How Wall Street is Ruining the Housing Market

Is Wall Street causing the end of the American dream? When most people think of Wall Street, they probably think about the buying and selling of things like stocks, bonds, and commodities. Well, it's time people started adding something else to that list: houses.

In recent years, huge Wall Street firms have dove head first into the American housing market. These include some of the most elite Wall Street institutions, like Blackstone and JP Morgan. So in this video, we're going to analyze Wall Street's impact on the U.S. housing market, why rich investors want to own your house, and if this really is the end of the American dream of home ownership as we know it.

But first, make sure to subscribe to the channel because our community is approaching 200,000 people strong. It's my goal to make you the smartest person in your friend group. Now, let's get into the video.

People have been making money in real estate for centuries. Corporations owning real estate is also not something new. To really understand Wall Street's influence on the housing market, you first have to understand the different types of real estate. The real estate market is separated by property type. We have office, which is leased out to companies for their employees to use as a place to work.

We also have industrial, which includes properties like warehouses and distribution centers. There's also multi-family, which are apartment complexes. Historically, corporations and large investors have dominated these different types of real estate. However, there was one type of real estate that these big investors tended to stay away from: single-family houses.

This property type is what people picture when they think of the word "house": a single-unit dwelling with one owner, no shared walls, and its own land. There is one huge reason why big investors have historically stayed away from investing in single-family houses; it has to do with a concept known as scalability.

Let me explain what I mean. Most big real estate investors are organized in a structure referred to as a fund. This means that these investment companies pool money together from many different groups: insurance companies, university endowments, pension funds, governments, and even wealthy individuals. That fund then goes out and buys real estate with the ultimate goal of making a profit.

That profit is then split between the people and the groups that contributed the money, and the investment company that did the work of finding the real estate to buy. For every dollar of profit that the fund makes, seventy percent of that may go to the people that put up the money, while the remaining thirty percent might go to the managers of the fund.

This profit split arrangement incentivizes the fund to grow as large as possible, even if that means lower investment returns. So, let's say we have two funds: Fund A, that is 100 million dollars in size, and Fund B, that is one billion dollars. Each fund has the same profit-sharing arrangement: seventy percent of the profits go to the investor and the remaining thirty percent goes to the fund managers.

In this example, let's say Fund A generates a profit of 20 million dollars for its investors. That means that the fund manager's thirty percent split comes out to six million dollars; not a bad payday by any means. Now on to Fund B: let's say that Fund B is only able to generate a ten percent return, half of the twenty percent return Fund A was able to generate. That ten percent return on the one billion dollar fund equates to a hundred million dollars in investment profits.

That thirty percent split the fund manager gets is a whopping thirty million dollars, despite generating only half of the percentage return as Fund A. Fund B's managers made five times more money. Now, all of this to say that fund managers have been incentivized to have as large of a fund as possible, even if that means settling for slightly lower returns.

This dynamic is a big part of the reason why real estate investment funds have historically stayed away from investing in single-family houses. The math behind this is simple. If you are a fund with a hundred million dollars to invest, it would only take you five properties if you were to buy twenty million dollar office buildings. But if instead you're buying one hundred thousand dollar houses, you would have to buy one thousand of them to invest all of that money.

It's a lot more work to have to buy a thousand houses compared to just five office buildings. It is also much more challenging and costly to manage the thousand properties while the investment fund owns them. While the returns on a percentage basis that single-family houses could generate may be attractive, it just doesn't make sense for these investment funds to go through the effort of having to buy a hundred houses for each large apartment building they could buy.

Instead, this is why most investors in single-family houses have historically been the so-called mom-and-pop investors or individuals who own just a few properties. These mom-and-pop investors didn't have to invest hundreds of millions or billions of dollars; they just wanted a way to grow their savings from their job or small business or invest in something besides the stock market.

Large institutional investors were perfectly happy letting the mom-and-pop landlords dominate the single-family rental market. That has changed, though. Houses aren't the only place Wall Street is putting its money. The investment bank Goldman Sachs has come out and said that the ideal allocation for stocks has dropped from sixty percent to around forty-five percent. What do they recommend you do with the difference? Invest in real assets.

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Now, back to the video. There are four big factors at play that are causing large Wall Street firms to want to buy up every house that they can get their hands on. The first reason is that single-family houses are now viewed as an attractive investment. The roots of Wall Street's interest in the single-family rental market date back to the aftermath of the great financial crisis.

After the housing bubble burst, there was a wave of houses that got foreclosed on and hit the market. At the same time, there was a huge spike in rental demand from the displaced former homeowners. This combination created a tantalizing opportunity that Wall Street simply could not pass up.

In 2012 and 2013, investment firms began to buy up single-family homes that were in foreclosure, many of them in bulk directly from banks. Leading the way was Invitation Homes, at the time a subsidiary of Blackstone, a large private equity firm. In 2012, Invitation Homes spent four billion dollars to buy 24,000 single-family homes, becoming the largest buyer of homes for rent in the U.S. virtually overnight.

These Wall Street firms were able to buy these foreclosed houses at just a fraction of what they had been selling for just a few years ago. Also, many of these properties were actually able to be bought at prices below what is referred to in the real estate industry as replacement cost. Replacement cost is what it would cost someone to buy the land and build the exact same house from the ground up.

In markets that were hit especially hard, Wall Street investors could purchase a house for, let's say, one hundred thousand dollars that had just cost two hundred and fifty thousand dollars to build a couple of years ago. When you're buying properties at this type of a discount, it's virtually impossible to lose money.

The second reason is that demand for single-family rentals increased. I touched on this a little earlier, but while Wall Street was scooping up these foreclosed houses by the tens of thousands, there was a new trend emerging: an increased demand for single-family rentals. Prior to the last decade, if you wanted a place to rent, you had a few typical options.

