Chapter 2 Literary Review
2.1 Background
Durham County currently has a population of over 300,000 residents. Since 2000, the population has increased a whopping 50%, two-thirds of which is attributable to the heavy influx of new residents. 85% of the Durham population currently lives in the city of Durham. According to Mayor Steve Schewel, in 2018, the city of Durham saw an influx of 20 new residents every single day. That adds up to approximately 7,000 people each year, which places Durham as the fourth highest city in people moving in, per capita, in North Carolina (Krueger, 2018).
Furthermore, migrants pouring into Durham are on average richer than residents currently living in Durham, especially in the downtown area. The average new resident in Durham makes approximately $13,000 more a year than current residents do (Vaughan, 2018). As more residents pour into the county, and job growth continues to grow, residents have seen a rise in rents, specifically in the Triangle area (Eanes, 2019). Further, apartment occupancy rates are at the highest they have been in the past 20 years, which means tenants have less room to negotiate with their landlords on rental contracts (Eanes, 2019).
To meet this new demand for housing, 4,316 new housing units, including single-family homes, duplexes and apartments were built in 2017, up from 4,015 units in 2016 (Krueger, 2018). As the skyline of Durham continues to change, it is important to understand the types of entities that are investing in the community. My thesis aims to tackle one part of that investigation: specifically, I uncover how the ownership of the county’s multi-family dwellings have changed. As residents and investments continue flooding in, Durham County currently faces one of the highest eviction rates in the country and the state. In the 2015-2016 fiscal year, one eviction case was filed for every twenty-eight Durham County residents, putting Durham County at the highest eviction rate among the ten largest counties in North Carolina (Willets, 2017).
The increases in investment and construction in Durham County in the past decade coupled with the current eviction crisis make it an interesting case study for my thesis. As it stands, there is little research that looks at the systematic changes in ownership of rental properties across our nation’s cities, and its subsequent impact on housing stability. Given the unique position of Durham County as a hot spot for evictions as well as a hub for investment, I contend that it is one of the best places to begin to explore this relationship. The distinct contribution of this paper is to investigate the changes in ownership of Durham’s multi-family rental market between 2000 and 2018 and what it reveals about Durham’s eviction crisis.
2.2 Literary Review
2.2.1 History of Investment in the Rental Market
The subprime meltdown and financial crisis of 2008 led to high rates of foreclosures in the United States, which led to serious imbalances in the housing market. At the core of this imbalance was the excess supply of owner-occupied housing and a very low demand for it, coupled with a heightened demand for renting. There were a number of reasons that these imbalances came to exist. Firstly, there were restraints on mortgage credit following the crisis. Many lending institutions tightened underwriting conditions dramatically, so consumers were unable to secure loans to buy homes. Further, there was an extra reluctance to extend credit to borrowers who actually could meet the underwriting standards currently set by the GSEs, or government-sponsored enterprises, leading to even more reduced levels of lending. Specifically, lending to first time homebuyers dropped precipitously, a demographic which represented an important source of incremental housing demand. Therefore, families that were either unable to or reluctant to purchase homes started entering the rental market in large swaths. Rents started to rise and vacancy rates for multifamily properties were on the decline in most metropolitan areas by 2012 (America’s Rental Housing, 2013).
In 2012, in order to meet the high demand for renting and stabilize the rental market, the Federal Reserve suggested that private equity firms invest in foreclosed homes and turn them into rental properties (Bernanke, 2012). Perhaps to create incentive, Chairman Ben S. Bernanke also stated that REO (real-estate owned) holders would make more money by renting rather than selling their properties (Bernanke, 2012). The geography of the foreclosures coupled with the low price-to-rent-ratios spurred investment mainly in the “Sun Belt” region across the United States, which stretched across the Southeast to the Southwest, including states like California, Texas, Arizona and Georgia. In various cities, such as Las Vegas and Boston, investors were able to channel a tremendous amount of capital into distressed areas, which likely did stabilize – at least in the short-term – occupancy of foreclosed properties in the absence of effective demand by owner‐occupants (Herbert et. al, 2013a). However, the long-term impacts of these new institutional investors on the community were yet to be seen.
