Although the real estate owned (REO)-to-rental market has likely hit its peak, a lower homeownership rate, rising rents, increasing property values and rising mortgage interest rates are factors that will ensure the market's long-term viability, a report from Moody's finds.
An influx of distressed homes, combined with strong demand for rentals, has fueled investor interest in the REO-to-rental market in recent years, according the report by Celia Chen, senior director, economic research, Moody's Analytics titled ‘Solid Demand Drivers Underpin the REO-to-Rent Market.’ Investment firms including Blackstone, Colony Capital and American Homes 4 Rent have allocated billions of dollars to invest in REO properties for rent. Between January 2011 and November 2013, institutional investors purchased more than 366,000 single-family homes, the report points out, citing research from RealtyTrac and Pintar Investment Co.
As investors scoop up bank-owned properties, the poor job market, rising home prices and rising mortgage interest rates (not to mention the drop in average income for those who are employed) have combined to drive strong demand for single-family rentals. (Although not mentioned in the report, a high percentage of the homeowners who lost their homes as a result of the financial crisis ended up becoming renters.)
Also driving the trend are high price-to-rent ratios, which, although they have declined substantially since 2005, remain elevated when compared with pre-crisis levels. This is primarily due to the recent sharp increase in home prices. This imbalance, the report points out, has caused many consumers to choose renting as opposed to owning.
Moody's predicts that the economy will continue to improve in 2014. However, due to rising home prices and increasing interest rates, most consumers will remain priced out of the housing market, which means they will continue to rent. Many younger people – specifically millennials and generations X and Y – will likely move out of home and become renters as their employment prospects improve. Thus, demand for rental properties is forecast to increase. These factors, according to the report, ‘will persist, providing good returns to investors in the REO-to-rent market.’
The report also examines current REO-to-rental ‘hotspots’ – areas where home values are elevated and investors are likely to find a decent supply of REO properties. It points out that most of the hot markets have already been tapped out – cities such as Los Angeles; Riverside, Calif.; Sacramento, Calif.; Phoenix; Las Vegas; and Atlanta, which were hotbeds of REO-to-rental activity in 2012 and early 2013, have already worked off a good chunk of their REO inventory. The key now is for investors to identify areas with strong home price appreciation and favorable economic conditions (primarily the job market) for renters.
‘Now that the low-hanging fruit has been picked, investors are turning to other markets that still suffer from large inventories and where house prices remain well-below peak,’ the report states. ‘Florida metro areas, for example, still have elevated foreclosure rates because of their judicial foreclosure process. Tampa, Jacksonville and Lakeland are examples of metro areas that still have a substantial overhang of distressed homes, yet have good prospects in terms of job, household and house price growth.’
The report concludes that while the REO-to-rental market faces a ‘number of uncertainties’ – not the least of which is the ‘potential for consumer preferences to shift back to homeownership’ – current economic and demographic factors bode well for this market in 2014.
The report is included in this month's ResiLandscape, Moody's newsletter covering a range of issues in the U.S. housing market.