Earlier this week Redfin reported that real estate investors abandoned the Housing Market. Reporting a record 49% YoY decline in investor home purchases across America in the first quarter of 2023.
In one year, real estate investors went from dominating the US Housing Market to running scared due to a nasty combination of 1) higher interest rates, 2) declining home prices, and 3) stagnating rents.
This was especially true in specific housing markets where the Wall Street buyers were most active. Like Phoenix. and Atlanta. and Nashville. Where investor demand has fallen to the lowest levels in a decade.
In this post I will explain why investors stopped buying in these cities. How this shift benefits regular homebuyers. And when we could see the investors eventually return.
Point #1. Buying real estate in Phoenix is not profitable in 2023.
Real estate investors want to make money. Whether they're the big Wall Street type, or the small mom and pop type. And the main problem for these investors right now is that it is simply not profitable to buy real estate.
To get a sense of this, take a look at this rental listing in Phoenix. Which is owned by Roofstock, a corporate investor. Roofstock purchased this 3br, 2ba starter home during the peak of the pandemic housing boom in 2021 for $440,000.
Fast forward to today and the property is now listed at $2,200/month for rent (6.4% rent cut from the levels in 2021). Assuming Roofstock is able to lease this property at $2,200/month, they will derive approximately $17,660 in annual net income from the property.
That $17,660 net income represents a 4.0% cap rate, or investment yield, on the original purchase price of $440,000. That's a very low return given that you can go and buy a low risk certificate of deposit at 5.1% interest right now.
Which highlights problem #1 for real estate investors. The opportunity cost of buying real estate in a city like Phoenix is negative. Since you can earn more by buying short-term government bonds or CDs.
But problem #2 is an even bigger one. And that's the these corporate real estate investors almost always use debt to finance their acquisitions. And that debt is typically priced near the 30-year fixed mortgage rate, which is currently at 6.9%.
Meaning that if another investor wanted to buy this property off Roofstock right now and finance it with debt, they would be deeply in the red.
How much in the red? Around -$7,000 if they made an offer at Roofstock's original $440,000 purchase price and financed it 80% with debt.
So yeah - no wonder investor purchases in Phoenix crashed 64% YoY. Any new investor would be losing tons of money after paying interest. And even if they paid in cash (few do), their opportunity cost of owning would still be negative compared to bonds and CDs.
What really needs to happen to bring these investors back into Phoenix, and other markets around America, is for home prices to collapse.
Point #2. Sellers don't want to capitulate.
Notice that Roofstock still is electing to still rent this property, even though the rent has gone down 6% and the value has likely gone down as well. They're not ready to throw in the towel and sell it yet.
That's because the "clearing price" for this property to sell and be profitable to a new investor at current rates is $300,000. A massive 32% crash from what Roofstock purchased it for two years ago.
Alternatively - if Mortgage Rates went down to 4.90% then a new investor could turn a profit at the original purchase price. With perhaps a more realistic scenario being a situation where the price goes down to $360,000 (-18%) and Mortgage Rates down to 5.90%.
Mind you - this is just to get the property to turn a profit. A new investor who's sane would likely want an annual profit after debt service closer to $8,000/month (9% return on equity). And the only way that's possible is if the price goes down to $280,000 and mortgage rates drop to 4.40%.
As you can see - current prices and mortgage rates are so far removed from making this property profitable for a new investor that Roofstock is likely deciding just to hold onto it rather than go through the headache of trying to sell.
Ultimately there will need to be some economic turmoil to entice Roofstock, and the myriad other corporate investors, to sell. For instance, if the Phoenix economy hits recession, causing evictions and vacancy rates to surge, then maybe they'd sell. Or maybe if a capital partner demanded an appraisal revaluation of their Phoenix portfolio and decided to margin call Roofstock to cover any value declines. That might spur some sales.
But until that type of turmoil happens, existing investors are unlikely to sell at the dramatically lower prices needed to entice new investors back into the market.
