Hedge fund manager Bruce Rose was among the first investors to coax institutional money into the mom and pop business of single-family home rentals, raising $450 million last year from Oaktree Capital Group LLC. (OAK:US)
Now, with house prices climbing at the fastest pace in seven years and investors swamping the rental market, Rose says it no longer makes sense to be a buyer.
“We just don’t see the returns there that are adequate to incentivize us to continue to invest,” Rose, 55, chief executive officer of Carrington Holding Co. LLC, said in an interview at his Aliso Viejo, California office. “There’s a lot of -- bluntly -- stupid money that jumped into the trade without any infrastructure, without any real capabilities and a kind of build-it-as-you-go mentality that we think is somewhat irresponsible.”
Carrington, which started in 2003 as a mortgage investment fund and has managed almost 25,000 rental homes for itself and others, has been joined by hundreds of institutional and international investors buying single-family homes after prices plunged following the housing crash. The firms are building a new institutional real estate asset class from the 14 million leased single-family residences that are worth an estimated $2.8 trillion, according to Goldman Sachs Group Inc.
Even as demand for rentals rises amid a falling homeownership rate, yields are declining and companies (SBY:US) formed to buy the homes that have gone public haven’t yet been profitable.
It’s also getting harder to buy properties cheaply, with purchase prices rising 11 percent in April from a year earlier to a median $192,800, according to the National Association of Realtors. Asking prices for rents rose just 2.4 percent in the 12-month period, according to Trulia Inc. (TRLA:US)
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Funds are buying property now, including homes sold by Carrington, for rents that yield 6 percent to 8 percent a year, before costs such as insurance, taxes and vacancies, according to Rose. Carrington’s model called for mid-single digit net returns on annual rents on an unlevered basis, according to Rose. While returns would vary by market, they would generally be in the mid- to high teens over the duration of the holding period, with the profit from home price appreciation.
“We selected our capital for this trade, sourced from a level that’s just too expensive for what the market has morphed into,” Rose said. Oaktree, the Los Angeles-based investment firm founded by Howard Marks, declined to comment, said Alyssa Linn, a spokeswoman at Sard Verbinnen & Co.
Instead of acquiring rental homes, Carrington is buying nonperforming loans, including about $4 billion in 2012. While that’s a potential source of rental properties if the owners can’t pay the mortgages, Rose’s preferred outcome is to get the loans performing again by offering a modification that keeps the current owner in the house, he said.
Carrington also is buying mortgage servicing rights and expanding a loan origination business for borrowers who can’t qualify for prime loans because of low credit scores. Rose expects to issue securities backed by these loans as soon as the end of this year, he said.
“It’s all about control,” Rose said. “We learned the better loans would be created for us to invest in if they originated off of our own platform and then boarded onto our own servicer, where we could control the performance longer term rather than leaving it in someone else’s hands.”
That desire for control is reflected in Rose’s life outside the office. He got a pilot’s license at age 17 and worked as a commercial aviator, including a stint flying for the U.S. Drug Enforcement Agency, before moving to Wall Street. He still enjoys taking the helm of Carrington’s two Dassault Falcon jets when he visits the company’s properties around the country.
Another investor that has stopped putting money into rental homes is Och-Ziff Capital Management Group LLC (OZM:US), a $31 billion hedge fund managed by Daniel Och, which cut its stake last year in 643 Capital Management LLC, a single-family rental operator with almost 2,000 homes in California, Florida, Nevada and Texas. Gregor Watson, managing partner at San Francisco-based 643 Capital, declined to comment on the Och-Ziff relationship. In general, the single-family rental business has matured to a lower-risk, lower-return investment as more funds get a track record, he said.
“It’s gone from an opportunistic business to a value-add one in terms of returns,” Watson said in a telephone interview. “We and other groups have proved you can manage these at scale.”
