Thursday, May 23, 2013

ZIRP in Action - Buy to Rent

The media message of housing being back, baby, is in full swing. Prices are rebounding. Sales are picking up. It's turning around, friend. The good Dr. Housing Bubble had a nice rundown of what is going on in the housing market if things are moving up as the media and some numbers show, but home ownership rates are still dropping and it still feels like a mess at the street level. His major point is that the housing market has seen a huge influx of the big boys gobbling up properties in huge chunks to turn into rentals. As a Mike Krieger article on Zero Hedge put it, this is idiotic and going to fail. It will likely fail if they keep buying more and more homes, but why are they buying the homes? The buy to rent madness is a preferred outcome and another product of the FED's zero interest rate policy (ZIRP).

The FED's entire playbook is designed to juice aggregate demand in their misguided mindset that not enough money was thrown at the deflation of the Great Depression. Pay no attention to the debt overhang cause of the Great Depression's length. The ZIRP functions to flush cash into the system, to give banks cheap money and to pull the yield of widely held assets so low that investors are tempted to chase anything for yield. While in a fearful period of panic, investors rush for security in US Treasuries. This has crashed the UST yields to record lows. Now risk premiums have brought all debt instruments down to generational lows with high yield bond indexes yielding what the US Treasuries were yielding roughly a decade ago. The next step in that hunt for yield would be in an alternative investment that generates a monthly return like rent. Why not use cash to gobble up distressed and foreclosed properties at depressed prices compared to several years ago and rent them out? Krieger points out how rents aren't rising, but these investment firms don't need rents to rise. They just need cash flow. If they get 15% cash flow right now, who cares about stagnant rents, they will get 15% on their investment and treat the place like a slumlord to keep their maintenance + upkeep expenses down. Future asset capital gains would be nice, but they are focused on the cash flow right now. Somewhere in all of this, the FED believes this will employ more people.

While Krieger and others have a point to say this is madness, they miss the cause and therefore the content behavior in the buy to rent equity fund madness. Bernanke's ZIRP makes for return free risk, but it reduces the opportunity cost of comparison to USTs insignificant. I love criticizing Wall St jerks, but think of their pitch to clients who want to see gains. Think sitting in 2% 10 year USTs will make investors content? No. The private equity buy to rent is the old MBS buying game, cutting out the middleman. The big boys are making 15% on their money, the leaked out housing pipeline finds a buyer at an elevated price than it truly is (helping banks + MBS holders), the municipalities see a stabilization and rise in property tax collections and the entire home owning crowd sees their biggest asset rise in value. To the Bernanke, this is a win-win-win-win. This is also short term thinking. The gains for everyone are fleeting just as the low interest rates set by Greenspan set up our last crisis. The clearing mechanism is prevented and reset of the system is delayed. No new jobs are generated by these actions so the recovery is unsustainable. Criticize this all you want, but this is by design and what the FED wants.

Update: The big boy investors are already packaging these up for REITs to sell to institutional and retail investors. They will take their cut and then sell an REIT at 6%. Bubble go pop.


PRCD said...

We're having layoffs again. We've been in a recession for over a year.

Once the G20 get off the dollar, there will be a sea change.

Portlander said...

Selling REO to private equity also helps the banks, which are the Fed's real client. Once the banks' balance sheets have cleared off their property holdings, look for interest rates to normalize and property prices to take another dip down. But it won't be the banks taking a hit on the second dip, so the Fed won't care.

Son of Brock Landers said...

Good point on rates rising once balance sheets are clear but the FED cant see rates rise or it will need a bailout. Their balance sheet has a long bond bias and bumps up in the interest rates will crush them. They'd need a bailout (post coming on that).

The dollar crisis will change things and set off the macro, political and social changes of the big "turning' secular crisis.

Portlander said...

I don't think the mark to market losses will matter to them. They'll make some excuses that they are holding to maturity and it doesn't matter since they aren't a dealer with a trading book, blah, blah, blah... Who's going to argue? The Japanese?

The Chinese and Russians have already been voting with their feet and buying gold.