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Hedging On The Real-Estate-Owned-To-Rental Trade

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The first-time homebuyer may finally be awakening

The Great Recession was not kind to the Millennial generation. The biggest challenge was a lousy job market for recent college graduates. Finishing college with a degree, large amounts of student-loan debt, and bleak job prospects forced many young adults to move back home with their parents or take on roommates in a multi-bedroom apartment. You can see this effect in the chart below, with the big decline in household formation starting in 2008. Remember, the Millennial generation is bigger than the Baby Boomers.

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Ironically, many older Millennials were completely priced out of the housing market during the boom days. In one sense, they dodged a bullet, and are not lugging around an underwater home they cannot afford. That said, they were unable to take advantage of the low prices we saw in 2010–2012 because they didn’t have the required down payment, credit history, or debt-to-income ratio to qualify for a mortgage.

To add insult to injury, many hedge funds raised capital to take advantage of the real-estate-owned-to-rental trade, or REO-to-rental trade—buying distressed homes and refurbishing them to be put up for rent. So far, it appears this strategy has not delivered the high single-digit rental yields that were promised investors. At some point, the hedge fund investors may decide to pull the plug on the strategy, which would add to supply on the market.

How did the homebuilders play this?

The REO-to-rental trade primarily involved distressed starter homes. These weren’t McMansions. Many builders such as Toll Brothers (TOL) and NVR (NVR) focused on the luxury segment and didn’t have to worry about supply at the low end. Other builders including D.R. Horton (DHI) and PulteGroup (PHM) have more exposure to the first-time homebuyer. These two companies may end up competing with the hedge-fund selling of rental homes.

An alternate way to invest in the sector would be through the SPDR A&P Homebuilders ETF (XHB).

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