Point #3. Make no mistake: this is good news for regular homebuyers.
While it might be frustrating to see Roofstock hold on to a property that they probably should be selling, the current decline in investor purchases is still a "win" for regular homebuyers.
That's because homebuyers are regaining a big piece of market share in cities like Phoenix, Atlanta, and Tampa. For instance, data from Redfin shows that the investor market share of purchases in Phoenix dropped to 18% in Q1 2023. Meaning that regular buyers bought 82% of the homes.
A dramatic improvement from the pandemic when investors were buying over 30% of the homes. And much closer to the long-run level.
A similar situation exists in Atlanta. Where investors tumbled from buying 36% of the homes at the pandemic peak to 20% of the homes in Q1 2023. This investor share is below the levels that occurred in 2018-19 before the pandemic.
Same thing in Tampa. Where investors only purchased 18% of the homes that sold in Q1 2023 compared to north of 25% at the pandemic peak. The current investor share in Tampa is roughly on par with what occurred in the decade prior to the pandemic.
More homes in these Sun Belt markets are being purchased by regular buyers. Who actually live in the homes.
Which is great news (even if prices haven't come down enough yet to make it affordable to buy).
Point #4. Investors are running out of money.
I expect this trend of declining investor home purchases to continue over the long-term.
That's because these Wall Street investors are running out of money.
To understand this point, take a look at the graph below. Which tracks the amount of money raised in the Single-Family Mortgage-Backed Security ("MBS") market from 2016 to 2023.
This MBS market is one of the main ways that the big Wall Street landlords raise capital to go buy houses. And what do you notice...
In 2023 a mere $600 million has been raised thus far in Single-Family MBS (enough to buy 1,800 houses).
That compares to an astounding $11 billion raised in 2022, $17 billion in 2021, and $9 billion in 2020. And an average of about $5 billion per year prior to the pandemic.
Meaning that 2023 Single-Family MBS issuance is on pace to be about 90% below peak and 75% below normal.
Meaning that Wall Street investors are going to be scrambling for cash once they deplete the excess capital raised in 2020-22. At that point, many will be forced to sell their existing portfolio in order to fund new acquisitions.
Which is when things could get very interesting. Especially in a market like Phoenix.
Point #5. Don't be surprised if there's a short-term bounce in investor buying.
Despite the realities of a 49% investor purchase crash in Q1 2023, a stagnating rental market, sky-high interest rates, and a lack of new funding, don't be surprised if there's a bounce in investor home-buying in Q2 2023.
That's because bullish sentiment is sweeping the financial markets right now. People think we dodged the recession. They see the stock market going up. They see inflation coming down. They see home prices stabilizing.
There's a perception building that the "worst is over". Which will likely cause some investors to come off the sidelines and utilize the excess cash they raised during the pandemic to purchase more homes in Q2 2023.
I don't think it will be a big bounce. But there will likely be a bounce. And it will be short-lived. Because the fundamentals I outlined in this article haven't changed. Buying real estate with debt is a money-losing proposition in most markets.
Point #6. Use Reventure App to find markets where it's better to buy.
If you are an investor who insistent on buying in 2023, I would recommend looking at higher cap rate markets where home prices are more fairly valued.
History says these markets will weather the turmoil of the next several years better.
You can use Reventure App to find these markets using the filters tab. In the map below I isolated metros to ones that are 1) max 20% overvalued and 2) have cap rates above 6.0%.
aka - markets that are less likely to see prices drop, and more likely to return cash flow from Day 1.
One complaint about some of the markets on the map above is that they are "low growth". And unlikely to have big appreciation in the long-term. Which is true.
Another version of this map, relaxing overvaluation to 25%, Cap Rate to 5.5%, and adding in positive Migration as a filter, would return some higher growth markets. And look like:
Less Midwest and Lousiana. More Georgia, South Carolina, Kentucky, and Oklahoma.
Play around with the filters and let me know what you find.