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The rate at which real estate investment trusts (REITs) are investing in single-family homes in order to rent them is quickly increasing, and they are buying based on a long-range view. But is this a good thing for the single-family market?
At one time, the single-family residence was the epitome of having attained the American dream—white picket fence, and you know the rest.
But today that dream has largely been replaced by the need to survive. You might be wondering at this point, why are things like rent so high that people are just scraping by? First, I want to deal with a few more things and then I will get to that. The dream that I spoke of, the American dream, is just that: American.
People in most countries don’t have the same need to own land as many in Western countries do. The United Nations has indicated that 68% of the people of the world will live in cities by 2050. Are you seeing many single-family residences in the city? Is this a problem? That depends on your needs and human nature; human nature swings—today they are city hipsters, tomorrow they could be parents to screaming little ones who need a yard.
In an environment of rising interest rates, the economy must experience pangs, and as such, all matters tethered to it become tentative. One would think that the housing market would make a quicker descent. In some areas, that may turn out to be the case, in others, there is an abstraction called the REIT.
The goal of the traditional home buyer is the manifestation of a dream, but for the REIT it’s something else. For them, it is all about the return on investment (ROI). Many people wonder if REIT’s participation distorts the market.
To help answer that, let’s look at the REIT’s motivation. The purpose of the REIT is to produce a return on capital invested by its investors. That is all that they are supposed to do (environmental, social and governance criteria aside for now). As such, they need investment vehicles that are commercially viable and understandable for the most part. Who doesn’t understand what a house is?
But a house is traditionally for the small-time, and these are Wall Street types, masters of the financial universe; why would they want houses? You only have to look at the price of rents lately, which are high and only getting higher.
REITs are cash buyers whose cost of funds in most cases indeed is less than traditional purchase competitors. They pay cash, have it ready and close quickly with short to no due diligence.
They quite often pay over market value. Far from being foolish, they have been looking at the things we discussed above and determined it is better to purchase for a little more to secure the cash flow vehicle: the house. Qualifying for a home mortgage is not easy and is time-consuming. REITs can pull the trigger quicker and pay more.
Over time, as the supply of houses tapers and those priced out seek housing, renting will surely be among the best options. The rent increases will supply the REIT investors with an ever-increasing cash flow and at some point property appreciation to make up for most overspending.
Not a bad deal if you can get it. That’s the rub though. Can you participate? The way things are looking, I would say that avenue to wealth attainment has been co-opted from on high, and most people’s arms are too short to box with REITs.
This is not reflected the same in all countries, as mentioned prior, but the fact that the United States might become a renter nation is a strange dream; let’s hope it doesn’t become a nightmare.
Of course, if you have the means, you could ride the rails with the REITs by investing, perhaps practicing a 1031 exchange into a REIT in order to avoid paying capital gains taxes. I believe that is something you would have to check with your tax accountant about. If you are a larger property trader, of course, you should go with the trade flow while REITs meet the needs of the market. But be on the lookout, for things can always change.