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Wall Street’s Rental Gambit

This article originally appeared in American Affairs Volume V, Number 1 (Spring 2021): 27–36.

Wall Street’s rental gambit began a decade ago at the depths of the housing crisis, when financiers sent buyers to foreclosure auctions with duffel bags full of cash.

The Covid-19 pandemic set off a frenzy for suburban houses. But it’s not just millennials looking for patios and home offices; Wall Street is house hunting as well. Private equity firms, insurance compa­nies, and pensions are betting that many Americans will have to rent the suburban lifestyle to which they have now become accustomed and are racing to accumulate houses to lease to them.

Wall Street’s rental gambit began a decade ago at the depths of the housing crisis, when financiers sent buyers to foreclosure auctions with duffel bags full of cash. By the time the economy was shut down in March 2020 to slow the spread of coronavirus, public companies and institutional investors owned more than 350,000 single-family rental homes clustered in good school districts around growing cities.

The sudden unemployment of millions seemed to present a grave threat to this business model, however. How many of these investors’ tenants would keep paying rent? As it happened, pretty much of all of them.

Mega landlords such as Invitation Homes, American Homes 4 Rent, and Tricon Residential—with more than 150,000 houses be­tween them—have reported record occupancy and timely rent pay­ment on par with pre-pandemic rates. Cooped-up members of the work-from-home class are streaming their way and quickly snapping up vacancies, despite asking rents being pushed up by more than 10 percent year over year in some places. That’s remarkable in good times. It’s eye-popping amid recession.

The pandemic has thus allayed any lingering doubts that pools of suburban rental houses can be managed profitably. Plus, there’s not a lot of other appealing places to invest the $150 billion or so amassed in private equity funds dedicated to property deals. The outlook is cloudy for office towers, hotels, and shopping malls. Apartment complexes catering to service workers have been walloped.

Bold-faced names of finance have piled into landlording since the pandemic began. J.P. Morgan Asset Management is building $625 million of houses expressly to lease with American Homes 4 Rent. Rockpoint Group, a private equity firm that historically invested in apartments and developed subdivisions, teamed with Invitation Homes to buy $1 billion worth of high-end rentals for six-figure earners and then struck a $250 million deal with another landlord to buy cheaper houses for working-class tenants.

Blackstone Group, which built Invitation into the country’s largest landlord and cashed out in November 2019 with billions in profit, didn’t stay on the sidelines long. In August, Blackstone invested $240 million in Tricon.

Koch Industries, Brookfield Asset Management, and Nuveen have each made their own nine-figure investments in expanding rental operations. Last year, a multibillion-dollar bidding war broke out for a fourteen-thousand-house landlord called Front Yard Residential.

The pandemic has emboldened Wall Street, offering proof that the mega-landlord business model can withstand economic shock. But investors are counting on their bets to keep paying off well after Covid-19 is tamed.

Housing 2.0

Most Americans associate the housing crash with 2008, but three years later, in 2011, home prices were still in free fall. Double-digit foreclosure rates plagued cities like Miami and Las Vegas. Home values plunged by more than half around Phoenix.

That summer, a team of housing analysts at Morgan Stanley sent the investment bank’s clients a report that would become wildly influential. It was titled “A Rentership Society.” In it, as well as in subsequent papers, the analysts forecast a surge in the number of renters and a potentially massive opportunity for investors to convert the glut of repossessed homes into rental properties.

There were more than 1.6 million foreclosed homes on the market around the country, and judging by the hundreds of billions of dollars in delinquent mortgages out there, more were on the way. In each foreclosed home, the analysts saw both a potential rental property and a new renter hitting the street whose needs—room for children, access to good schools—were unlikely to be met by an apartment.

The analysts noted the bursts of household formation that usually follow recessions, during which people tend to delay things like marriage, having children, moving out of their parents’ homes, and even divorce. Banks were stunned by losses and facing the wrath of lawmakers. They were being as tightfisted with home loans as they had been lavish with them before the crash. Billowing student debt was making it as difficult as ever to save for down payments, which were back in style among lenders.

Attitudes toward renting were changing, too. Homeownership had resulted in financial pain and sacrifice for millions of Americans. The argument that paying rent was wasteful had lost resonance. The economy’s shift from manufacturing to service and information jobs meant fewer workers tethered to particular towns for their entire careers. That had boosted the option value of renting, the analysts said. Being able to move for employment without worrying about selling a house and paying sales commissions and other fees was more important than ever. A big rental investor who was an early acolyte of the rentership society once asked me, when I interviewed him for the Wall Street Journal (where I’m a reporter), “Is renting a home really that much different from renting the money to buy one?”

