Real Estate Investors Run From Housing Market in 2023

In 2023, the real estate market witnessed a significant shift as investors began to retreat. According to data from Redfin, there has been a staggering 49% year-over-year decline in investor home purchases in the first quarter of 2023. This marks the most substantial annual drop in investor demand in the US since records began in 2000. In the counties that Redfin monitors, investors bought 41,000 homes in Q1 2023, a 49% decrease from the previous year and a notable drop from pre-pandemic levels.

Factors Behind the Decline

1. Rising Interest Rates: One of the primary reasons for this decline is the extream surge in interest rates. For years, the Cap Rate (unlevered profit yield from rentals) was higher than the Mortgage Rate, making it profitable for Wall Street investors to borrow money and invest in homes. However, by early 2022, this dynamic changed. The Mortgage Rate rose sharply, surpassing the Cap Rate. By spring 2023, the Mortgage Rate stood at 6.9%, while the Cap Rate was at 4.6%. This shift mean that investors who borrowed money to buy rental homes would incur losses after paying their lenders.

2. Investor Retreat from Sun Belt Markets: The Redfin report highlighted that investors particularly withdrew from the Sun Belt markets they had heavily invested in during 2020 and 2021. Cities like Atlanta, Charlotte, Phoenix, Las Vegas, Nashville, Jacksonville, and Tampa saw declines ranging from 54% to 66%.. These were the markets previously touted as long-term investment hubs due to the influx of people. However, interest rate hikes quickly changed this narrative.

3. Stability in Northeast and Midwest Markets: Interestingly, markets in the Northeast and Midwest, often overlooked in national real estate discussions, experienced the least decline in investor purchases. Cities like Baltimore, Providence, Seattle, Milwaukee, Cleveland, and Cincinnati saw declines between 9% and 25%. These markets are less influenced by Wall Street's investment whims and are more stable due to local investors with a deeper understanding of the area.

Implications for the Future

For potential investors, the focus should now be on the Cap Rate, which indicates the rental profit earned from a property. In the current high-interest-rate environment, cash flow will become the primary success metric. Markets in the Midwest and Deep South offer the highest Cap Rates, while Mountain/West regions and some Northeast markets have the lowest.

The decline in investor purchases could also signal the beginning of a bear market for expensive, low Cap Rate markets, especially in California. These markets might also see reduced demand from regular homebuyers since low cap rates suggest that home prices have risen faster than rents, making renting a more economical option.

Lastly, this decline in investor activity is a win for regular homebuyers, especially in cities like Charlotte, Atlanta, Phoenix, and Jacksonville. However, the housing market remains a challenging place, with high prices and low inventory levels. It's essential to remember that housing changes can take years to play out, and we might just be at the beginning. Author: Jeremy Wilkerson

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