The last time a big financial firm rushed into buying rental exposure (just as others were quietly leaving the sector in droves and when the ingenious Wall Street was coming up with such derivatives as Rent-Backed Securities to dump their exposure to dumb yield-starved Germans and Asians), it had a very unhappy ending for the buyer. That transaction of course was Lehman Brothers' rushed acquisition of landlord Archstone, which as many have noted over the years, was a big contributor to the Lehman bankruptcy once the rental payments dried up. But then again, as others have pointed out, Lehman was so deep in its real estate exposure by then it really had no choice but to keep doubling down all the way to the bitter end. Which may explain why while most other brand name hedge funds and P/E firms are now cashing out of the US housing market whose second bubble may already have peaked (only last night Goldman said that "On house prices, we have started to see the first signs of deceleration and expect a slowdown"), Blackstone, which is now the US' largest landlord, is digging in its heels and is not letting go. In fact, it is adding to its exposure - as the WSJ reported overnight, Blackstone has invested another $1 billion to purchase GE's stake in 80 apartment complexes amounting to 30,000 apartment units, located in Dallas, Atlanta and other parts of Texas and the Southeast.
The total size of the deal is estimated at $2.7 billion, and merely adds to the tens of billions Blackstone has already invested in the buy-to-rent space.
With the investment, Blackstone is wading into a debate in the real-estate-investment world over the future of the rental market. Apartment buildings have been the hottest real-estate sector since the downturn because of strong demand from people unable or unwilling to buy homes. Rents and occupancy rates have been rising while the prices investors have been paying for apartment complexes have moved into record territory.
But in recent months, some analysts and investors have begun to worry that the party is coming to an end. They have warned that the recovery of the single-family-home market will erode demand for apartments and that competition is increasing from new supply being developed in many parts of the country. "I would expect multifamily rent growth to begin decelerating because of the new construction," said Tad Philipp, director of Moody's Investors Service's commercial-real-estate research.
Over the past year, when the most acute part of the housing bubble has unfolded, these kinds of deals have been largely profitable, if only due to the flipping component where one investors sells to another. The question of how affordable rents at all time highs are, is separate and one which the Blackstones of the world will have to answer. But for the time being, if not much longer, the good times are rolling:
Investors who purchased apartment buildings early in the downturn have enjoyed sharp increases in value. Moody's apartment index, which tracks the national average price of multifamily rental buildings, is up 59% from its 2009 lows, compared with a 35% gain for its National All Property Index.
The rise in values has been propelled by rent increases of 2.3% in 2010, 2.4% in 2011 and 3.8% in 2012, according to Reis Inc., a property-research firm. Vacancy rates, which hit a 30-year high at 8% in 2009, are now at 4.3%, a 12-year low.
In Houston, for example, average apartment rents increased to $799 a month in the second quarter, up 4.4% from the second quarter of 2012. In Seattle, rents were up 6.2% in the same time frame to $1,096.
But the party is ending and one doesn't need a Ph.D. in Fed Balance sheetology to get that:
The big question now hanging over the market is whether or not these trends will continue to push values higher.
In the past year, investors in real estate investment trusts have been getting increasingly wary. The compounded return for the apartment sector declined 3.23% in the past 12 months, compared with an 8.76% increase for all equity REITs, according to the National Association of Real Estate Investment Trusts.
For Blackstone however, the warning signs are only there to be ignored. "Blackstone's apartment purchase from General Electric is its largest U.S. real estate investment in two years, as it continues to buy from a record $13.3 billion global real-estate fund it recently raised."
Why is Blackstone scrambling? Because it is late of course, so it hopes to make up for price appreciation with volume:
Blackstone has come relatively late to the rental apartment sector but it has been betting on the housing market in other ways. The firm has invested more than $5.5 billion to buy more than 30,000 single-family homes in about one dozen major U.S. markets. The strategy is to rent those homes out for now and sell them as home prices rise.
Perhaps a better question is why GE is selling:
For GE, the sale is part of an effort to sell down its real estate portfolio. GE boosted its equity investments in commercial property in the years before the financial crisis, but its portfolio suffered during the downturn. The company has since taken steps to sell down its real estate holdings, which may have made it made it a motivated seller of the large portfolio.
But the best question by far is how Blackstone plans to generate the required return on investment:
It's unclear if Blackstone plans to renovate these buildings, or how it intends to get the high-teen to 20% returns it usually seeks. Initial yields on apartment buildings nationwide are around 6%, and lower in popular markets, according to Real Capital Analytics Inc., a real estate data firm.
And, alongside that, what happens if, gasp, history repeats, this time is not different and the the unthinkable does happen, and the housing bubble pops once more leading to a crash in real estate values and rental cash flows. Just like it did last time.
Is Blackstone's next strategic move a far simpler one: to preemptively become a bank holding company? Because when getting bailed out by US taxpayers for taking on outsized risks, it is never too early (or late) to get ready for the inevitable.
And with that, we once again bring you... the Bluth mansion.