Private Equity Taps Builders as Foreclosures VanishJohn Gittelsohn
Investors seeking single-family homes to rent are buying land and newly-built properties as foreclosures dwindle and existing home prices in the U.S. rise at their fastest pace since 2006.
Landsmith LP paid $32.5 million this month for 250 Houston-area houses that were built last year. The firm, which began buying properties to rent in 2009, has 2,000 lots for new homes under contract and expects to purchase a total of 4,000 new houses this year, according to San Francisco-based Chief Executive Officer James Breitenstein.
Just as investors flocked to Atlanta after picking through foreclosures in Phoenix, they’re now seeking deals from builders who want to lock in sales or sell property quickly. The appeal of buying newly-built homes that are typically more expensive than repossessed ones is growing as the number of borrowers facing foreclosure falls to the lowest level since 2008 and after prices of bank-owned properties was driven up by Blackstone Group LP, Colony Capital LLC and other private-equity firms snapping up tens of thousands of houses.
“A big part of our business plan is to execute this strategy,” Breitenstein said in a telephone interview. “It’s a way to control your pipeline and not have to fight with the herd.”
The share of mortgages in foreclosure, meaning the lender filed to repossess the property, fell to 3.55 percent in the first quarter from 4.39 percent from a year earlier, the lowest in four years, according to a Mortgage Bankers Association report last week.
“The dwindling supply of such properties may be cause for concern among some institutional investors whose residential business models depend crucially on being able to snap up these bargains,” Paul Diggle, an analyst with Capital Economics Ltd. in London wrote in a note after the Mortgage Bankers report.
Demand from rental investors may bolster some homebuilders, which have rallied 22 percent this year and more than doubled since the end of 2011. Steve Eisman, who rose to fame betting against subprime mortgages during the housing crash, said last week that investors should buy shares of builders and land as the housing market strengthens.
“While homebuilders are cheap, they have not priced in how much fundamentals have improved,” Eisman, founder of Emrys Partners LP, said at a conference in New York.
New home sales also have “higher economic multipliers and local impact relative to existing home sales,” Sam Khater, deputy chief economist with CoreLogic Inc., wrote in a newsletter published today. “For example, the sale of every new home requires the equivalent of five full-time jobs for 12 months.”
Builders selling to Landsmith have mostly been capital-starved smaller operators, according to Breitenstein, rather than publicly-traded companies such as D.R. Horton Inc. or PulteGroup Inc. Other investors have bought small numbers of houses from the largest builders.
American Homes 4 Rent, a Malibu, California-based company headed by Public Storage founder B. Wayne Hughes, bought from Lennar Corp., KB Home and M/I Homes Inc. in Florida’s Hillsborough County, according to property records.
Blackstone, which has acquired more than 24,000 houses over the past year, bought five Lennar homes in Hillsborough County since September. The new houses, which sold for $200,000 to $257,000, are in areas with low crime and good schools and can make money from rent or price appreciation, according to Eric Elder, spokesman for Invitation Homes, Blackstone’s single-family rental division.
“It was an opportunistic buy,” Elder said in a telephone interview. “It’s not a specific bullet point in our strategy.”
American Residential Properties Inc., a Scottsdale, Arizona-based rental company that raised $288 million in an initial public offering last week, bought 21 to-be-built Las Vegas houses last year from William Lyon Homes, the last of 325 lots in a subdivision that opened in 2003.
“If we can make the numbers work, we’ll look at that the way we look at any other opportunity,” American Residential Chief Operating Officer Stephen Schmitz said in a telephone interview.
Wall Street-backed investors began buying single-family rental homes in the last few years after prices plunged more than a third from the 2006 peak and more than five million homeowners lost property to foreclosures, bringing institutional capital to what has been a mom and pop industry.
While low prices and record-low interest rates have made homes more affordable, many potential buyers are unable to get a mortgage because they don’t have money for a down payment or lack high enough credit scores to borrow. The U.S. homeownership rate dropped to 65 percent in the first quarter, down from 69 percent in 2004 and the lowest rate in 17 years, according to Commerce Department data. For people younger than 35, an age group when families begin raising children and buying home, the ownership rate fell to 37 percent last year from 43 percent in
“The massive supply of homes coupled with the significant drop in prices create an opportunity for investors to acquire homes at significant discounts while delivering housing solutions for many displaced residents,” Colony American Homes, the rental division of Thomas Barrack Jr.’s investment firm, said in a regulatory filing.
Colony has raised $2.2 billion and acquired more than 9,500 homes in eight states as of April 21. The average house was 26 years old, 1,760 square feet (164 square meters) and cost $159,000.
Las Vegas; Indianapolis, Indiana; and Orlando, Tampa and Jacksonville, Florida, have the highest yields on rentals according to a report last month by Goldman Sachs Group Inc. Those yields are higher on foreclosed homes, which typically sell at a 30 percent discount to other properties, according to the report. In Las Vegas, for example, the yield on bank-owned properties is 8 percent compared to 6.2 percent for other rentals, after factoring in vacancy rates and costs, such as taxes and insurance.
