US Investors are betting on a recovery in the housing sector, and in US homeownership, writes Stephanie Schwartz Driver

The rebound in the US housing market is sparking hopes of an economic recovery and creating potential opportunities for institutional investors.

Despite the uncertainty, a few trends are suggesting positive prospects for the housing sector. House prices and home ownership both reached their peaks in 2006-07. The ensuing foreclosure crisis has brought US home ownership down to its lowest level in 15 years. According to the Census Bureau, home ownership in 2012 stood at around 65%, down from a high, in 2004, of nearly 70%.

In fact, the real home ownership rate might be well be lower, since the figures are based on occupancy and would include people in their homes who are unable to pay their mortgages and at risk of foreclosure. The effective rate may well be below 60%, which would put it at the lowest since the rate was first calculated in 1963.

Home prices average around 35% lower than they were at their peak, according to the S&P Case Shiller index of 20 US cities. At the same time, mortgage rates are historically low, at around 3.25%, and it looks like they will remain low for some time; the Federal Reserve announced recently that low rates would continue for at least two more years.

These factors are encouraging transaction activity. The National Association of Realtors has recorded 16 months of consecutive year-over-year increases in home sales. It anticipates that existing home sales will rise 9% during 2012 and another 8% in 2013.

New home prices are also rising consistently – the Federal Housing Finance Agency found that US home prices increased almost 4% in the 12 months ending in July, compared with the same period a year earlier. And the pending home inventory is shrinking: in August there were only 141,000 homes available for sale nationally, and it would take only around 4.5 months to clear the inventory of homes on the market.

This is all good news for the US economy, and for people who are looking to buy homes. Homebuilders are gearing up to provide housing stock, and their share values have consequently risen. Other bets related to the housing recovery include timber (for building new homes) and land. Simultaneously, investors are turning away from multifamily real estate investment trusts (REITs), which were the worst performing REIT sector in the third quarter of 2012.

But perhaps the most interesting prediction is that home ownership will not rise. Some observers expect home ownership in the US to remain low, and might fall even lower.
One factor in this regard is that foreclosures are still taking place. Although foreclosure filings are consistently declining, they remain at a high level. In July, according to RealtyTrac, there were more than 190,000 completed foreclosure filings in the US. And while this shows a decline, foreclosure starts increased 6% in July compared with the same period a year earlier.

Homes imminently in foreclosure contribute to what is known as the ‘shadow supply’. This potentially represents as many as 12-14 million homes that could come on the market as the credit crisis continues to play out.

In addition, people who lost their homes to foreclosure are ineligible for federally secured loans for seven years afterwards, making it very difficult to get another mortgage.
In general, it is significantly harder today to qualify for a mortgage than it was before the credit bubble burst, says Oliver Chang, former head of housing strategy for Morgan Stanley and today a founding partner in Sylvan Road Capital. “We have gone from a period of very easy credit to an environment in which credit is very tight.”

Today, the average credit score required for a mortgage is around 760, and most lenders require a 20% down payment. As a result, fewer people are qualifying for mortgages.
Within this context of lower home ownership, the US has seen positive household formation growth since 2007, as a result of immigration as well as natural population increases. “Despite the weakness in the economy, the overall demand for shelter is on the rise,” Chang says. “If you can’t own, you have to rent, and there is a significant increase in the demand for properties.”

Jack Chandler, global head of real estate at BlackRock, agrees that the rental business is set to grow. BlackRock is already an active investor in the multifamily sector and now is starting to move into buy-to-rent. “There has been a fundamental shift in demand,” he says. “Today, people are renting.”

Chang estimates that out of the total rental market, around 50% is in multifamily properties and the other 50% is in single-family homes. The single-family rental market is worth around $3trn.

“This in not an institutional market; it has always been a ‘mom and pop’ business,” says Chang. “That is the opportunity that we are pursuing, the institutionalisation of part of the single-family rental space.”

Chang and his partners search out distressed single-family homes that are undervalued because of physical distress and are selling at a discount to replacement value. “We’re looking for houses with good bones, in good neighborhoods, but that are in need of renovation.”

“I do not expect to see fundamental house price appreciation for a significant amount of time,” says Chang. Nonetheless, investors will see a return from the rental yield as well as capital appreciation resulting from buying at a significant discount. The investment is likely to generate returns regardless of whether home ownership comes back strongly – properties can be sold if home ownership recovers, but if home ownership remains low, the total demand for rental properties will remain strong.

Sylvan Road, founded this year, is not the only institutional investor to identify opportunities in the housing sector. Beazer Homes, a homebuilder based in Atlanta, has partnered with Kohlberg Kravis Roberts to form a private REIT. The Beazer Pre-Owned Rental Home REIT will purchase, renovate and rent out distressed properties, initially, in the Phoenix and Las Vegas areas. The partnership is focusing on recently constructed homes (some of which were originally built by Beazer itself). Beazer contributed some 200 homes it already owned, and KKR added $65m in capital for new acquisitions. The Blackstone Group has also started a similar initiative, focusing initially in Southern California and Phoenix.

Sylvan Road is not positioned in direct competition with these larger groups, says Chang. “The big institutional investors are competing with each other – and with potential homeowners – and are pushing up prices in some areas by as much as 20%,” he says.
Investors like Beazer or Blackstone are looking for newer properties that require much less renovation than Sylvan Road is targeting. Chang says his group will typically put in $30,000-50,000 in renovations and will establish local management offices and play a role in their communities.