For many it may not be, especially if they have to put their life’s savings at risk. In addition, though home prices had come down since 2008, other ownership costs were up. Hurricanes along the East and Gulf Coasts and wildfires out west were pushing homeowners’ insur­ance premiums higher in some of the most populated parts of the country. Cash-strapped municipalities were raising property tax rates to counteract the negative effects that lower property values were having on revenue.

Homeownership, long upheld as the American dream, was in crisis, the Morgan Stanley analysts wrote. One in five homeowners either was no longer willing or able to make mortgage payments or had lost every penny of home equity. If you counted only people with a mortgage, it was roughly one in three. “That dream,” the analysts wrote, “has become more of a nightmare.”

The first great hauls from the housing bust came when contrarian fund managers, such as John Paulson and Michael Burry, and traders at Goldman Sachs constructed complex wagers against subprime mortgages. The Morgan Stanley analysts said the next fortunes could be minted scooping up repossessed homes and renting them out. They estimated that even in the worst-case scenario—one in which home values never recovered and not a penny could be borrowed to amplify returns—the yield from renting homes bought cheaply enough on the courthouse steps or from desperate banks would be much higher than almost any other investment given how low interest rates were being held. The opportunity as they saw it was nearly boundless, measured in trillions of dollars. They deemed it Housing 2.0.

There were doubters—mostly apartment owners. They were in the business of managing large numbers of residences, and it was hard enough when they were all under one roof. There were good reasons no one had ever attempted to manage huge pools of rental homes, skeptics argued.

If ever there was a time to try, though, it was now. Apple released its iPhone in 2007 and the iPad in 2010, launching a new era of mobile computing. These devices as well as advances in cloud computing enabled investors to conduct an unprecedented land grab and profita­bly manage thousands of far-flung properties.

The phones at Morgan Stanley were flooded by inquisitive invest­ment fund managers. Ben Bernanke, who helmed the Federal Reserve during the crisis, endorsed the idea in early 2012 while speaking at a National Association of Home Builders conference in Orlando, Florida. “It could make sense in some markets to turn some of the foreclosed homes into rental properties,” Bernanke said. By then, more than $1 billion had been raised by investors for the purpose of doing just that. Some of the biggest names in finance were hoarding houses.

Blackstone, the world’s largest property investor, was introduced by an investment banker to a group of Arizona men with a fast-growing rental-home business: they had been buying mobile home parks around Phoenix when home prices crashed and decided to trade up to single-family houses. Their business was led by Dallas Tanner, a fourth-generation Phoenician who had just completed his graduate degree at Arizona State. They had accumulated more than a thousand rental homes with cash from the country club set, but Tanner and his partners wanted to expand to other cities. They went looking for an investor, someone with deeper pockets than the doctors and dentists who had so far been funding their splurge.

Blackstone, with billions of its investors’ dollars locked up in its private equity funds, had been studying a move into U.S. single-family homes, the world’s largest asset class and the final frontier for the institutional property investors who had already conquered malls, apartments, offices, and other segments of real estate.

At Blackstone’s Park Avenue offices, the firm’s brass weighed a big rental-home investment. Blackstone’s billionaire chief executive was on board. “Oh my goodness, this could be huge,” Stephen Schwarzman said. “Nobody is going to be able to borrow. They’re going to need housing.”

Within a couple years, flush with Blackstone’s billions, Tanner’s Invitation Homes was spending $150 million on foreclosed houses each week.

The Rise of the Upper-Middle-Class Renter

Between 2006 and 2016, when the homeownership rate fell to its lowest level in fifty years, the number of renters grew by about a quarter. The nearly 9.5 million new tenants aren’t just the bottom-rung earners and subprime borrowers you’d expect. Rent rolls these days include a surprising number of upper-income professionals.

By 2018, about 19 percent of U.S. households with annual incomes of $100,000 or more were renters, up from 12 percent in 2006, according to U.S. Census Bureau data adjusted for inflation. That equates to about 3.4 million new renters who, given their incomes, probably would have been homeowners a generation ago. And they’re not renting where you’d expect. Less than 20 percent of them are around New York City and San Francisco, where sky-high real estate values have long limited homeownership. Their ranks swelled in places such as Houston, Denver, and Nashville, as well as in Cincinnati, Seattle, and San Antonio.

