THE BIG LONG / THE ECONOMIST

Property

The Big Long

A new generation of investors is betting on America’s housing market

Dec 1st 2012
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THOSE feeling nostalgic for the boom before 2007 will have been heartened this week by headlines about Lehman Brothers selling a portfolio of American apartments for $6.5 billion. Lehman Brothers? No, the investment bank felled by the mortgage miasma is not rising from the dead: its administrators are merely flogging its remaining assets to repay creditors. But the sale shows that American housing, once so toxic it made the global economy choke, is once again attractive to investors. Hedge funds and private-equity firms, so often the villains, may be helping a housing revival.




America’s residential sector was once the preserve of “mom-and-pop” investors or local developers. The role of hedge funds became apparent only when those who bet massively against the housing market—“The Big Short”, as it was later termed—made billions while their rivals floundered. By gambling that subprime mortgages, extended to borrowers with no plausible means of repaying them, would poison the financial system, John Paulson personally pocketed $3 billion after his hedge fund skyrocketed.

 

 

 

The Big Long is now slowly taking shape. House prices have stabilised since their 2009 trough, and have even made small but steady gains in recent months. Investors convinced that a full-blown housing recovery is under way—a big “if”—are looking for ways to profit from it.




The most predictable of these is to invest in mortgages, or the very same residential mortgage-backed securities that were so avidly shorted in the run-up to the crisis. It is a deep pool: the $10 trillion of home loans outstanding is second only to equities as an asset class. Over half of these mortgages are tacitly guaranteed by the government, turning them into something akin to Treasury bonds. But packaged in tax-efficient structures to which large dollops of debt are added, these can kick yields up to the 10% range: not bad in a low-interest environment.
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The risk is that even a small rise in interest rates will wipe out all the value. “You really have to believe interest rates are going to stay low for the foreseeable future,” says Gregory Perdon of Arbuthnot Latham, a bank.




Mortgages not guaranteed by the government, known as “non-agency”, are far more volatile and thus more appealing to return-hungry investors. Their price is closely correlated to that of the houses which underpin their value.



Repayments are also higher when house prices are buoyant: if the house is worth less than the mortgage, the owner may simply walk away. Picking up those mortgages at rock-bottom prices has delivered returns of 30% or more for savvy hedge funds this year.




The other, and more intriguing, way of betting on rising house prices is to buy the houses themselves. KKR, Colony Capital and Blackstone are among those amassing large portfolios of homes, mostly buying from banks’ foreclosure auctions. Keefe, Bruyette & Woods, an investment bank, estimates that around $6-8 billion is being lined up to invest in single-family homes, the most appealing part of the market.




In practice, this is a fiddly process that involves finding, buying and managing thousands of homes scattered around the country. This is not easily done from a skyscraper in Manhattan. A property-management company is helping Blackstone buy some 100 houses a day in selected markets.




Such is the pace of its investing that its agents do not even step inside all the properties it buys. Auctions of foreclosed properties can run to several thousand homes per month for a large city, often selling at half their 2006 peak price.




The plan is to fix up the houses and rent them, generating yields of around 7%. Jonathan Gray, the head of real estate at Blackstone, says that part of the investment case is that house-price increases will create fat capital gains.



This has already happened in Phoenix, Arizona, the best recent performer of the 20 cities tracked by the Case-Shiller index of house prices (see chart). This may spoil Blackstone’s appetite for more than the $1.5 billion of houses it has already gobbled up. Others have already scaled back, disappointed by the returns.




Still, fully 20% of all home sales in October were to purchasers classified as investors, according to the National Association of Realtors. Rents as a proportion of house prices are at their highest for a decade. Oliver Chang, a former Morgan Stanley housing analyst now looking to buy $1 billion in single-family homes, says residential prices do not even need to go up for the trade to be profitable, as long as the houses are selected properly and value-adding repairs are carried out.



There may be even simpler ways to bet on bricks and mortar. Warren Buffett, an investor, recently bought a chain of estate agents. (He already owns a brick company.) Shares in home builders and Home Depot, a do-it-yourself store, are up sharply. Mr Paulson himself is buying development land in hard-hit markets.




Buying houses themselves may be the smartest bet of all. Having been too lax in granting mortgages before 2008, banks are now erring on the side of caution. People still need a place to live, which pushes them to rent instead of buying. Home ownership swelled artificially from 64% to 69% in the boom years; it is now edging back down. Huge investors like Blackstone have credit ratings that the public cannot match. If America is moving towards a rentership society, they will rake it in.




As a trade, buying houses is the polar opposite of what made hedge funds rich from 2007; it is a bullish bet which eschews complex financial products. It is also far less racy: a 7% yield is hardly the stuff of investment lore, even if greater profits may come. As sequels to blockbusters go, The Big Long is mercifully dull.