This article is adapted from a recent white paper written on the same topic.
In 2010 and 2011, single family homes were derided as an investment by everyone but small, entrepreneurial operators who made money buying, renovating and reselling them (or, in some cases, leasing them).
In 2012, U.S. housing is being touted as a well-priced "asset class" that deserves attention. Below is an excerpt from a recent Warren Buffett interview on CNBC:
If I had a way of buying a couple hundred thousand single-family homes… I would load up on them… it's a very attractive asset class now. I could buy…them at distressed prices and find renters and … [take a] mortgage, it's a leveraged way of owning a very cheap asset and I think that's as attractive of an investment as you can make.
Warren Buffett, CNBC's Squawk Box, Monday, February 27, 2012
In addition, research analyst Oliver Chang at Morgan Stanley has written a series of reports focused on the "rentership society" and the merits of investing in single family homes. One such report is available by clicking here.
Why Buffett Isn't Buying
But to take advantage of the opportunity to purchase homes well below replacement cost, with attractive current income of 7% or more, someone needs to be willing to oversee the renovation and to be the landlord. That means fixing the plumbing and getting the roof repaired when necessary. In a word, this is why Warren Buffett hasn't loaded up on single family homes. He isn't interested in dealing with these issues and he can't find a way to invest on a scale that moves the needle for him, even by leveraging other people's time and talents.
For the rest of us mere mortals, it doesn't take a billion dollars to move the needle. Even a small number of good acquisitions can provide solid income and potentially a significant profit over a 5-10 year holding period.
A Case Study
For example, together with a local operating partner, we recently purchased a home in Southern California for about $74,000 and spent another $10,000 renovating the property. The home, which is two blocks from a major medical center, is now rented for $1,145 per month. This is gross rent; net operating income is about $4,500 per year less, because of operating expenses including property taxes, insurance, maintenance and reserves. The last time this property sold, in 2001, the sale price was $239,500.
This investment is appealing because of the combination of (1) good current income; (2) the ability to use leverage; and (3) the prospect for meaningful appreciation when the housing market emerges from the foreclosure crisis. Of course the neighborhoods where home values are most depressed are usually not the same neighborhoods where investors have lots of extra capital to invest in purchasing homes as investment properties.
For this reason, those wishing to invest in U.S. housing need to put in place some infrastructure to execute on their strategy-specifically, relationships, accounting systems and controls. As Milton Friedman said, "there is no such thing as a free lunch." In the case of this strategy, the cost of the lunch is a multi-year commitment by the investor to owning and managing an asset that is probably not around the corner from one's own house or office. In addition, this is not just an asset but a leased asset with a tenant. Having the judgment to pick the right tenants, or partnering with someone who does, is both critical and non-trivial.
What about apartment REITs like AEC, AIV, AVB, BRE, CLP, CPT, EQR, ESS, HME, MAA, PPS and UDR? As I have written in a prior article on Seeking Alpha, the implied capitalization rates of apartment REITs are frequently under 5%. In addition, a recent Business Week article argues that apartment values may be experiencing a government financing-induced bubble. In any case it seems clear that single family homes offer more current income than apartments. One can also make the case that single family homes can appreciate more, given current depressed values and the fact that home buyers are currently more or less on the sidelines. When the supply of distressed bank sales finally comes back to normal levels, some price appreciation is likely. Meanwhile apartment values will be held back by any rise in capitalization rates, which is likely (see this article for reference).
In summary, Warren Buffett is correct to note that U.S. housing today is cheap by many standards. The leased single family home asset class is not easy for investors to access-it takes work and judgment to find the right partners, and the opportunity is probably not worth the effort for the Buffetts of the world. But for those of us open to investing in homes, 2012 is likely the best market for buying that we will see for many years to come.