When you have an economic crisis, there are always ways to profit on the backside. Smart investors are taking advantage of the rebounding housing industry with funds buying single family homes.
When you have an economic crisis, there are always ways to profit on the backside. In the late ’80s and early ’90s, smart investors made a lot of money in the commercial real estate market after the savings and loan bust. We are in the process of recovering from the housing crisis, and smart investors are taking advantage of the opportunities to buy single family homes on the cheap, fix them up, rent them out, and possibly watch the values soar as the industry rebounds.
It’s the same concept of taking advantage of an asset class that is out of balance — just a different crisis with a different asset class.
As you look outside the stock market for intriguing opportunities that can deliver yield, start to focus on the opportunity to own single family homes inside a small fund. Projected cash-on-cash returns are in the high single digit range at 6% to 9%. And remember, this is a passive investment, which means that you are not going to be fielding that call from a tenant on a Sunday morning because their water heater went out.
One key to understanding this investment is how the sponsor has modeled getting to the cash on cash return. The best programs can deliver the 6% to 9% return through the rental payments alone with no debt on the properties and no price appreciation factored into the return. In this case, if the house goes up in value over time, that’s pure upside to the investment.
Buying up homes
Here’s what’s happening on courthouse steps across the country. The large institutional investors have deployed their ground game and have representatives strategically buying homes in specific marketplaces. They have largely tapped out Arizona and California and are currently in states like Georgia. These out-of-towners are bidding alongside smaller local investors in an attempt to snatch up hundreds, and eventually thousands of homes, to place in large portfolios. There is no secret to how they plan on delivering returns to investors. Buy distressed single family homes at roughly 30% to 50% of their 2006 peak value, fix them to livable standards and rent them to families displaced by foreclosure.
Two potential exit strategies exist for institutional investors. First, they might rent the houses until the market comes back and then sell for a nice profit in a few years. A second possibility is to create a new asset class on Wall Street of owning pools of single family homes. In that case, they can just repackage it and sell it back to us.
Advantages for the small guys
The big guys are doing it. But so, too, are the little guys. Just like anything, there are some significant advantages to being the small guy playing with the big boys. A large institution must own thousands of homes in their fund. The reality of buying thousands of homes is that a portion of those homes will not perform to expectations — you pay too much, rehab costs exceed budget or the home will not support the rental rates necessary to make the desired investment returns. Conversely, a smaller investor fund looking to buy 50 to 100 homes can be much choosier on the properties it decides to purchase. The smaller fund can cherry pick only the best opportunities that come across.
In addition, the larger institutions are finding that the cost of operating in the foreclosed home business is high. In order to show returns that will attract capital, these institutions are placing a significant level of debt on the properties. They also assume yearly appreciation in the properties. This creates two wildcards. The housing crisis reminded us what too much leverage can do. It also reminded us that homes can go down in value in a short period of time. Smaller funds seeking to be more conservative in their approach are able to model similar type returns without factoring debt or price appreciation of the property.
Finally, here are some thoughts that should be running through your head before you invest. Are there favorable landlord/eviction laws in that state where the home is located? Does the area have positive demographics and attractive growth rates? What’s the cost of living?
One old adage in real estate is that you make money on the buy. Right now there is a window to buy distressed properties, fix them to appropriate standards and rent for strong rental rates. That window continues to close, so now’s the time to consider allocating a portion of your total net worth to owning a piece of 50-100 single family homes.
Marshall H. Dean JD, MBA,
is a registered representative at Alliance Affiliated Equities Corporation, a FINRA-registered broker/dealer specializing in the evaluation and acquisition of alternative investments. Feel free to reach out at (913) 428-8278 or firstname.lastname@example.org.