The investments made post-financial crisis were not the first-time institutional investors entered the rental market in large numbers. A combination of low stock market returns, low interest rates in the early 2000s, and a tight rental market created a prime opportunity for investment in multifamily rental housing in New York several years before the housing crisis (Fields, 2015). Between 2005 and 2009, private equity funds bought up approximately 100,000 units, which represented around 10 percent of the supply of rent-stabilized housing in New York (Association for Neighborhood and Housing Development (ANHD), 2009). The investors paid extremely inflated prices for these properties, based on appraisals that underestimated operating expenses and overestimated rental income (ANHD, 2009). Thus, the firms were unable to make returns keeping the rents at current levels and began to engage in what advocates later termed, “predatory equity” practices, which included displacing tenants through eviction filings in order to raise rates, or intentionally cutting back on maintenance costs and letting building conditions deteriorate to unlivable conditions (Fields, 2015). These tactics were used with the goal of securing double-digit returns in the rental market (Fields, 2015).
2.2.2 Recent Trends in the Rental Markets
The entry of institutional investors into the rental market continues to grow. Historically, the single-family segment of the rental market has been classified as a “real goods” market, comprised of small investors with small inventories. However, the financial liberalization and changes in housing policies have created market conditions that are favorable to larger investors (Fields & Uffer, 2016; Immergluck, 2013; Herbert et. al, 2013b; Mallach, 2013). According to the Rental Housing Finance Survey conducted in 2015, individual investors are still the biggest group in the rental housing market in 2015, accounting for 74.4 percent, or 16.7 million rental properties (US Census Bureau). However, individual investors owned less than half (47.8 percent) of rental units, since property size tends to be smaller among smaller investors (Lee, 2017). While non-individual investor share in all property sizes has increased since 2001, the most significant increase in their ownership share has been in properties with 5-24 units, where non-individual investors now own 62 percent of these properties compared to 35 percent in 2001. Overall, non-individual investors continue to have a majority share in properties with over 25 units but are a minority in properties with 2-4 units (23 percent), which allows for continued market penetration (Kolomatsky, 2017).
Perhaps, the reason financial institutions are so interested in the rental market is because it is increasingly seen by the financial sector as a new investment opportunity with the potential to yield high returns. Eisfeldt and Demers published a paper in the National Bureau of Economic Research in 2015 that studied the total returns that could be achieved in the single-family rental market, analogizing the dividend yields and capital gains that constitute total equity returns to rental yields and house price appreciation, which they deemed as the two components for rental returns. The researchers then studied how much return could be made in different price tiers and regions of the United States’ single-family rental market (Eisfeldt and Demers, 2015).
Historically, institutional management faced barriers to entry into the real-estate space such as high management costs, risks associated with renters’ vulnerability to economic shocks, and the absence of a track record for structured finance opportunities (Berry, 2000). Fields, in a paper published in 2018 discusses how these barriers have been breached by private equity firms in the past decade and traces the history of the financialization of the rental space (Fields, 2018). This recent research demonstrates the financial sector’s growing interest and view of the rental markets as investment opportunities.
The main reason I expect the behaviors of corporate investors to be different than individual and non-corporate investors lies in their fundamental motivations. Private equity firms typically seek returns of 10-20 percent a year over relatively short investment terms; in contrast to this, real goods markets such as housing have generated moderate profits in the single-digit range (Fields, 2016; Evans & Habbard). This highlights a fundamental discrepancy in the motivations between the usual small investor base in the real estate market and the expectations being placed by new financial players on the housing market.
