Are Institutional Investors Making the Housing Market More Vulnerable?

The mainstream media continues to report that the housing market in the U.S. economy is hot again, but I don’t share their optimism for a second. The fact of the matter is that the U.S. housing market may be headed toward a period of decline after just a few months of glory.

As I have mentioned before in these pages, the housing market will only improve when real home buyers buy homes. That hasn’t been happening in the U.S. economy. Real home buyers—those who plan to live in their homes—are shying away from the housing market.

For the week ended June 28, the number of completed mortgage applications in the U.S. economy plummeted 12% from a week earlier—the biggest drop in two years. The applications filed for refinancing a home decreased 64%—the lowest since May of 2011. (Source: Wall Street Journal, July 3, 2013.) Regular Americans just can’t afford to buy a house.

So who is actually buying homes in the U.S. economy and driving the housing market higher?

It’s the institutional investors who are buying homes, because this real estate provides them with a greater return than many other investments. It shouldn’t be too surprising—yields on stocks are low and the bond market is in a dangerous territory, edging toward a collapse.

Institutional investors have spent $17.0 billion on more than 100,000 homes in the housing market over the last two years, and they’ve become the biggest buyers in some parts of the U.S. economy. (Source: Bloomberg, July 8, 2013.)

Here’s how institutional investors work the housing market: Say they have $10.0 million. To keep things simple, if we assume they buy each home for $100,000 and rent it for $1,500 per month, they will receive 1.5% of their capital invested every month. Over a one-year period, they receive 18% of their capital. And if the housing market keeps going higher, they see capital appreciation as well. Those are high yields in any economy.

As we move forward, I just don’t see real home buyers rushing to the housing market. We might just see more of the same—institutional investors buying up residential homes in the U.S. economy.

Consider this: The Blackstone Group L.P. (NYSE/BX) has spent $5.0 billion to buy residential properties in the U.S. housing market. It has accumulated 30,000 homes. And if that’s not enough, the firm is starting a lending service that provides loans to other institutional investors who want to buy even more homes.

What the optimists in the mainstream media don’t realize is that this sort of thing can’t go on for very long. Institutional investors are constantly working to improve their bottom line, and since they currently believe the housing market is hot, they are buying houses and renting them out. But once the yields on investments like stocks and bonds start to edge higher, and rent drops due to an overabundance of rental homes, they will be in trouble—shareholders will ask for higher returns, and institutional investors might be forced to sell what homes they have accumulated.

Certainly, without real home buyers—who provide liquidity to the housing market—the home prices will edge lower once institutional investors begin to sell.

We need real home buyers to see real recovery. Until they make a comeback, I continue to question the housing market and the optimism surrounding it. Just look at homebuilder stocks; they are in decline—and that affirms my views on the housing market.