It's official: real estate investors have abandoned the Housing Market in 2023.
With data from Redfin reporting a colossal 49% YoY decline in investor home purchases in the first quarter of 2023. This is the biggest annual decline in investor demand in US history (at least going back to 2000).
Investors purchased 41,000 homes in the counties that Redfin tracks in Q1 2023. Which is not only a 49% drop from last year, but also a significant decline from pre-pandemic levels.
Overall investors purchased 18% of the homes that sold in the quarter. Which is a slightly higher share than they were doing before the pandemic. However, the overall drop in absolute sales indicates that the short-lived era of investor domination of the US Housing Market is over.
Rising Interest Rates nuked Investor Demand
Going back 12 months ago I was predicting that Wall Street Investors would exit the US Housing Market.
And my logic was simple: higher interest rates were going to make being a landlord unprofitable. And cause the Wall Street buyers to drop out. A reality which you can see clearly on the graph below, which compares the 30-Year Mortgage Rate in America to the Cap Rate for investors (the unlevered profit yield from the rental).
From 2015 to early 2022 the Cap Rate was higher than the Mortgage Rate. Meaning that Wall Street investors had a big incentive to take out debt and buy up homes. Since they were guaranteed to make money after paying their lender (in the business we call this spread "accretive leverage").
But now this dynamic has completely shifted. Mortgage Rates started to skyrocket in early 2022. And by April 2022 the Mortgage Rate was officially higher than the Cap Rate. Which is precisely the point in time that investors began to make fewer offers on home.
Fast forward to spring 2023 and the situation is completely untenable for investors. The Mortgage Rate is 6.9% and the Cap Rate is 4.6%. Meaning that any investor who takes out debt to buy rental homes is guaranteed to lose money after paying their lender (we call this "negative leverage").
(Note: some people think mortgage rates don't matter for Wall Street investors because they "buy in cash". However, the underlying source of the cash is usually debt. Often raised from the Mortgage Backed Security market. With the debt priced at a similar interest rate to the prevailing 30-year Mortgage.)
Investors bailed everywhere. But especially in the Sun Belt.
The other interesting trend revealed in this Redfin report is about where investors bought fewer homes.
Metros with Biggest Decline in Investor Purchases
- Atlanta: -66% decline
- Charlotte: -66% decline
- Phoenix: -64% decline
- Las Vegas: -60% decline
- Nashville: -60% decline
- Jacksonville: -57% decline
- Tampa: -54% decline
The investors bailed most on all the hot Sun Belt markets they piled into in 2020 and 2021. The markets they said were great long-term places to buy because of "all the people moving in".
Well, that was a bunch of baloney. All it took was some Jerome Powell rate hikes to sour investors on the idea of buying in Sun Belt boomtown cities. So much for these investors having a "long-term strategy".
What's even more interesting are the markets that experienced the lowest decline in investor purchases. It's basically the reverse of the above list.
Metros with Lowest Decline in Investor Purchases
- Baltimore: -9% decline
- Providence: -10% decline
- Seattle: -16% decline
- Milwaukee: -22% decline
- Cleveland: -23% decline
- Cincinnati: -25% decline
With the exception of Seattle, the markets that held investor demand the best were Northeast and Midwest "rust belt" areas. These areas largely go ignored in the national real estate discussion with very few big institutional players raising capital to buy homes there.
Which is precisely why they held up better. These markets are less reliant on the ebbs and flows of where Wall Street wants to put its capital. Rather, they're supported by local investors with a firmer knowledge base and tie to the area.
Going forward: it's all about Cap Rate
If you are an investor, or someone who wants to be an investor in the future, I'll say this: all hope is not lost. There are still opportunities out there and some markets where you can find success.
However, your main guidepost for finding these markets and deals needs to be about Cap Rate. That is, how much rental profit you earn from the property (net income / purchase price). Because in this higher interest rate environment, cash flow is going to become the key measure of success.
