We called it, and it’s happened: institutional investors are tucking tail and getting the heck out of Southern California real estate.
Institutional investors — defined as buyers of ten or more properties per year — traditionally do not play a significant role in California real estate transactions. Due to California’s steady population growth, demand for housing is higher. This makes for a more competitive housing market than is seen in other states.
With that said, institutional investors’ participation in the California real estate market is a telling bellwether of the behavior of smaller buy-to-let and buy-to-flip investors. Although not as prevalent in other, less competitive real estate markets, the big guys came to California to play starting in late 2012 and throughout 2013. The first trough in the bumpy plateau recovery occurred in 2009. After a brief flurry of market activity mostly generated by the first-time homebuyer’s credit, prices bottomed again in 2012. This is when speculators and institutional investors began doubling-down on California single family residences (SFRs).
Now, however, after unsustainable price rallies (hovering around 20% during the past year alone), institutional investors are bowing out. Nationwide, they accounted for 5.2% of all residential sales in January, a 3% decline from one year prior, according to RealtyTrac.
Institutional investor purchases were even lower in California, settling at 2.1% of all January sales, compared to 7% in January 2013. The Inland Empire was the greatest site of exodus for large-scale buyers, with institutional investor purchases freefalling from 11% of total sales in December to just 1.4% in January.
The reason for this buy-to-let fallout is undoubtedly the asset price inflation brought on by last year’s speculator orgy.
Buy-to-let investors are, by definition, interested in their return on investment (ROI). Given the favorable price-to-rent ratio over much of California early last year, those with sufficient funds to invest in income-producing property were able to do so at an attractive rate of return. However, investors sowed the seeds of their own demise (as they often do in “cyclical” markets) by first gobbling up housing inventory at the bottom of the market. This drove prices up, as is crystal clear by now. As they continued to play the momentum game, buying at forever increasing prices, they were no longer able to capture a reasonable rate of return on SFR rents. Add the one percentage point increase in interest rates that we’ve had over the last year and any investors that did go leveraged were fated to watch their profits go by the wayside.
The good news here is that the exit of investors from this market heralds a return of sustainable prices. With that said, a lack of jobs and honest income increases will keep demand in the sink of secular stagnation for some time.