As reported by Morningstar Credit Ratings, as the institutional residential rental market matures, so does the dominate geographic location of new purchases. At the same time, key sources of new purchases has changed. The prevailing geographical location has shifted from the southwest United States to the southeast. While Florida remains the industry’s largest market, institutional investors have shifted their buying to states such as Texas, North Carolina, and Indiana. They are finding fewer opportunities in California, Arizona, and Nevada.
Additionally, this evolving industry is moving into a period of refinancing existing assets. At the same time, strategic consideration is being given to sell off homes that have appreciated in value.
Rental demand remains high, as the nation’s home ownership rate recently hit a 50-year low. Simultaneously, the housing purchase market continues thriving but faces several hurdles. Rentals have historically made up at least 10 percent of the single-family housing stock with about a million more rental homes added over the course of the foreclosure crisis.
Today, institutional investors, small investors, and want-to-be homeowners all face many of the same challenges. While home sales have risen, so have interest rates and home prices. At the same time, the distressed property market along with the retail resale market (low inventory) have shrunk dramatically. There is no sign that new construction is stepping up in a significant way to fill the void. Essentially, all buyers are scrambling after the same shrinking market.
From 2012 through 2014 was a period of higher volume of distressed property purchases for institutional buyers. From 2015 to 2016, the distressed property market retracted with a 65.6 percent acquisition decline in 2016 compared with 2015. This coincides with the geographic shift in purchasing.
Property purchases in California, Arizona, and Nevada were more prevalent in 2012-13, while Texas, North Carolina, Tennessee, and even Indiana had more institutional acquisitions from 2014 to 2015. Florida has been among the top states for acquisitions annually since 2012.
More recently (2015-2016), saw a period of more selective institutional investment in single-family rental properties. Florida properties accounted for greater than 20% of acquisitions in both time frames and Georgia was consistently above 10%. However, Texas, North Carolina, Tennessee, and Indiana acquisitions picked up in recent years, while those in Arizona, California, and Nevada dropped off.
Institutional buyers of single-family rental houses consider several factors when purchasing properties. These include the acquisition channel (foreclosure auctions, distressed REO, MLS, etc.), the costs associated with the purchase, initial rehabilitation and ongoing maintenance, gross and net yields, and potential home price appreciation. Institutional buyers also consider economic factors like regional employment, income, and demographic factors such as school-district rankings. Changes in these considerations affect the geographic makeup of securitized pools.
In its early days, institutional investors bought distressed properties at discounts through bulk purchases and auctions. However, a generally improved housing market, including sustained house price appreciation, has resulted in fewer of these opportunities.
Today, institutional buyers are selectively adding assets. Rather than REO and foreclosure auctions, the trend appears skewed towards more multiple listing service (MLS) purchases.
While purchase prices are higher today, this more opportunistic buying allows institutional buyers to target properties requiring less up-front renovation, as evidenced by declining rehabilitation costs (see the full report). Lower initial rehabilitation costs may also be partly explained by institutional investors improving their operational efficiencies. Despite lower rehabilitation costs, the total cost to purchase homes is higher for more recently acquired properties.
The composition of future institutional single-family rental deals depends on property acquisition and disposition strategies. Predictably, these will flow over to influence smaller investors and the residential real estate market as a whole.
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Author bio: Brian Kline has been investing in real estate for more than 35 years and writing about real estate investing for seven years. He also draws upon 25 plus years of business experience including 12 years as a manager at Boeing Aircraft Company. Brian currently lives at Lake Cushman, Washington. A vacation destination, a few short miles from a national forest in the Olympic Mountains with the Pacific Ocean a couple of miles in the opposite direction.