Homebuyer competition was incredibly fierce in 2021 and continues to fuel a rapid sales pace in the first quarter (Q1) of 2022. But one increasing force homebuyer occupants are often surprised to contend with with is cash-heavy investors.
While the economy remained on shaky ground during the pandemic and even more recent global events continue to rock the global economy, investors are shunning many of their go-to investment products in search of a safe haven for their funds. This is the reason why U.S. Treasuries plummeted to historic lows in 2020 — even though the return was low, a return was at least certain, as it was backed by the security of the federal government.
Thus, lacking alternative safe forms of investment — and seeing the potential for hefty and rapid returns — investors poured into real estate in 2020-2021.
Investor purchases made up 18.4% of U.S. home sales in Q4 2021. This is up significantly from 12.6% a year earlier and the highest level since record-keeping on investor purchases began in 2000, according to Redfin, a national real estate brokerage.
For historical reference, the share of investor purchases gradually increased throughout the Millennium Boom, hovering around 6%-9%. In the years following the home price crash of 2007-2009, investors rushed to profit from low prices and lower interest rates, with the share of investor purchases reaching a cyclical peak of 13% in 2013, putting today’s 18% share of investor purchases in perspective.
Here in California, the investor share in Q4 2021 was:
- 20% in San Diego;
- 20% in Anaheim;
- 19% in Sacramento;
- 19% in Los Angeles;
- 18% in San Francisco;
- 16% in Riverside;
- 13% in Oakland; and
- 12% in San Jose.
Three-out-of-four investors paid all cash for their home purchase, making it nigh on impossible for homebuyers reliant on mortgage financing to compete. Further, investors end up paying lower purchase amounts on homes than buyer-occupants, according to RealtyTrac, reflecting seller preference for an easy cash sale.
Every type of homebuyer is desperate in 2022
As the old adage says: buy low, sell high. This occurred when investors swarmed California’s housing market following the housing crash of 2007-2009, when low-tier home prices fell a whopping 60% from their 2006 peak.
But home prices are currently at an all-time high at the start of 2022, begging the question: are investors behaving irrationally?
Today’s investors are a mix of buy-to-let investors who aim to own the home as a long-term investment — and flippers, looking to make a quick profit on the sale. Flippers contribute nothing beyond (maybe) a fresh coat of paint, seeking to make a profit on market momentum alone.
The recent juicy home price increases have beckoned investors of all types. After all, real estate is a hot commodity and changes in value occur slowly, over the course of months. In contrast, stock market values can change drastically over the course of several hours.
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But one thing that today’s flippers don’t understand is that, just as home values adjust course slowly over time, the biggest profits are to be had for those who hold over the course of several years rather than weeks. A one-time profit can be quickly lost due to carrying costs, rising interest rates and economic losses.
But long-term investors who rely on their investment for monthly income rather than a one-time sales profit will find the most success in real estate. These investors look to a property’s capitalization (cap) rate for an idea of each property’s investment potential.
A property’s cap rate measures the annual rate of return produced by the operations of an income property, stated as a percentage of invested capital. In terms of rental properties, it’s presented as the annual yield — the continuing receipt of net operating income calculated for each year of ownership — from rental operations in relation to the seller’s asking price.
Low cap rates become acceptable to cash-heavy investors faced with few investment opportunities. Or, in the case of flippers, cap rates are simply irrelevant.
Today’s flippers will soon find that they have purchased at the top of the market. Rising mortgage interest rates, the end of government stimulus support, alongside the 700,000 jobs still missing from California and the rise in forbearance exits are all putting downward pressure on home prices in 2022.
Once home prices begin to fall — expected heading into 2023 — short-term investors will begin to see the light, demanding higher cap rates and shifting their focus from short-term profit to long-term yields.
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