Saturday, April 4, 2020

Investors, Gentrifiers, and Flippers, Oh My!

Last summer there was surge in the "Beware real estate investors!" genre.

Here is NPR, the Wall Street Journal, and the New York Times.  These are all quite similar in content and tone.  I will generally review the NYT piece here.

It starts with "This house in Atlanta was sold three times in one year, a sign of exploding investor interest in starter homes that is reshaping the nation’s housing market and driving up prices."  The house was in a neighborhood that had "fallen on hard times" and went from $85,000 to over $300,000 over the course of those transactions, which, according to the article, included extensive renovations and treatment for a termite infestation.

Here is some of the rhetoric in the article regarding this house:
A confluence of factors — rising construction costs, restrictive zoning rules and shifting consumer preferences, among others — has already led to a scarcity of affordably priced housing in many big cities. Investors, fueled by Wall Street capital, are snapping up much of what remains.
“If it weren’t bad enough out there for first-time home buyers, the additional competition from investors is increasingly pushing starter homes out of the reach of many households,” said Ralph McLaughlin, deputy chief economist at CoreLogic, a provider of real estate data.  
Mr. Makarovich, 34, arrived in 2016, part of a wave of young professionals moving into one of the last affordable parts of Atlanta.  
Ms. Ellis looks at the changes in her neighborhood — and her role in those changes — with some ambivalence. She once derided the out-of-towners moving into the area as carpetbaggers. Now, she is playing at least some role in that transformation. “I was like, what are we doing?” she said. “Are we doing the same thing, ultimately, bringing in people who are going to change the place?”  
Later, investors are described as “locusts (that) came down and bought everything up.” 2019
Source: Zillow Data
Here, I will just start with a graph comparing rent affordability and mortgage affordability for both the US and for Atlanta.  This is the portion of the median household income required to either buy a home with a conventional mortgage or to rent the same home. 2019
Source: Zillow Data
Beginning in 2007, there was a sharp divergence between rent and mortgage affordability.  The reason investors flooded the market, and are still active is because owning real estate suddenly became very profitable and that divergence has barely closed at all.  Even the recent small amount of reconvergence was mostly from rising mortgage rates, which have reversed since I produced these charts.  Starter homes are usually purchased with a significant amount of leverage.  Entry level buyers are absolutely not being priced out of the market.

If rising costs and zoning rules were the problem here, then both rent and mortgage affordability would be high, which is exactly what you see in a place like Los Angeles, where zoning restrictions and high costs are the actual reason for a lack of affordability.

Clearly, the problem in Atlanta isn't that investors are "snapping up" all the homes.  The problem is that homeowners aren't snapping them up.  As for young homeowners moving into the "last affordable parts of Atlanta", what can one say?  There are vast swathes of Atlanta where homes are available for less than $150,000.  In fact, there are several homes for less than $150,000 within a block of the house profiled in the story.  The reason the buyers didn't buy those houses was because they wanted a nicer house and they had the money to pay for it.  This is not a story about affordable housing.  The house that sold for over $300,000 sold to a relatively affluent couple expressing a preference.

Are all those sub-$150,000 neighborhoods suffering from too much residential investment and too many interlopers?  None of these reporters seem capable of imagining anything else. The article goes on to lament the struggles of another potential homebuyer who is shopping in the $300,000+ range in Atlanta.  Her real estate agent, who also represents investor buyers and who invests in properties himself, says, “If it is anybody’s fault, it’s probably mine, because I brought people in.”

A question one might ask here is, how can the same market provide good investment opportunities for the real estate broker while simultaneously being bereft of affordable units for the tenants?  These homes are affordable for the investor, but not potential home buyers?

One might also wonder why all that capital isn't funding new housing units.  The truth is, that capital is funding new units, but only for the "haves".  Sales of new homes with prices above $200,000 is back near the boom peak, but new homes under $200,000 are practically nowhere to be seen.  We suffer from a lack of affordable housing while mortgage affordability is fabulous, and yet home buyers just aren't interested in building new homes that sell for less than $200,000?

The truth is that there is great demand for affordable homes, but the families who would live in those homes have a very difficult time getting mortgages today.  Here is a graph comparing two measures.  The black line is the average FICO score of new mortgage borrowers.  After the crisis, loans to average American families dried up and the average FICO score of today's borrowers is much higher than it was before.  The orange line is a comparison of home prices in the most expensive 20% of Atlanta's zip codes compared to home prices in the least expensive 20% of zip codes.  When high end prices rise compared to low end prices, this line rises.  After lending standards were tightened, low end homes in Atlanta dropped by more than 30% compared to high end homes, even though there hadn't been much difference during the boom.

The real estate broker and investor is buying the homes whose tenants are blocked from getting mortgages.  Those homes are affordable, but unavailable to their tenants.  The brokers' clients are the types of buyers who can qualify for mortgages.  They aren't interested in living in $150,000 homes.  They are buying the homes above $200,000 that have risen in value and that have ample new supply coming on line.

There is no natural shortage of homes with affordable prices.  There is a shortage of Americans with permission to buy them.

It is the lack of lending that is creating this gentrification process.  Since lower tier homes have been underpriced, investors have incentives to buy those homes and fix them up so they are nice enough to attract high end buyers in the market that isn’t underpriced.  The way to stop this is to allow more working-class households in those neighborhoods to buy homes.  That will be associated with rising prices, until they are high enough that those investors aren’t attracted to the neighborhood anymore.  But, even with higher prices, those mortgages will be more affordable than rents are today.  Instead of bemoaning greedy landlords that jack up rents and evict working class tenants, why don’t we let those tenants solve their own problem?  Many of those tenants are capable of being their own landlords, and regulators today are preventing that from happening.

As the chart shows, low tier prices have been catching back up with high tier prices lately.  This makes it very tempting to point to low tier price increases since 2012 and react in fear that another credit-fueled bubble is on the way.  But, clearly, those rising prices are catch up growth.  It needs to happen.  It is a sign of a return to sustainability, not a return to unsustainable excess.  There should be more of it, and the demand should be coming from the tenants themselves rather than investors.

There is a shortage of homes with affordable rents because their tenants are denied other options and because the prices on those homes are too low to justify building more and increasing supply.  The investors are buying them because they are great deals, but they are only great deals if you can get funding.

Rents have been on the rise, and the only way they will moderate is by increasing supply - bringing in capital.  Yet, these articles routinely paint capital as the enemy.  But the lack of capital is what is driving up rents.  Residential investment in new single family homes is well below any levels in the decades before the financial crisis.  The affordability problem certainly isn't due to too much investment.

Every home has to be owned by someone. If, as a matter of public policy, it can't be the tenant, then it's going to be an investor.  Presumably, New York could only have become such a great city because it was a place that welcomed change, that welcomed newcomers, and that welcomed the capital needed to house them.  How else could it become a metropolitan center with 20 million people?  Those days are in the past.  An early step in that trend was the implementation of zoning laws that led to the condemnation of tenements that housed the newcomers.  Today, these articles suggest that one is expected to apologize for fixing dilapidated units or for becoming a new resident in a long-growing city.  This is not a frame of mind that will help maintain affordability in Atlanta or regain it in New York.  A primary challenge for the twenty-first century economy is that many of our legacy economic centers now fail to perform the most basic function of an urban center – to attract and house people.  We can’t let New York spread that pathology to cities like Atlanta.


  1. Excellent blogging.

    However, the federal government has engineered a solution to overpriced housing. Stop all economic activity.

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