The High Price of Popularity

If your goal is to lose money, go with the hot hand: invest in the dominate theme, the latest fad, the newest investment securities. 

Unfortunately, popularity has the same influence on investors as a flame has on a moth. Meaning that it draws them in and incinerates them.

I've seen it time and time again. Money that wasn't lost investing in Japanese stocks in the 1980s was lost investing in Internet stocks in the 1990s. Money that wasn't lost in Internet stocks was subsequently lost in residential real estate in the early 2000s.

And if there's any money left, it's set to be lost all over again in real estate.

This time, losses will accumulate in residential rental real estate. I'm convinced money will be lost because of the torrent of new investments large institutions have devised to capitalize on the  “residential rental” thesis. 

You might be familiar with the pitch. It is simply this: underwriting standards are tight, so more people are forced to rent. This pushes rental rates higher, which in turn leads to lower vacancies and higher rental housing values. 

Last month I wrote about an apartment rental REITs. These are some of the lowest yielding REITs. And there are many new apartment REITS that have come public the past couple years to exploit the rental theme.

But there's an even more dangerous REIT, one focused on single-family homes. Large institutions are buying large swaths of single-family homes, rehabbing them, and renting them. 

Now these large institutions are tapping public equity markets to let you participate in their good fortune (or a cynic – and I'm one – might say, to cash out to suckers).

Silver Bay Realty Trust Corp (NYSE: SBY), American Residential Properties (NYSE: ARPI), and US Masters Residential Property Fund (ASX: URF) have had IPOs this year.

Investors who got in at the ground floor are hardly crowing.

Silver Bay is down 9% from its IPO price and American Residential Properties is down 20%. As for US Masters, it's a penny stock that trades on the Australian Stock Exchange and is up 19% to a whopping $1.90 a share.

And more IPOs are on the way. These include:

  • American Homes 4 Rent – the second-largest owner of single-family rental properties with 10,000 properties
  • Colony American owns 9,900 properties, making it the third largest home owner
  • Waypoint Homes Realty Trust – #5 in terms of home ownership, with 3,500 rental properties, filed for a $100 million IPO

It’s only a matter of time before Blackstone Group (NYSE: BX) – the biggest homeowner with 25,000 homes – has an IPO for its Invitation Homes unit. 

The popular investing thesis I shared sounds logical and enticing. But it's one that's well known today. Nearly every investor understands the opportunity.  And for that reason, the opportunity is fully priced. 

More important, the thesis fails to tell the full story. Yes, underwriting standards are tight, but people are getting loans. Indeed, conforming loans below $417,000 are readily available. Year over year, mortgage loans are up 12%. 

In addition, data collected by Fannie Mae and Freddie Mac show Americans overwhelming prefer to own than rent. Why would anyone be surprised? Neighborhoods composed of owner-occupied homes are more stable and hold their value better than neighborhoods composed of renters.

As for the thesis of perpetually rising rents, ignore it. In my opinion, we're approaching a top, if we haven't reached one already. 

Nationwide, landlords increased rents an average of 0.7% to $1,062 in the second quarter. The increase is slightly above the 0.6% increase posted in the first quarter, but it's well below the 1.3% rise one year ago.

The vacancy rate, meanwhile, held steady at 4.3% in the second quarter. Standing pat means the rental market experienced the first quarter since early 2010 when vacancy rates haven't declined. 

The single-family rental market is poised to disappoint, because popularity always disappoints. Give me a popular investing thesis, and I'll give you an account of investor heartache and misery. 

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