A. Background
Below is a chart showing quarterly home sales based on CoreLogic’s property records database for “non-investors” and for “investors” based on size of investors. Here is how CoreLogic defines an investor purchase: An investor is an entity (individual or corporate) who retained three or more properties simultaneously within the past 10 years or has a corporate or non-individual identifier on the deed. Examples include LLCs, CORPs, and INCs, to name a few.” For the data underlying the chart below see https://www.corelogic.com/intelligence/
The chart shows the rising share of purchases by investors. The investor share in the third quarter of 2021 was 26 percent.
But how can we tell if these purchases by investors are pushing up home price appreciation for potential owner occupiers (HPAoo is year-over-year home price appreciation for owner occupiers)?
B. Impact of Investor Purchases on Home Price Appreciation
What motivates investors (INs), potential owner occupier (OOs) and sellers (SEs)?
Investors (INs) have several advantages. (1) Speed due to lack of emotions: for an investor, all properties with the same financial characteristics -- same rent, expected capital appreciation, maintenance costs and vacancy rates -- are worth the same. Consistent with this perspective, market participants anecdotally say that an investor can easily walk away from a deal whereas a perspective homeowner is often emotionally invested in the bargaining process. More recently, technology not emotions drives the purchase. Some large investors have moved to using algorithms, so they can move the same day the house comes on the market. (2) Speed due to funding: Many INs pay cash for the property, whereas OOs almost never pay cash. That ability to pay cash and "as is" helps investors win deals for lower prices (realtors will tell you that "cash is king"). (3) Speed due to relationships: practitioner say generally they work with realtors and can move instantly. Realtors watch for deals and will often contact small mom and pop investors if they have a seller that wants a quick deal for cash and does not want to bother listing it. In a tight market, all buyers have to move quickly, so the investor watches carefully and can make an offer within a day even without seeing the house. OOs almost always want to look at a house very carefully and evaluate if it is right for them. In contrast, investors only care if they can rent it for a profit and if it has enough initial characteristics that they like. The key point is that INs can move much faster than OOs because they already have the cash/financing in hand to pay for the property when it first hits the market and can walk away if they are pushed to pay too high a price.
Having said all of that, the financial target of investors in purchasing rental properties is not straightforward. Investors are not a homogeneous group. Investors might be attracted to: 1) CBSAs with high price growth rates (HPAinv); 2) CBSAs with low home prices, or properties that need repair and can be flipped; 3) CBSAs with a high rental return (R/Pinv), or a high total return (TR = HPAinv + R/Pinv) or a high total return after property taxes (TRAT = HPAinv + NRVP), where NRVP = (R/Pinv - UCK – taxp). Where R is rent, P is home price, UCK is a user cost of capital and τaxp is the property tax rate. What motivates investor behavior? Certainly, investors would prefer markets where their properties might appreciate quickly ex post. These different preferences impact how they bid.
Sellers (SEs) function differently. (1) Sellers always prefer a cash deal to a financing because there is far less chance of the deal falling through. Financing a deal typically takes at least a month and there is always a possibility that the financing will be held up or refused. (2) Practitioners say generally they work with realtors and can move instantly. Realtors working for the SEs will often contact small mom and pop investors to see if the investor can facilitate a quick deal and can offer cash. Of course, if the seller is not under a time pressure they will wait for the best deal. In a hot market, a seller with a house in good condition can organize a bidding schedule whereby the OOs would compete against each other OOs and the INs drop out first. In this sense, OOs are competing against other OOs and not INs.
Potential owner occupier (OOs) often pay a premium which reflects the additional cost they must pay for the time/expense/risk of making the seller wait longer for the sale to go through. (1) Slower due to due diligence: OOs often want inspections of the condition of the house and ask to re-negotiate the initial deal when they get the inspector's report of all the problems. Most sellers understand that these "inspection" requirements almost always result in extra time, extra hassle, and extra costs to repair problems found by the inspector. This simple requirement creates problem for the OOs. (2) Slower due to funding: An economist at the CHTR and a property investor related “the last house I bought I gave the seller my best-and-final offer and lost because it was low. But, within a week the buyer that won was turned down for financing, so the seller came back to me for the sale at my lower price. They took several $000 less from me because I was offering cash and willing to buy the home "as is." Most OOs can only offer to "try" to get financing and may make an inspection a condition of the deal. Many OOs have to sell the house that they are currently living in which introduces uncertainty. (3) Emotions: we bid on things that we like and would feel like living in. (4) Need a place to live: most potential home occupiers have to hedge because they need a place to live. This hedging motive pushes prices in the same direction (with homeowners paying more) because while the homebuyer is short housing, i.e., needs a place to live, an investor is not pressured by the same sense of urgency. Thus we might expect potential homebuyers to pay more for a property, to get the house they want.
