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The rate at which real estate mutual funds (REITs) invest in single-family homes to rent out is accelerating rapidly and they are buying on a long-term basis. But is this a good thing for the single-family market?
Once upon a time, the single-family home was the epitome of achieving the American dream: a white wood 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But today, that dream has largely been replaced by the need to survive.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 just drop by? First I want to finish a few things and then I’ll get back to that. The dream I was talking about, the American dream, is just that: American.
People in most countries do not have the same need to own land as many in western countries. The United Nations has indicated that 68% of the world’s population will live in cities by 2050. Do you see many single-family homes in the city? Is this a problem? That depends on your needs and human nature; human nature fluctuates – today they are townshipsters, tomorrow they could be parents of screaming little ones in need of a yard.
In an environment of rising interest rates, the economy must be experiencing torments, and as such, anything attached to it becomes tentative. You would think the housing market would fall faster. 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’s all about return on investment (ROI). Many people wonder if REIT’s participation is distorting the market.
To help answer that, let’s take a look at the motivation of the REIT. The purpose of the REIT is to generate a return on the capital invested by its investors. That’s all they should be doing (excluding environmental, social and governance criteria for now). As such, they need investment vehicles that are commercially viable and understandable for the most part. Who does not understand what a house is?
But traditional is a home for the little ones, and these are Wall Street types, masters of the financial universe; why would they want houses? You just have to look at the rents of late, they are high and are only going to get higher.
REITs are cash buyers whose cost of funds is indeed lower in most cases than traditional buying competitors. They pay cash, have it ready and close quickly with short to no due diligence.
They often pay more than market value. Far from being foolish, they looked at the things we discussed above and decided it’s better to buy something more to secure the cash flow vehicle: the house. Applying for a mortgage is not easy and time consuming. REITs can pull the trigger faster and pay more.
Over time, as the supply of housing decreases and the more expensive properties start looking for housing, renting will certainly be one of the best options. The rent increases will provide REIT investors with increasing cash flow and, at some point, real estate appreciation to make up for most of the overruns.
Not a bad deal if you can get it. That’s the trick, though. Can you join? As things stand now, I’d say the path to wealth acquisition is co-opted from above, and most people’s arms are too short to box REITs.
This is not reflected the same in all countries, as mentioned earlier, but the fact that the United States could become a tenant nation is a strange dream; let’s hope it doesn’t turn into a nightmare.
Sure, if you have the means, you could drive the REITs by investing, maybe practicing a 1031 exchange in a REIT to avoid paying capital gains tax. I think that’s something you should check with your tax advisor. Of course, if you are a larger real estate trader, you have to go with the flow of trade while REITs meet the needs of the market. But be wary, because things can always change.