In the last five years, institutional investors with large portfolios of rental homes have begun financing these portfolios through single-family rental (SFRs) securitizations, which are backed by rent checks from the portfolios of thousands of single-family rentals. In November 2013, the Blackstone Group released the first-ever rated bond backed by securitized rental payments, and since then, numerous firms, including American Homes 4 Rent, have followed with similar security offerings (Gottesdiener, 2017). Even then, tenant advocates voiced concern over the potential future for residents whose homes made up parts of these portfolios, and with reason. According to an article in 2014 from the Los Angeles Times, American Homes 4 Rent expressed they were met with “relatively little resistance” as they began “experimenting this Spring with 4 percent to 5 percent rent hikes on lease renewals” (Logan, 2014).
The financing of portfolios of this size also occur through the capital structure of publicly traded real-estate investment trusts (REITs). The presence of REITs and the number of SFRs have continued to increase in recent years, both of which fundamentally treat renters’ homes as publicly traded financial assets, often without the express knowledge of the tenants. By leveraging their investments in this way, these firms are able to buy higher numbers of properties, which makes them an especially important case to investigate.
Much like the predatory equity practices in New York a decade ago, recent studies have already pointed to the possibility of abusive practices in recent years from institutional investors. In Atlanta, a study on corporate landlords and displacement found that larger investors, defined as those with over 15 single-family properties in the city, were eight percent more likely to evict than other landlords in single-family residences (Raymond et. al, 2016). The study also revealed that areas with high levels of evictions corresponded to predominantly black neighborhoods in the southeast corner of the city. In a paper published in 2016, Fields et. al investigated SFR securitization products and found that among the first 15 securitizations ever offered, only one firm, Invitation Homes, included properties rented to tenants with Section 8 vouchers (Fields et. al, 2016). Taking Section 8 tenants as a proxy for low-income accessibility, this would suggest that low-income tenants may have limited accessibility to rentals owned by these landlords. Finally, distant investor landlords make it more difficult for tenants to hold landlords legally and politically accountable at the local level when they have problems with their living conditions or are being evicted for corrupt reasons (Fields et. al, 2016). Part of the reason for this is that institutions often invest through other investment vehicles such as shell companies, which can make it difficult for tenants to not only reach landlords to solve issues, but to determine who the beneficial owner truly is. This suggests that owners based out-of-state may have a higher likelihood to evict than tenants based in-state.
Recent studies have begun to study the unique strategies institutional investors take to obtain returns on their investments: strategies that often have negative consequences for tenants. Mallach places distressed property investors into four broad categories: rehabbers, flippers, milkers and holders (Mallach, 2010). Rehabbers and flippers refer to investors who intend to make their return by reselling the property, with the main difference being that rehabbers are more focused on investing in necessary capital improvements, while flippers typically put minimal investment before selling the property quickly. On the other hand, milkers and holders do intend to hold the properties but while “milkers” extract high rents with little investment, allowing building conditions to deteriorate, and subsequently dump the property on the market or the municipality, “holders” seek profits through home price appreciation, placing more importance on maintenance, and may keep properties vacant until prices rise (Mallach, 2010).
Researchers have applied Mallach’s framework to numerous case studies conducted in Atlanta, Boston, Las Vegas and Cleveland (Immergluck, 2013; Herbert et. al, 2013b; Mallach, 2013; Ford et. al, 2013). Taken holistically, these case studies show that the type of investor active in and the strategies used will vary based on differences in market opportunities (Fields & Uffer, 2016; Immergluck, 2013; Herbert et. al, 2013; Mallach, 2013; Ford et. al, 2013). In other words, these investors do not restrict their activities to specific regions or markets; rather, they employ unique strategies, as identified by Mallach, depending on the conditions of the city in which they operate, which suggests that their continued entry into rental markets is widespread (Mallack, 2013).
Most of the literature in recent years has been focused on the impacts of changing ownership in the single-family rental market. Little literature, however, has focused on the changing landscape in the ownership of the multi-family rental market. Yet, most of the increases in corporate ownership in the rental space is driven by higher ownership of multi-family rental properties of all sizes (Kolomatsky, 2017). Perhaps, part of the reason that multi-family rental markets remain unexplored is due to the history of the financialization of the rental market. Following the 2008 financial crisis, institutional investors bought up large numbers of foreclosed single-family residences, creating large portfolios that in recent years, investors were able to turn into publicly traded financial instruments. While this similar phenomenon did not take place in the multi-family rental markets, there is evidence to suggest that the multi-family rental markets are also beginning to be viewed as a potential new market to be exploited for profit. Not only has corporate ownership of this space continuously increased, but as of the beginning of 2018, a new financial asset class has been created backed by multi-family rental income.
