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Property - The Big Long - A new generation of investors is betting on America s

rlp

Dec 1st 2012 | from the print edition

THOSE feeling nostalgic for the boom before 2007 will have been heartened this

week by headlines about Lehman Brothers selling a portfolio of American

apartments for $6.5 billion. Lehman Brothers? No, the investment bank felled by

the mortgage miasma is not rising from the dead: its administrators are merely

flogging its remaining assets to repay creditors. But the sale shows that

American housing, once so toxic it made the global economy choke, is once again

attractive to investors. Hedge funds and private-equity firms, so often the

villains, may be helping a housing revival.

America s residential sector was once the preserve of mom-and-pop investors

or local developers. The role of hedge funds became apparent only when those

who bet massively against the housing market The Big Short , as it was later

termed made billions while their rivals floundered. By gambling that subprime

mortgages, extended to borrowers with no plausible means of repaying them,

would poison the financial system, John Paulson personally pocketed $3 billion

after his hedge fund skyrocketed.

The Big Long is now slowly taking shape. House prices have stabilised since

their 2009 trough, and have even made small but steady gains in recent months.

Investors convinced that a full-blown housing recovery is under way a big if

are looking for ways to profit from it.

The most predictable of these is to invest in mortgages, or the very same

residential mortgage-backed securities that were so avidly shorted in the

run-up to the crisis. It is a deep pool: the $10 trillion of home loans

outstanding is second only to equities as an asset class. Over half of these

mortgages are tacitly guaranteed by the government, turning them into something

akin to Treasury bonds. But packaged in tax-efficient structures to which large

dollops of debt are added, these can kick yields up to the 10% range: not bad

in a low-interest environment.

The risk is that even a small rise in interest rates will wipe out all the

value. You really have to believe interest rates are going to stay low for the

foreseeable future, says Gregory Perdon of Arbuthnot Latham, a bank.

Mortgages not guaranteed by the government, known as non-agency , are far more

volatile and thus more appealing to return-hungry investors. Their price is

closely correlated to that of the houses which underpin their value. Repayments

are also higher when house prices are buoyant: if the house is worth less than

the mortgage, the owner may simply walk away. Picking up those mortgages at

rock-bottom prices has delivered returns of 30% or more for savvy hedge funds

this year.

The other, and more intriguing, way of betting on rising house prices is to buy

the houses themselves. KKR, Colony Capital and Blackstone are among those

amassing large portfolios of homes, mostly buying from banks foreclosure

auctions. Keefe, Bruyette & Woods, an investment bank, estimates that around

$6-8 billion is being lined up to invest in single-family homes, the most

appealing part of the market.

In practice, this is a fiddly process that involves finding, buying and

managing thousands of homes scattered around the country. This is not easily

done from a skyscraper in Manhattan. A property-management company is helping

Blackstone buy some 100 houses a day in selected markets. Such is the pace of

its investing that its agents do not even step inside all the properties it

buys. Auctions of foreclosed properties can run to several thousand homes per

month for a large city, often selling at half their 2006 peak price.

The plan is to fix up the houses and rent them, generating yields of around 7%.

Jonathan Gray, the head of real estate at Blackstone, says that part of the

investment case is that house-price increases will create fat capital gains.

This has already happened in Phoenix, Arizona, the best recent performer of the

20 cities tracked by the Case-Shiller index of house prices (see chart). This

may spoil Blackstone s appetite for more than the $1.5 billion of houses it has

already gobbled up. Others have already scaled back, disappointed by the

returns.

Still, fully 20% of all home sales in October were to purchasers classified as

investors, according to the National Association of Realtors. Rents as a

proportion of house prices are at their highest for a decade. Oliver Chang, a

former Morgan Stanley housing analyst now looking to buy $1 billion in

single-family homes, says residential prices do not even need to go up for the

trade to be profitable, as long as the houses are selected properly and

value-adding repairs are carried out.

There may be even simpler ways to bet on bricks and mortar. Warren Buffett, an

investor, recently bought a chain of estate agents. (He already owns a brick

company.) Shares in home builders and Home Depot, a do-it-yourself store, are

up sharply. Mr Paulson himself is buying development land in hard-hit markets.

Buying houses themselves may be the smartest bet of all. Having been too lax in

granting mortgages before 2008, banks are now erring on the side of caution.

People still need a place to live, which pushes them to rent instead of buying.

Home ownership swelled artificially from 64% to 69% in the boom years; it is

now edging back down. Huge investors like Blackstone have credit ratings that

the public cannot match. If America is moving towards a rentership society,

they will rake it in.

As a trade, buying houses is the polar opposite of what made hedge funds rich

from 2007; it is a bullish bet which eschews complex financial products. It is

also far less racy: a 7% yield is hardly the stuff of investment lore, even if

greater profits may come. As sequels to blockbusters go, The Big Long is

mercifully dull.

from the print edition | Finance and economics