Blackstone Group LP (BX:US), the largest investor in single-family rentals, has spent $4.5 billion to amass more than 26,000 homes and continues to buy, according to Eric Elder, a spokesman for Invitation Homes, the rental housing division of the world’s largest private equity firm.
“We’re continuing to purchase homes where they fit into our business plan,” Elder said.
Blackstone’s net yields on its occupied houses are about 6 percent to 6.5 percent, Jonathan Gray, the firm’s global head of real estate, said during a May 3 conference call with investors. That’s before using leverage from a $2.1 billion line of credit the private-equity giant arranged in March from a lending syndicate headed by Deutsche Bank AG. (DBK)
While about 85 percent of Blackstone’s renovated homes were leased, Gray said, “we’ve got an awful lot of homes to continue renovating.”
Companies that release financial results for single-family rental investments have reported losses as they acquired homes faster than they can renovate and find tenants.
Colony American Homes Inc., a division of Thomas Barrack Jr.’s Colony Capital LLC, has found tenants for only 51 percent of the 9,931 homes it bought for $1.4 billion, according to a filing yesterday with the U.S. Securities and Exchange Commission.
American Residential Properties Inc. (ARPI:US), a Scottsdale, Arizona-based real estate investment trust, and Silver Bay Realty Trust Inc., a New York-based single-family REIT, both reported losses in the quarter ending March 31. Owen Blicksilver, a spokesman for Colony Capital, declined to comment. Silver Bay CEO David Miller was unavailable to comment, according to Tricia Ross, a spokeswoman at Financial Profiles Inc. American Residential CEO Steve Schmitz and President Laurie Hawkes didn’t reply to e-mails seeking comment.
Silver Bay declined 2.6 percent today in New York to $18.24 and has lost 4.4 percent this month. The company sold shares to the public in December for $18.50.
Rose worked in the mortgage department at Salomon Brothers from 1991 until 2003, after it had been acquired by Citigroup Inc. He started Carrington in Greenwich, Connecticut, as a securitizer of mortgages originated by subprime lenders such as New Century Financial Corp., Fremont General Corp. and H&R Block Inc.’s Option One Mortgage Corp.
In 2007, as defaults began to soar and the lenders were collapsing, Rose sought to gain more control over the trusts that admistered the loans. He paid $188 million for the servicing business of then-bankrupt New Century’s mortgages.
When Carrington foreclosed on the homes in its portfolio, Rose calculated it often made more sense to keep the houses as cash-flowing rentals rather than sell them into a weak market. By 2009, Carrington had expanded from being an asset manager to a loan servicer and property manager, overseeing its own holdings plus more than 3,000 rental homes that Fannie Mae had repossessed.
With home prices about one-third below peak at the time, Rose saw the opportunity to buy and manage thousands of properties as a way to make money on rents while betting on a long-term real estate recovery.
“This was the purest way to get pure housing exposure,” he said. “You can’t do it through banks or builders or mortgage companies or anyone else.”
Rose initially found it hard to find backers.
“There wasn’t a domestic investor at the time that had the foresight to see what the value of the product was,” he said. “Universally we got back: Oooh, housing. Really scary. It’ll never go back up.”
By the time Oaktree invested with Carrington, the housing market had begun to turn around in markets like Phoenix and California, where funds had started to buy thousands of residences for rentals.
While Rose isn’t buying now, Carrington’s 3,000 employees’ experience in renovation and rental management are a resource available to other investors entering the market, Chief Operating Officer David Gordon said during an interview.
“All the people who made money during the gold rush in California, they were selling the buckets and shovels,” Gordon said. “I think there is gold in them there hills, but you’re going to have to dig deep. And hopefully you’re going to need more than one shovel.”
Carrington may start buying rental homes again when other large investors decide to sell after learning they can’t make returns that justify the prices they paid, Rose said.
“We’ll sit back in the weeds for a while and wait for a couple of blowups,” he said. “There’ll be a point in time when we’ll be happy to get back into the market at levels that make more sense.”
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