These days the average tenant of both Invitation Homes and American Homes 4 Rent earns more than $100,000. Bruce McNeilage, who builds rental houses around Nashville and other southeastern cities and, once occupied, usually sells the properties to bigger landlords, said his typical tenants are six-figure earners, too. “I can’t think of anyone we’ve rented to recently who didn’t make $100,000,” he told me while we toured a neighborhood of thirty houses he was building south of Nashville with well-heeled renters in mind.

The houses were outfitted with dark hardwood floors, powerful ceiling fans, tile trim in the bathrooms, a kitchen full of granite and stainless steel. There wasn’t anything to suggest the house was a rental. They leased for about $1,800 a month and McNeilage was having no trouble filling them.

The houses were just up a hill from an elementary school in a corner of Middle Tennessee that had been recently opened to subur­ban development by a new outer beltway. McNeilage envisioned bathrobed parents sipping coffee and watching from their kitchen windows or back porches as their children ambled down the hill to school.

Renting to the relatively well-to-do is an enticing proposition for a landlord. They can afford a lot more rent and they’re usually more consistent in paying it than lower earners. A sick child or car troubles don’t cost them hours at work and income. Neither does a pandemic. High earners also tend to stay put, willing to absorb regular rent hikes if it means not having to move their children to new schools.

“Very early in this business, we figured out that the cost to replace the HVAC unit is, for the most part, the same on a $1,200 or $1,300 rental as it is on an $1,800 or $1,900 rental,” Tanner, Invitation Homes’ CEO, once told investors.

There are a lot of reasons for the surge in high-earning renters. Some aren’t buying because they can’t afford it. They have too much debt, usually thanks to student loans. They lack savings for a down payment. The houses in the booming cities where they can find good jobs might be too expensive even for people considered well-off.

Others aren’t buying by choice. They lack faith that their employment will last or don’t believe that the run-up in home prices is sustainable. Some don’t want to be tied down with a mortgage. Many aren’t wedded to the notion of ownership the same way as earlier generations.

Rental investors are giddy with the idea of high-earning, cash-poor, sharing-economy-steeped millennials making babies and alight­ing to the suburbs in search of nice schools and granite countertops. Many of these people will appreciate that they can live in a well-maintained, family-sized suburban home and send their children to good public schools without committing to decades of mortgage payments, tying up their savings in down payments, or risking entrapment in another market collapse. By renting, though, they forsake the method through which most Americans build wealth.

Last decade’s housing crisis threatens a more lasting and far-reaching impact on American society than other historic market meltdowns because the previous crashes have generally been in the stock market and share prices mostly affect the rich. The behavior of voters and consumers might be swayed by the direction of stock prices, but most people don’t own much in the way of equities. When the masses suffer following a stock market crash, it’s usually because of the knock-on effects of recession, such as job loss or lessened access to credit, not because their tech stocks lost 40 percent. The housing crash, on the other hand, delivered a direct hit to the middle class, widening the wealth gap in America.

Home-price appreciation has historically been how Americans achieve financial prosperity. A recent study of consumer survey data from the University of Michigan going back to the late 1940s found that rising home values fueled the surge in middle-class wealth after World War II. Unlike stocks and bonds, houses are widely held. Roughly half of housing wealth is owned by America’s middle class, according to the researchers at Germany’s University of Bonn who wrote the paper.

Family Values

Invitation Homes and its rivals kept buying even after the flood of foreclosures subsided, using house-hunting computers to find ideal rentals in targeted neighborhoods within moments of their hitting the market.

In April 2017, a real estate agent named Don Nugent listed a three-bedroom, two-bathroom home for sale in Spring Hill, Tennessee. It sat on a cul-de-sac at the northern edge of town. The house was built in 1997 and had a gable roof, an attached two-car garage, and his-and-hers sinks in the master bathroom. The owners bought it four years earlier for $160,000. They needed to move to another state and want­ed a quick sale. That wouldn’t be a problem.

The market in Spring Hill was red-hot. The economy around Nashville was one of the fastest growing in the country. Job seekers were streaming into Middle Tennessee, and the good schools, relative­ly affordable housing, and a new third shift at the GM plant led many to settle in Spring Hill. Builders raced to plat new subdivisions, but after being idled during the crash, they were well behind the influx of people. Houses sold hours after hitting the market.

Nugent hardly had time to pound the sign into the yard before he started fielding offers. The sellers had four to weigh within a few hours. The high bid of $208,000 came from a couple with a child looking for their first house. American Homes 4 Rent matched their offer, all cash.