Conclusions on the investor versus potential home owner:
Investors buy smaller run down properties and because of speed tend to get better prices than OOs on this low-end property class.
Potential owner occupiers pay more for properties at the high-end because of friction, an attachment to the house and competition from other OOs and some INs.
Impact of INs on OOs: Even though they might have different preferences, and operate in different emotional spaces, investor behavior does seem to influence the behavior of potential home buyers. Thus INs indirectly, rather than directly, raise the price paid by OOs.
C. Primary effect of higher investor purchase - higher HPAoo
Deed data obtained from Corelogic allows us to isolate home purchases made only by owner occupier. We see in Chart 2 that across CBSAs, as the investor share in a market rises, home price appreciation on homes purchased exclusively by owner occupiers rises faster than homes in CBSAs where the investor share is low. This upward pressure would make it harder for the marginal would-be owner occupier to buy the house.
Our data shows that investors generally purchase properties that are smaller or run down. Thus investors and the would-be owner occupiers operate in different sectors of the same market and one could argue that they are not directly competing against each other. Nonetheless, it appears that, by buying the small or run-down property, the investor puts pressure on the marginal buyer to raise home price appreciation on high-end properties higher than might have happened without this additional competition.
Research by the Center for Housing and Tax Research (On the CHTR website under Recent Research: Investors and Prices/Rents) shows that each one unit higher share of investor purchases in a CBSA raises HPA on owner occupied (HPAoo) properties by 2.5 bps. In a city like Chicago, IL with an investor share during Mar-21 of 32 percent, potential homebuyers paid 80 bps more to own their home had investors not participated. This would have added an extra $1,600 to house that was selling in 2020 for $200k and sold for $211.4k in 2021 but might have sold for $209.8k.
D. Other factors, impact of millennials
Some forces playing on the housing market are difficult to put into numbers.
Real estate professionals that we talk with are seeing more and more evidence that the recent surge in house prices are partly due to a sudden push by millennials that have put off children, marriage, etc. until their 30s and now are jumping on the need for long term housing, partly due to the impact of the pandemic. We at CHTR have seen this exact effect in several of our friend’s children, who waited until their mid-30s to marry, have children, and then now, a few years later buy a house. The Great Recession really put many millennials at a financial disadvantage. Many of them found themselves facing foreclosure or bankruptcy or student loans they couldn’t pay. They have really been struggling as a generation to achieve the same level of financial independence as previous generations.
The result of that has been that they’ve been slow to form households. What we’re starting to see now is an unwinding of that, such that millennials are beginning to form households. They’re starting to get married, they’re starting to have the financial independence to move out from living with their parents. Combine that with being at a life stage where they start to have children, and you need more space than a studio apartment in urban locations. We all need more bedrooms, bigger laundry rooms, preferably a yard. It doesn’t have to be a big yard, but just something to be able to have a barbecue and a table and chairs in the backyard. Although some millennials have postpone having children there’s been an unbelievable amount of pet adoption taking place during the pandemic, and these (residents) need a place for a pet. Unfortunately, traditional apartments — while many of them have shifted to allowing for pets — it’s just not super well-suited.
Thus our estimates above about the impact of investors might be too high because it is confounded with these additional buyer segment.
E.a Secondary effects of higher investor shares -- positive
Renters often rent because they do not have the credit scores nor the income to obtain the down payment to buy a home. Thus investors provide a service (supply of shelter) to renters who do not have the ability to do so for themselves (a positive to both groups). Many renters are stuck in a wealth trap. By renting they never build up equity.
Investors often purchase run down properties and fix up the properties. This purchase and rehab is beneficial to all of the current owners in the neighborhood because research shows that it raises the property values in the neighborhood (a positive to one group).
Some investors create rental housing by building new units.
E.b Secondary effects of higher investor shares -- negative
Rehabbing a neighborhood is beneficial to current owners (a positive for one group). Simultaneously, it makes the neighborhood less affordable (a negative to an alternative group). If investors newly construct properties, this adds to the stock of rental homes in the CBSA which should drive rents down.
Since investors receive income from renters, there is a wealth transfer (a positive for one group). If investors live in the same CBSA, then the wealth could be recycled back into the CBSA’s economy. If the investors lives in a different CBSA, then the wealth is transferred out of the CBSA where the renter lives making the renter CBSA poorer (a negative for the entire CBSA).
F. Policy prescriptions
Although renting reinforces the great wealth gap between renters and landlords, it is a necessary short term evil. Landlords provide shelter to a group who are not able to provide shelter for themselves if they could buy a home.
In the long run, the only solution is better education and better financial education. The denizen of any city can only function when they have the skills to obtain the salary to buy a house.
Investor participation in a CBSA should be made conditional on building new units, or restriction their purchases to certain zip codes.