[quote=SK in CV]Other than a reference to the same $2 billion borrowed by Blackstone a couple times, I don’t see much in there about debt. And that’s not debt secured by the individual properties. Blackstone has the wherewithal to repay $2B, so I don’t really think that can be called traditional leverage, at least not in the sense that it can create a distressed market.[/quote]
SK,
I’m including stuff I’ve collected over the past few weeks regarding this. Some related, some not as much. This is just a small sampling of what I’ve been reading, but the underlying theme throughout is that these funds are using leverage, and that they have a 5-7 year disposition plan.
From everything I’ve seen, it looks like the norm for these RE funds is 60%-75% leverage. Of course, we don’t really know unless they are publicly traded, and most of them aren’t. Blackstone is purported to be the largest institutional purchaser of residential RE, and Colony is just behind them.
The following are snippets and links:
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Both institutional and retail investors have been smitten with mortgage REITs and the 10%+ yields available from AGNC, Two Harbors Investment (Ticker: TWO), Armour Residential REIT (Ticker: ARR), Western Asset Mortgage Capital (Ticker: WMC), and others. Yes, these have had a remarkable run in terms of share appreciation and total return from dividends, but it’s important to remember how this has occurred. The Fed has purchased well over $1 trillion of agency MBS thus far, and this figure is only growing with the QE3 plan of an additional $40 billion per month.
As stocks continued to deliver strong returns, mortgage REITs took advantage of this opportunity by selling additional stock. Because some of these companies are compensated by assets under management (AUM), they had every incentive to keep selling shares to grow the REIT as large as possible. The chart below from J.P. Morgan shows mortgage REIT MBS holdings over the past 10 years in a hockey stick–shaped chart. Does this look healthy?
“From the very beginning, we’ve thought of this as eventually becoming a public company,” says Justin Chang, a principal with Colony and acting CEO of Colony American Homes, the private-equity firm’s new rental REIT. “This is a big opportunity, the beginning of an asset class.”
In its early stages, Colony’s effort, which started buying up distressed single-family homes about four months ago, looks fairly similar to the strategy pursued by Beazer and other single-family rental investors.
Colony says it has raised about $750 million so far, mainly from institutional investors, and has bought about 600 homes s in Arizona, Nevada, California and Colorado. The company expects that by the end of June, it will have bought more than 1,000 distressed homes, and it plans to expand by the end of the summer to Texas, Georgia and Florida. An IPO could happen in the next 12 to 24 months.
The stats are similar, too. Colony is underwriting their purchases of distressed homes for rental at cap rates of about 7-9%. What that means is each house Colony American Homes buys is expected to produce an annual rental income equal to about 7% of the house’s purchase price. That is slightly higher than the 5-6% range of yields that most apartment operators in strong apartment markets are making today.
Assuming that rents and home values will both increase about 3-5% per year going forward, and as Colony is able to put some leverage on the homes it buys, the company figures that it can give returns of 15% or higher to its investors. These are similar to the types of projections from other single-family rental investor groups, including Beazer.
Investors have always played a role in the housing market, but their presence was often small. Currently, cash buyers—largely investors—make up about 32% of sales nationally, according to the National Association of Realtors. In Southern California, a favorite target for investors, absentee buyers accounted for 31.4% of purchases last month, up from an average of less than 17% between 2000 and 2010, according to DataQuick MDA, a real-estate research firm.
While some firms have focused only on Sunbelt markets with newer housing stock, others are branching out. American Residential Properties Inc., which began amassing hundreds of homes in Phoenix four years ago, earlier this month bought 93 homes in Chicago’s southern suburbs, bringing its total there to around 300. On Friday, the company said it planned to raise $300 million in an initial public offering, according to a regulatory filing.
Instead of raising a huge fund from institutions with the discretion to invest as he chooses, he now raises capital deal by individual deal from an array of deep-pocketed private investors. He has also given up on borrowing heavily and using short-term floating-rate debt to pay for at least 80 percent of a building’s cost — a strategy that got Broadway and an army of other real estate investors into trouble a few years ago.
Mr. Lawlor says he now obtains long-term, fixed-rate financing for just 60 percent of an asset’s total cost, including renovations.
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The private equity real estate market placed a concentrated focus on fund management fees as a result of the economic crisis.
Fund managers face pressure to structure fees consistently with industry norms. Deal terms that were standard before the crisis have been challenged and modified as the sector moves into the post-crisis era.
The pendulum has definitely moved for many managers, although there is some evidence that it’s starting to swing back toward pre-crisis levels.
We’ve found that since the economic crisis, the average preferred return for real estate funds is 9%.
Leverage (maximum) Averaging in the 65%–75% range Averaging in the 60%–70% range
Leverage and its effect on performance measurement is the third big difference between
REITs and direct real estate. REITs, on average, carry leverage of roughly 50%, but it varies
across REITs and over time. By comparison, direct investors in property can decide exactly
how much leverage to assume and when; 65–75% of market value is typically available
on high-quality properties. For real estate open-end funds, leverage is more constrained
hovering currently around 25% for core funds. REIT returns incorporate the effect of
leverage. Direct real estate performance as portrayed in the commonly cited NCREIF-
NPI index does not; NCREIF returns as cited above are reported on an unlevered basis.
Investors in REITs have no control over the leverage assumed by REIT management; in
contrast, investors in direct real estate explicitly control leverage. Direct real estate fund
investors are somewhat in the middle in that they can select funds that make leverage
limits explicit in their investment strategies or not.
[For smaller investors who want to “cash-out” the equity after making an all-cash purchase, Fannie Mae made it easier for them. IMHO, this wouldn’t have been done if people (“investors”) weren’t lobbying for it. -CAR]
Last month Fannie Mae made a little change in the rules for all-cash buyers to apply for mortgages. I don’t recall a press release, and I’m quite sure I’m on their mailing list. But there it is, “Announcement SEL-2011-5,” a “Selling Guide Update:”
Currently, Fannie Mae requires a minimum of six months to elapse between the time a borrower purchases a home and subsequently applies for a cash-out refinance.
The Selling Guide has been updated to allow a cash-out refinance within six months of a purchase transaction when no financing was obtained for the purchase transaction.