You could rent an apartment at a large apartment complex—these were typically one or two-bedroom units. You could rent a unit at a small multi-family residential property; these properties have two to four units and are called duplexes, triplexes, and quadplexes, respectively. These properties tended to be larger spaces than apartments and more closely resembled single-family houses.

However, you still had a neighboring unit that was connected to the side, above, or below yours. The other option you would have would be to rent a single-family house. However, these houses tended to not be in the best condition or in the best area of town. This is because the houses that were in the more desirable parts of town were owned almost exclusively by owner-occupants—people that own the house they live in.

However, the great financial crisis started a trend of more people wanting to rent nice single-family houses in the most desirable neighborhoods. People wanted to rent large, nice houses with large backyards and good school districts. Importantly for investors, these renters were willing to pay up for these properties.

As house prices recovered dramatically after the collapse, people were priced out of buying these types of property. Since they couldn't buy the property themselves, their only option was to rent if they wanted to live in these desirable properties.

Now that we have a better understanding of the trends that have caused Wall Street investors to start buying up houses, I want to touch on the reason why these trends have accelerated dramatically over the past couple of years. There are really two big drivers of that. One reason is low interest rates.

Investors who want safe and steady returns tend to buy what are referred to as U.S. Treasury bonds. This is essentially where a person or corporation lends money to the U.S. government in exchange for interest payments. Until very recently, the interest payments on those treasury bonds were extremely low. For example, if you bought a 10-year treasury bond—essentially loaning the government money for 10 years—back in the summer of 2020, your annual interest on that would have only been 0.5 percent.

Yes, that is right, half of one percent. The returns from investing in treasury bonds were lower than the rate of inflation. This means that investors were actually losing money after factoring in inflation. Because interest rates were so low, the returns that investors could generate from most safe investments were virtually nothing.

This sparked what is called a search for yield among investors. Big investors like pension funds wanted to find a relatively safe investment that could generate at least some sort of return. This meant getting creative and looking in some places that, for the most part, large institutional investors had previously ignored.

This is where single-family housing enters the mix. Wall Street firms saw how successful firms like Blackstone and Invitation Homes were in the single-family rental market and decided to give it a try. The way real estate investors think about analyzing a deal is based on what is called the cap rate.

The math behind calculating a cap rate is simple: you just take the property's net operating income, or NOI for short, and divide it by the purchase price of the property. Net operating income is just a fancy way of saying profit. It is calculated by taking the rent you receive in a year from that property and subtracting out the expenses involved in managing and maintaining it—things like maintenance, property taxes, insurance, and paying someone to manage the property for you.

Let's say a house rents for three thousand dollars a month. That comes out to thirty-six thousand dollars a year; that is your income. So in this example, the expenses associated with maintaining and managing the property are nine thousand a year. Subtracting the expenses from the income gets you the net operating income of the property: twenty-five thousand dollars. In this example, assuming this property is valued at five hundred thousand dollars, the cap rate on this property is five percent, calculated by dividing the NOI of the property by its value.

Now think of the cap rate as what an investor's annual return would be if they purchased the house in cash, and not factoring in any increase in home value. If you're the manager of a pension fund and have the choice between investing in a government bond at a 0.5 percent annual return or a single-family house at five percent, it's easy to see why these large investors have such a desire to buy up as many single-family houses as they can get their hands on.

The five percent return in this example assumes the investor purchased the property completely in cash using no debt. That's rarely the case. These large investors use large amounts of debt when purchasing these properties. This debt helps boost the returns they generate, so instead of generating a five percent return after using debt, these returns can jump over to ten percent. This makes buying these single-family houses an even more attractive option compared to alternatives.

So we have covered why it makes financial sense for these Wall Street firms to be buying up houses, but there is still one area we haven't covered: the scalability issue that prevented big-time investors from entering the single-family space in the first place. Yes, it is still more challenging to manage a hundred houses spread out across the city as compared to one hundred units that are all part of the same apartment complex.

However, technology and software have made managing a sprawling portfolio of single-family houses much easier and less costly. Take the process of a landlord finding a new tenant for one of his properties as an example. It used to be that if you were a landlord, you or an employee of yours had to get in a car and meet each potential tenant at the property.

This is very time-consuming, especially if you own properties all throughout a large metropolitan area. Now technology and software have enabled something called self-showing. This is where tenants are able to tour a property they are interested in renting without an employee of the landlord physically meeting them at the house. Instead, the employee provides the tenant with a code that they enter at the front door that gives them access to the property.

It's pretty easy to see how this will save the landlord a ton of time and money. This is just one example of how technology has enabled Wall Street landlords to be able to grow and manage a massive collection of houses.

Wall Street buying houses has gotten a ton of attention. However, these large investment firms are only buying a very small percentage of the houses bought and sold in any given year across the U.S. However, for all the reasons we talked about, I think it's fair to say that the influence of large institutional investors in the U.S. housing market is only going to grow.

The massive size of these companies provides them with advantages that are extremely hard for the mom-and-pop landlords to compete with. At this point, it looks like the only thing that could slow down or stop Wall Street investors from continuing to buy up houses would be government legislation. This has already happened in Canada; in April of 2022, Canada announced that the country is banning foreign investors from buying houses for two years in an attempt to cool off one of the hottest housing markets in the world.

It wouldn't surprise me if at some point the United States government attempts to take similar measures. So there you have it! Make sure to like this video and subscribe to the channel because it's my goal to make you a better investor by studying the world's greatest investors. If you enjoyed this video, make sure to check out the video here on how Airbnb could crash the U.S. housing market. It has gotten over 200,000 views in just a matter of days, so I'm sure you'll like it too. Talk to you again soon!