Unlike the family, the company didn’t need to borrow a penny to buy the house. That erased the risk of a low appraisal or some lending hang-up derailing the sale. The company would do its own inspections, saving the seller time and big expenses. It wouldn’t fuss over scuffed floors or ugly paint since it would be renovating the house, using the same paint colors, flooring, and appliances as those in its hundreds of other houses around Spring Hill. It could close sales as soon as the seller desired.

Nugent had sold other houses to American Homes 4 Rent, which was founded by billionaire self-storage magnate B. Wayne Hughes and financed with Alaskan oil money. The sales agent lamented steering this latest house from a family that seemed to really want it. But it was his duty to get the best deal possible for the sellers. For clients in a rush to sell, the company’s offer was too good to pass up.

Twelve hours after the sixteen-hundred-square-foot house hit the market, American Homes 4 Rent signed a contract to buy it. The house was the seventh that it had bought on that short, curbless street and one of twenty-six hundred or so it had accumulated around Nashville. About a month later, the house was back on the market. This time it was for rent, for $1,575 a month.

The family whom American Homes 4 Rent beat out for the house was precisely the type of tenant that the company was hoping would lease it: parents who, for the sake of their children’s education and social lives, were likely to rent for years without interruption.

“We decided the most stable tenant would be the family,” Hughes told the trustees of Alaska’s state oil fund on a trip to Juneau to update them on their investment in his company.

“Some of you have had children, I’m sure,” Hughes said. “They don’t ever want to move.”

Rentership Society and Its Discontents

It’s an old idea in economics that landlords have the most to gain over the long run. During economic expansion, production of most goods rises. Scarcity relative to other assets pushes up the price of property as well as the cost of renting it. The influential economist David Ricardo outlined this in 1817. His worry was that landlords would amass a growing share of income and wealth. Ricardo didn’t have the data back then, but his assessment was prescient.

Between 1970 and 2010, housing wealth accounted for about two-thirds of the increase in the U.S. wealth-to-income ratio, according to economists Thomas Piketty and Gabriel Zucman. They found even greater proportions of wealth created by home-price appreciation in other developed countries, such as Canada and the United Kingdom.

It was thanks to rising home prices that the U.S. middle class was able to hang on to its share of the country’s overall wealth in the decades following World War II, despite losing major ground to the wealthiest Americans in terms of income, University of Bonn researchers Moritz Kuhn, Moritz Schularick, and Ulrike I. Steins wrote in a 2018 paper. The wealth of the bottom half of wage earners doubled between 1971 and 2007 despite incomes that were stagnant once adjusted for inflation, they found.

Wealth gains for the middle class also basically doubled even though inflation-adjusted wages rose by less than 40 percent. Most Americans weren’t really making any more money at work. They were richer because they owned homes that rose in value. “It is conceivable that these large wealth gains for the middle and lower middle class helped to dispel discontent about stagnant incomes for some time,” the German researchers wrote.

The housing crash wiped away a lot of that wealth, though, and with it some social tranquility. A lot of people never regained their economic footing. The median household earning $63,179 in 2018 couldn’t afford the median-priced home in very many American cities—even on the off chance they manage to save a 20 percent down payment while paying ever-rising rent. Yet the rich, whose wealth is concentrated in the stock market and corporate equity, rode the rebounding economy to new heights, producing what the Bonn researchers described as “the largest spike in wealth inequality in postwar American history.”

The lack of home equity is already showing. Those born in the 1970s, who were just starting out as homeowners when the crash hit, have much lower inflation-adjusted median net worth (about $47,000) than their elders, according to a 2016 study by John Burns Real Estate Consulting. At the same age, those born in the fifties or sixties were worth about $79,000 and $86,000, respectively.

Younger people don’t appear to be in a much better position to pursue homeownership. The median income of young adults, those aged twenty-five to thirty-four, declined at a rate of about 1 percent a year between 2000 and 2013, according to John Burns. Nearly one in five people born in the 1980s lives below the poverty line, which is the highest percentage for any cohort since the people born in the 1930s amid the dust bowl and soup lines of the Great Depression.

One of the levers that federal policy makers have pulled in hopes of preventing another depression during the pandemic has been to keep borrowing costs historically low. Mortgage rates around 3 percent have helped a lot of Americans become homeowners since the lockdowns started, but buying is getting harder.

The number of for-sale properties relative to the number of U.S. households hasn’t been so low in at least four decades. Home prices are shooting up in nearly every corner of the country, subsuming interest savings. For those priced out or wary of paying too much, Wall Street is waiting.

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