The median resale home price in 150 U.S. cities jumped 11.3 percent in the first quarter to $176,600, the biggest price rise in seven years, the National Association of Realtors reported May 9. Prices soared 31 percent in Atlanta, 30 percent in Phoenix and 27 percent in Las Vegas, the real estate group reported from Washington.
The largest rental investors have bought faster than they can find tenants. Only 55 percent of Colony’s homes, most of which were purchased within the last six months, were leased, according to a regulatory filing this month.
Landsmith has specialized as a mid-sized player in the single-family rental industry, buying homes for itself and assembling portfolios of as large as 200 leased-up properties that it sells to larger investors. The company is in the process of closing deals this month to buy 87 rentals in Raleigh, North Carolina, for $5.1 million and 118 homes in Nashville, Tennessee, for $11 million.
It paid an average $130,000 for the 250 Houston-area homes, Breitenstein said. The rentals are sprinkled around 12 communities where builders sold most of the houses to owner occupants, he said.
The new houses have low maintenance costs and are more efficient to manage than more scattered properties, Breitenstein said. About 98 percent of the Houston residences are already leased for $995 to $1,500 a month, according to an offering memorandum obtained by Bloomberg News. Tenants are willing to pay a premium of $50 to $100 a month to occupy a brand new home, according to Breitenstein.
“They like the smell of new,” he said.
While fewer bank-owned properties are coming to market, the number of new homes for sale has increased -- slowly -- rising 5 percent from a year earlier to 153,000 in March, according to Commerce Department data. That compares with a high of 572,000 in July 2006.
The new homes sold for a median $247,000, up 3 percent from a year earlier. Average prices rose 9.3 percent at Lennar, 10 percent at PulteGroup and 14 percent at D.R. Horton during the companies’ most recent quarters as they emphasized improving profit margins over sales volume.
“Our goal is improve the bottom line better than we improve the top line,” D.R. Horton CEO Donald Tomnitz said during an April 26 earnings call.
Builders sell houses to Landsmith at a discount compared with owner occupants, because they don’t have to pay real estate broker fees and it’s easier to raise project financing if a large number of sales are guaranteed, Breitenstein said.
“We help builders by giving them a bullet-proof takeout,” said Breitenstein, who declined to name the builders to keep his competitive edge.
Building new homes to sell to landlords was a viable option in markets such as Charlotte, North Carolina, a year or two ago, according to John Burns, chairman of John Burns Real Estate Consulting. The opportunity to build new homes as rentals may have passed as land, lumber and labor prices rise and more buyers seek new houses amid a tight supply of existing homes, he said.
“Today, it makes way more sense to sell,” Burns said in a telephone interview from Irvine, California.
Beazer Pre-Owned Rental Homes Inc., a venture formed by private-equity firm KKR & Co. and Beazer Homes USA Inc., started last year with a portfolio of 190 houses in Phoenix and Las Vegas, hasn’t been able to find new houses to rent that fit its criteria, according to CEO Patrick Whelan.
“It’s harder to make the math work on new houses to rent, and they are often located in inferior submarkets,” Whelan said in a telephone interview from his office in Scottsdale, Arizona. “Buying for less than replacement cost is a key metric we focus on. Obviously, if you’re buying new, you’re buying at full cost, including builder margin.”
Last year, builder Hovnanian Enterprises Inc. and its investor GTIS Partners debated whether to sell or rent units in Vistabella, a 70-unit townhouse community in Boynton Beach, Florida. They opted to sell, a decision that’s been vindicated, according to GTIS Chairman Tom Shapiro.
“I’d say the debate’s over now given what’s happened in the for sale market,” Shapiro, whose New York-based firm has $2.3 billion under management, including 5,000 rental homes and 30,000 lots, said in a telephone interview. “Had rents kept increasing and prices stayed low, I think we could’ve gotten there. Today, I don’t think it will be your best economic option.”
The economics of building to rent depend mostly on the price of lots, which Landsmith tries to keep below 25 percent of the final costs, Breitenstein said. Ready-to-build lots in Texas markets, such as Houston, are about 20 percent of the cost of a home, compared with as much as 50 percent in coastal California markets, according to Jeff Meyers, a housing consultant with Beverly Hills, California-based Kennedy-Wilson Holdings Inc.
“In Texas, the land isn’t such a big component,” Meyers said in a telephone interview.
Landsmith started tying up land in 2008 and 2009, when prices had plunged to pennies on the dollar, buying foreclosed subdivisions from banks and builders who ran out of cash. For now, it makes financial sense to keep some of the new houses as rentals.
“The key is executing quickly enough and moving fast enough,” he said. “In a year or two, this might not work.”