buy homes in cheaper metros like Greensboro and Columbus.
That business model would allow Wall Street investors to continue buying properties and actually add incremental value to their shareholders by getting into higher yield markets.
I believe Phoenix and Las Vegas will be the first metros to be firesold. (Sacramento could enter the mix as well.) And that inventory will skyrocket in these metros with prices dropping hard in 2023. Investors will push more towards the Midwest, Carolinas, and parts of Florida with their new purchases.
Nothing goes to Heck in a Straight Line
Some might be upset to hear that Wall Street will still be buying homes in 2023. And that they could invade some new markets. And perhaps we even see a bump in investor home purchases in Q1 2023 as they burn off some of the excess capital from the $32 Billion they hadn't invested yet.
But ultimately the thing to remember is the old adage, coined by Wolf Richter: "Nothing goes to Heck in a Straight Line."
Wall Street Investors, as well as small-time investors, were groomed by the Fed for 10 years to expect easy monetary policy and bailouts. Many real estate investors quit their regular jobs to pursue their dreams of becoming a landlord, home flipper, or wholesaler. Lots of money was raised in 2020-21 to facilitate those dreams. And lots of narratives were spun ("housing shortage", "millennial demand", etc.) to make investors believe those dreams were valid.
And so it's going to take some time for investors to accept reality. A 46% drop in home purchases is a good start. The next phase of accepting reality will be selling out of blacklisted markets like Vegas and Phoenix. The final phase of reality will come when the Recession worsens and investors realize there truly are no "safe haven" markets.
Want more content on this Investor Crash and what it means for the Housing Market in 2023?
Make sure to watch the YouTube video I just posted on the Investor Crash here: