Market Mad House

In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule. Friedrich Nietzsche

Market Insanity

America Faces a Dangerous Real Estate Bubble not a Neo-feudal nightmare

America’s dangerous real estate bubble has entered a frightening new phase. Wall Street is joining the home buying frenzy.

Hedge funds, private equity funds, and other giant investors are investing enormous amounts of money on residential real estate. For example, Havenpark Capital Partners spent $71 million to buy Blaine International Village, and Brandondale Manufactured Housing Community, two Minnesota mobile home parks, MinnPost reports.

Similarly, online property property investing platform Fundrise LLC spent $32 million to buy 124 new houses in Conroe, Texas, from D.R. Horton Inc, The Wall Street Journal reports. Fundrise LLC manages funds for around 150,000 people.

Wall Street Starts Flipping

The Journal’s Ryan Dezember speculates Fundrise plans to flip the homes. Hence, fund managers are flipping houses just as speculators before the Great Meltdown of 2007-2008. In 2007 private individuals and investment banks speculation with mortgage-backed derivatives led to catastrophe.

Now flipping is back and driving a new real estate bubble, but it’s not Main Street doing the flipping. Its’ Wall Street and rich people. The flipping is occurring on both an individual and an institutional level.

The Wall Street flipping is generating hysterical headlines. MinnPost’s Bill Lindeke writes: “If left unchecked, institutionalized housing threatens to become a modern-day feudalism.”

Data, however, casts doubt upon Lindeke’s claims. He admits a handful of wealthy investors control is only around 4% of the housing stock. Hardly a Wall Street takeover of America’s housing market.

The Danger from Institutional Home Investment

I consider the Neo-feudalism claims hysteria but there are real dangers from all this institutional home ownership.

First, there is no evidence any of these institutional investors can manage or maintain the properties they are buying. Homeline, a Minnesota tenant advocacy organization has collected a long list of renter complaints about a lack of repairs by Havenbrook and Front Yard Residential; two investment groups buying up Minneapolis homes.

“Corporate landlords companies have a worsening track record of poor maintenance,” The Institute for Policy Studies alleges.

One frightening consequence of the lack of maintenance could be to drive down property values. Hence, institutional investors could turn some middle and working-class neighborhoods into slums. I think slumification could replace gentrification as a problem in American cities.

Moreover, some of the home-buying organizations could lack expertise and experience in property management. MinnPost’s Lindeke describes Havenpark Capital Partners, the organization that bought Blaine International Village as an investment firm run by veterans of the Nu Skin multilevel marketing operation. In other words, pyramid-scam hucksters not property managers.

Overpaying for Real Estate

Second,evidence suggests investors such as Front Yard and Havenbrook are overpaying for homes. Minnesota’s Fox9 reports that Front Yard Residential paid an average price of $171,225 for around 354 homes in Minneapolis-Saint Paul.

However, Fox9 also claims that one home Havenbrook bought was really worth around $106,000. Notably, Front Yard sold the homes it purchased to Havenbrook in 2018.

The obvious danger is that the properties will not generate enough income to repay the mortgages the institutional buyers took out to buy them. Notably, one in five US renters or 13.5 million renters were behind in their rent in February 2021, The Institute for Policy Studies claims.

Hence, investors could sink hundreds of millions of dollars into properties that generate no income. Worse, they could overpay for that property and drive real estate prices to unsustainable highs.

For example, the Median home value in Denver rose to $529,269 in June 2021, Zillow estimates. As somebody who knows Denver, I consider the $529,269 amount bullshit. In my estimation, most homes in Denver are worth half that amount or less.

One reason for the unrealistic price is that institutional investors are speculating in real estate with other people’s money. Notably, lack of expertise could drive the bubble. Speculators could accept grossly inflated appraisals at face value, for example.

There is sound evidence many real estate appraisals are inaccurate and unrealistic and driven by emotion rather than math. For example, Indianapolis resident Carlette Duffy alleges appraisers cut her home’s value by over $100,00 because she is black. Duffy claims the same appraisers raised the value of the same house by over $100,000 when she had a white man pose as the owner.

Frighteningly, some institutional landlords such as Fundrise are speculating in real estate with individuals’ retirement money. The Wall Street Journal estimates Fundrise invests on behalf of 150,000 individuals, many of whom could be retirees.

Therefore, the institutional speculators are generating a real estate bubble. The real estate bubble could collapse and wipe out tens of thousands of people’s retirement incomes.

How the Real Estate Bubble drives Corruption

One of the worst aspects of Wall Street’s real estate buying spree is the spread of high-level corruption to local and municipal government.

Miami Mayor Francis Suarez raised $1.207 million in contributions for his reelection campaign in May 2021, The Miami Herald calculates. Hedge fund managers and private equity investors made many of those contributions. For instance, Joseph DaGrosa; the chairman of Miami-based private equity firm DaGrosa Capital Partners, gave Suarez $150,000.

DaGrosa partners hired Saurez a real estate attorney as a senior operating partner, The Herald reports. Similarly, hedge fund executive Daniel Sundheim, founder of D1 Capital Partners, contributed $100,000 to Suarez.

In addition, private equity billionaire Orlando Bravo gave $100,000 to Suarez’s reelection committee. Several other hedge fund managers gave Suarez $25,000 to $50,000, The Herald alleges.

Obviously, the hedge fund and private equity operators are not donating to Suarez out of civic obligation. Instead, I think the hedge fund operators want to limit local government oversight and regulation of their properties. For example, limiting city inspections of properties which could lead to expensive maintenance.  

I think such corruption will make such local governments less responsive to people. Notably, Suarez used donations to fund a ballot initiative to make himself Miami’s chief administrator. Fortunately, voters wisely rejected Suarez’s power grab.

Unfortunately, there are many other ways corrupt officials can rig the system to benefit real estate speculators. For example, inspectors who give hedge-fund owned properties a pass could get free rent at a hedge-fund owned home or a job at the fund’s property management company.

What Happens when the Bubble Bursts?

The most frightening scenario is that the new institutional landlords could run out of money and collapse.

That collapse could bankrupt thousands of investors and impact thousands of homeowners. A bankrupt institutional investor could abandon thousands of homes and turn neighborhoods into wastelands over night.

It could also disrupt the entire economy. The last time a speculation-driven real estate bubble collapsed in America the result was the 2007-2008 Financial Crisis. That crisis occurred because Wall Street was playing around in the real estate market through mortgage based derivatives.

America Faces a Dangerous Real Estate Bubble not a Neo-feudal nightmare

Now, some of the same Wall Street geniuses who crashed the economy with mortgage investments think they can manage residential real estate. Given Wall Street’s history with real estate, I’m scared.

Thus, America does not face a neo-feudal nightmare. Instead, the United States faces a destructive real estate bubble that could burst and bring down the entire economy.

One history lesson from the 2007-2008 Meltdown is that the last stage of a nationwide speculative frenzy is often a real estate bubble. After betting on everything else, the speculators turn to real estate and lose their shirts.

Can we end Big-Money Speculation in Private homes?

We need to end big-money speculation in private homes. There are ways to stop such speculation.

An obvious one is to raise the interest rate to stem the flow of cheap credit from the Federal Reserve to speculators. Real estate is undergoing inflation. The late, great, Paul Volcker taught us that the way to control inflation is to jack up interest rates.

Sadly, there is no Paul Volcker at today’s Federal Reserve to fight the new inflation. Only yes people who will keep churning out cheap credit until it overheats the economy and triggers a meltdown.

Another is to make it illegal for investment companies to own single-family homes. A long-term solution could be some sort of GI Bill style mortgage program to help ordinary people buy homes at a low cost.

The GI Bill helped millions of World War II veterans buy homes with low-cost mortgages and helped create the middle class. A modern GI Bill could offer cheap no-down payment mortgages to ordinary people and groups such as blacks who have been shut out of the real estate market.

We will need to take action against this speculation if we want to prevent the American Dream of home ownership from becoming a nightmare that will impoverish millions.