On September 25, 2018 Freddie Mac priced a new 912 dollar million offering of multifamily mortgage-backed securities, just over a month after it had issued 1 billion dollar offering of the same type of security, on top of the 248 million dollar bond offering backed by multi-family rental income from May 2018 (“Freddie Mac Prices 1 Billion”; “Freddie Mac Prices 912 Million”; “Freddie Mac Prices 248 Million”). At a total capital value of at 2.1 trillion dollars, compared to the 2.5 trillion dollar market of single-family residences, the multi-family rental market is an important real-estate market that should not be ignored.
2.2.3 Housing Stability
Housing instability is difficult to define and even harder to measure. Frederick et. al defines housing stability as “the extent to which an individual’s customary access to housing of reasonable quality is secure” (Frederick et. al, 2014). Housing instability encompasses a number of challenges for residents, including trouble paying rent, overcrowding, and moving frequently (Frederick et. al, 2014). Though many forced moves do not leave paper trails, one quantifiable proxy that has been used to study housing instability is the number of eviction filings in an area (Raymond et. al, 2016). A study conducted by Raymond et. al in Atlanta in 2016 on the relationship between investors and eviction filing rates in single-family rentals found that larger investors are significantly more likely than small landlords to file eviction notices 4. With the changing landscape in the ownership of these large multi-family rental complexes, evictions become a natural proxy for the influence of these owners on housing stability. The body of literature linking evictions to detrimental outcomes for individuals and communities is extensive. For individuals, evictions have been linked to homelessness and material hardship, substandard housing and increased residential instability (Burt, 2001; Desmond, Gershenson, and Kiviat 2015). Evictions have also been tied to higher levels of parenting stress, material hardship and depression in mothers, which can continue for years after the eviction takes place (Desmond and Kimbro, 2015). Furthermore, there is evidence that suggests renters who are evicted are more likely to lose their jobs due to the stressful and time-consuming process that can lead them to miss work (Desmond & Gershenson, 2016). The impacts of evictions are not just felt personally, but also communally. Evidence suggests high residential turnover rates in cities can lead to a loss of social cohesion, opening communities up to violent crime (Morenoff, Sampson, & Raudenbush, 2001; Sampson, Raudenbush, & Earls, 1997).
Even when an eviction does not occur, it is detrimental to the tenant’s feeling of security and stability and can have long-term consequences. Eviction filings alone, regardless of whether they lead to an eviction, become part of the residents’ public record – in their rental or credit history – and can be detrimental when the tenant is forced to look for housing in the future. In Durham, evictions were granted in approximately 50 percent of the cases in 2017 according to an article in a local newspaper (Willets, 2018). Perhaps, it is even more significant when an eviction is ultimately not granted, because this suggests the landlord’s eviction filing was distinctly unwarranted, especially considering the fact that most tenants do not have lawyers. (Willets, 2018).
Since I am interested in the relationship between landlord’s behaviors and housing stability in Durham, the fact that 50 percent of eviction filings are not granted suggests that the eviction filing itself might be used as a bullying tactic. According to lawyers from the Durham Eviction Program, some landlords tell residents they do not need to show up to court, in which case the eviction is automatically granted (Willets, 2018). Other times, tenants simply cannot miss a day at work or risk being fired, so it becomes a question of whether they lose their job or their home. Overall, this suggests that there may be a high number of evictions that are being granted for unjust cause and looking at eviction filings gives us a better picture of the behaviors of landlords when it comes to displacing tenants. In my thesis, I use eviction filings as a proxy for a landlord’s direct impact on the housing instability of tenants.
Large investors were defined as investors that held more than 15 single-family rental properties.↩