High cap rate markets/deals give investors this cash flow from Day 1. You can actually buy a rental and start putting money in the bank right away. Rather than having to hope and pray for rent growth and appreciation into the future to "save your investment".
The map below shows the metros in America color-coded by their Cap Rate. And what you can immediately see is that the highest Cap Rates (rental profits) are found in the Midwest and Deep South.
Whereas the lowest Cap Rates are in the Mountain / West regions of America, as well as select Northeast markets. You can access this data for yourself by going on Reventure App and selecting "Cap Rate" under premium data points.
And just so you can understand these differences practically, let's compare two markets: Pittsburgh, PA and Phoenix, AZ.
An investor looking to buy a home in Pittsburgh would be looking at paying around $200k for the typical house and could expect to earn around $14k in net income before paying interest. Good for a 7.2% unlevered return.
- Metro: Pittsburgh, PA
- Purchase Price: $198,928
- Net Income: $14,285
- Cap Rate: 7.2%
Now, let's compare that to the experience of an investor who wants to buy in Phoenix. They would have to pay around $435,000 for the typical house and they'd take home $21,000 in net income before interest. For a measly 4.9% cap rate.
- Metro: Phoenix, AZ
- Purchase Price: $435,984
- Net Income: $21,367
- Cap Rate: 4.9%
If this investor is using mortgage debt to facilitate the transaction, they will likely be losing money in Phoenix after paying their lender. And desperately praying that rents in Phoenix will surge in coming years to bail out their investment and make it profitable.
Low Cap Rate Markets at the start of a long Bear Market?
No wonder investors are bailing on Phoenix. It just doesn't make sense to buy there. And ultimately I think we could be at the start of a long bear market for these expensive, low Cap Rate markets.
Especially across California. Where you can see that metros like San Jose, Los Angeles, and San Diego offer investors miniscule cap rates ranging from 2.5 to 3.5%. Those returns are less than what someone could get by buying a treasury bond.
Other markets with low cap rates include Austin, Seattle, Salt Lake City, Portland, and Denver. I suspect these areas are in for an investor bear market so long as interest rates remain elevated.
These markets will also likely have lower regular homebuyer demand going forward. Because a low cap rate essentially means that home prices have grown a lot faster than rents. Indicating that it's cheaper for households to rent in low cap rate markets than it is to buy (something you can confirm on Reventure App by clicking "Rent v Buy Calculator" under premium data points).
So long as it remains significantly cheaper to rent than to buy, households will sit on the sidelines and wait for home prices and mortgage rates to drop further.
Wall Street bailing is a WIN for Regular Homebuyers
Lastly - we need to acknowledge how this collapse in investor home-buying is a WIN for the regular homebuyer in America. Especially in metros like Charlotte, Atlanta, Phoenix, and Jacksonville, where investors lost the most market share according to Redfin.
In a metro like Charlotte investors went from purchasing 33% of the homes one year ago to only 18% of the homes in Q1 2023. Similar declines in investor share (gains for regular buyers) occurred throughout much of the Sun Belt.
Of course - homebuyers in these cities are still unhappy. Because they see prices and mortgage payments that are way too high. Far beyond what they can afford in many cases. They also see low inventory levels and are frustrated from 2+ years of searching for the right home.
And ultimately this frustration is understandable. The Housing Market is frozen right now and a tough slog for both buyers and sellers. However, the thing to remember is that housing downturns take time to play out. Often 4-5 years. And we are just now exiting Year 1 of this housing downturn.
Note that back in the mid-2000s bubble the investor purchases peaked in 2005, a good three years before prices began declining substantially. The decline in investor purchases was a leading indicator about what was coming for the market overall.
Ultimately home prices and mortgage rates still have a long way to go down before they reach levels where they entice both investors and regular buyers to come back into the market.
Are you an investor?
I'm curious - are you an investor? If so, how are you looking at the market right now? Are you buying with a mortgage or planning to pay cash? What markets are you interested in? Let me know in the comment section below.