They Rent Houses, Don’t They?
Sam Chandan May 3, 2012, 2:30 p.m.
Apartment investors dismiss the notion that houses for rent will compete for their tenants. They should think twice. Institutions ranging from the largest investment banks to the smallest private equity investors are lining up behind policymakers who see things differently. The financing structures necessary to support the new market are under development, even though the implications for housing are ambiguous and the realtors have voiced objections.
While renters will not substitute into single-family homes in every case, plans to repurpose foreclosures will foment a credible shadow inventory in some segments of the markets. In particular, young families who have remained in conventional apartments because of inaccessible mortgage financing have been key contributors to prevailing occupancy and rent trends. Well-located rental homes and condos will compete directly for these tenants, siphoning demand in proportion to the scale and competitiveness of the alternative stock.
The coordinated rental of single-family homes is moving from theory to institutional application. Plans for drawing down the single-family real estate owned (REO) holdings of Fannie Mae, Freddie Mac and the Federal Housing Administration (FHA) will reach a major milestone over the next month. The Federal Housing Finance Administration (FHFA) announced plans earlier this year to auction nearly 2,500 foreclosed homes from Fannie Mae’s REO inventory, stipulating the properties must then be made available for rent for some period of time. The deadline for bidder applications, from which the set of qualified investors will emerge, has passed. The Credit Suisse-advised offering is rumored to be pushed back from its original May closing date; in spite of the agencies’ overwhelming reliance on taxpayer largesse, the process has grown opaque since the initial foray of announcements.
Speculation on the program’s potential success and the required size of discounts on bulk sales are subjects du jour. Rumored expressions of interest from several large fund managers and investors—including Paulson & Co., Berkshire Hathaway and Colony Capital—have added to speculation on the program’s efficacy in stabilizing the housing market if it is ultimately deployed across a larger number of properties. At the same time, there has been surprisingly little discussion of the program’s implications for the multifamily market, which has seen occupancy and rental rates climb on a favorable balance of supply and demand. The initial auction pool, which is being marketed in eight metro-specific sub-portfolios, has an 85 percent occupancy rate. The program’s expansion to a much larger number of vacant properties, or the adoption of a similar model by major banks, would be material for rental dynamics in some areas.
The absence of strong empirical data relating to substitution out of conventional multifamily units and into homes for rent presents a challenge for lenders and investors attempting to gauge whether the program could feed a new shadow rental inventory. Markets like Manhattan are unlikely to be affected significantly. But in markets where foreclosed homes and apartments are co-located or where young families constitute a major source of new apartment demand, the potential for substitution is real. In the latter case, the household lifecycle dominates other considerations.
Housing preference is tied to location preference that, in turn, is a function of access to schools and other location-based services. Among the leading factors that will determine rates of substitution should the REO program expand in scale, the relative proximity of conventional rental units and foreclosed homes for rent will coincide with households’ preferences for their differing amenities and the relative cost of the alternatives. Where repurposing of housing stock will be most efficacious, lenders and investors should remain on guard.
Sam Chandan, PhD, is president and chief economist of Chandan Economics and an adjunct professor at the Wharton School.