Distressed Housing
A Winning Strategy for Main Street and Wall Street
By Stuart Denyer
It is no secret that the single-family housing market faces a severely constricted supply of inventory. Reports suggest that the country has experienced an “underbuilding gap” of 5.5 to 6.8 million units since 2001 with only a 1.7-month supply of homes currently for sale. The perfect storm of low supply and high demand has created record prices and fierce bidding wars.
And now, investors and buyers face new fears of inflation, higher costs for labor and materials and skyrocketing rates—currently 4.8% for a 30-year mortgage. But there is a category of housing that has weathered the volatility of the Great Recession and is poised to continue to be a gamechanger for investors large and small: distressed housing.
According to a White House brief, “approximately 40% of U.S. housing stock is at least 50 years old and more than 15 million properties are vacant even as families struggle to find affordable housing.” While builders are struggling to dig out of the hole and fill the gap, investors can fix-and-flip, or buy-and-rent, an older property much faster than a new build.
From Wall Street to Main Street
The opportunity with distressed housing is not new but was born out of the chaos of the 2008 foreclosure crisis. Companies like New Western served as an exit for institutions and banks to offload foreclosure properties and get out from under large pools of nonperforming assets.
Many of these distressed properties made their way directly from Wall Street into the hands of Main Street investors who were only just beginning their journey as SFR investors. Not only did this provide opportunities for mom-and-pop investors, it also benefited communities across the country as these homes were given new life and neighborhoods were improved one property at a time.
Prior to the Great Recession, small investors used conventional means to find and buy properties. But 2008 changed everything. It was time for disruption and data was the answer.
In 2012, big institutions like Invitation Homes, a subsidiary of Blackstone, and American Homes 4 Rent began buying properties at the courthouse steps at or above market value. Their data projections allowed them to project future profit that local investors just did not anticipate.
New Western saw an opportunity to help bridge the gap. We aggregated foreclosure data and applied core algorithms to identify opportunities, allowing investors to identify and purchase their next property within days.
Fast forward to today, and Wall Street’s investment in data and technology has made it to small investors on Main Street who can now tap into tools that they did not have access to before—from real estate platforms and apps to workflows and exit strategies.
One example of how a small investor can capitalize on data is to identify properties with two lots on them. While a large institution is unable to work in such a fragmented space, a smaller investor can isolate available properties like this online and acquire them with a plan to resell the unit on one lot and retain the second lot for investment purposes.
Bringing Wall Street technology to Main Street has also allowed for the online integration of property management, home viewing, and maintenance, all of which had historically been a time-consuming and inefficient process. These platforms, intuitive websites, and user-friendly apps have enabled small investors to easily expand and scale their business.
On the flip side, big institutions may have big money and Big Data, but today’s market requires hyper-local intelligence. The Street has realized that technology cannot replace human insight. Pricing is happening at the neighborhood, block, and even individual house levels. Localized networks are a must.
As a result, mom-and-pop investors are now offering inventory, local market information and understanding back to Wall Street institutions. The big institutions require large amounts of scale and swaths of land to build and rent. They are leaning heavily on local investors who aggregate inventory. Main Street plays an important role in helping Wall Street learn and scale.
The Power of Small
Being small allows tremendous flexibility and creativity to improve ROI—often in ways that are just not feasible for big buyers. In high-density areas, the small investor is able to capture benefits that are more difficult to attain for an institutional investor, such as renting garages or driveways to create cash flow.
Savvy investors have gone into subsections of Seattle and have been very fast and innovative to create value—from getting a zoning exception for a pre-built nanny pad to building a free-standing apartment unit in the back. Investors are able to buy a property that looks like it is complete, but realize a significant profit—profit that would have been left on the table without an insider’s understanding of the local market.
In expensive markets like Los Angeles, small investors have popped the top on detached garages to maximize limited lot size. Adding a room and renting a unit or simply reselling the property with an additional bed and bath creates huge value as the cost to build out the additional square footage is far surpassed by the potential return.
The Rental Reality
“Investors are chasing rising prices because rental payments are also skyrocketing, incentivizing
investors who plan to rent out the homes they buy,” notes Redfin economist Sheharyar Bokhari. However, large institutions often do what is in the best interest of share-holders, not middle-class Americans.
To put some numbers to it, institutional investors own approximately 450,000 homes in the U.S., more than half the total number of homes for sale right now. “Investors are buying everything from finished homes to entitled land and anything you can imagine to get scale,” commented Margaret Whelan, chief executive officer of Whelan Advisory Capital Markets.
In some California markets, “neighborhoods that were formerly ownership neighborhoods…are being slowly, or not so slowly, turned into renter communities, and not renter communities owned by mom-and-pop landlords but by some of the biggest private-equity firms in the world,” commented Peter Kuhns, formerly director of Alliance of Californians for Community Empowerment.
And while big organizations may be turning to SFR to build a portfolio, small investors are building long-term relationships. Solopreneurs and semi-pros are vested in their local communities and want to see them flourish.
Looking Ahead
We are beginning to see ripples in the market that will continue throughout the year. Buyer demand appears to be calming amid rising rates and prices. Rents may have finally hit their ceiling. And frenzied bidding wars will lessen as interest rates impact a buyer’s ability to reach price points that may have been attainable in a lower interest-rate environment.
The Fed will likely overreach and then recalibrate by lowering the rate and easing the speed at which it is adjusted. Ultimately, the supply and demand imbalance will continue with more demand than inventory. As buyers lower expectations of what they can afford, we anticipate resilience in first-time and second-home purchases.
The opportunity for large and small buyers will remain strong and both will look to change their “buy-boxes” to accommodate a transitioning market. Distressed housing will continue to offer a ready supply of inventory and opportunity for both.
At the end of the day, there will be plenty of room for all, big and small.
