Last week, we broached the possibility that the residential rental real estate market could be forming a bubble. We found it interesting, even if it were only coincidental, that the the Wall Street Journal ran a piece this week on institutions piling into single-family residential rental real estate.

The Journal article featured a private-equity firm, Colony Capital, that has been buying single-family homes, harrisburg pa real estaterefurbishing them, and then renting them. Colony has accumulated 3,600 homes, most purchased out of foreclosure. Business, so far, has been remunerative.

Colony Capital isn't the only institutional player in single-family rentals. According to investment bank Jefferies & Co., big private-equity players Blackstone Group, Och-Ziff Capital Management, and Oaktree Capital have raised more than $8 billion to buy houses, which they plan to refurbish and rent.

This flood of institutional investor money into the single-family rental market is a big reason we are less concerned about distressed shadow inventory than most market observers. A lot of demand has developed to soak up supply. Over time, that supply will continue to dwindle.

The trend in multi-family residential rentals is also revealing. Data from the National Association of Real Estate Investment Trusts (NAREIT) show money flowing freely into this market as well. In fact, REITs that focus on multi-family residential properties have been some of the best performers in the real estate segment over the past year.

The point we want to emphasis is that investors and market watchers should become more alert when markets heat up – and the rental real estate market is certainly heating up. More risk resides in the hot market, because the hot market doesn't stay hot forever. We reported a couple week ago that rents, which have been on a tear the past two years, are already showing signs of slowing. Trulia's data show rents rose 4.7% in August from a year ago, but that growth is lower than the 5.8% year-over-year growth reported in May.

We obviously can't say for sure if a bubble is forming in the residential rental market, but we can say the bullish sentiment is starting to sound like the sentiment that prevailed in the single-family purchase market circa 2004.

There is another reason we should maintain our perspective on rentals: People still prefer to own their own home, which is why we expect to see sustained growth in the owner-occupied market over the next couple years.

Risk aversion is the impediment to more owner-occupied activity. The financial firm Redwood Trust recently issued a private jumbo mortgage-backed security. The security was backed by mortgages with an average FICO score of 771 and a loan-to-value ratio of 67%. Such issues have been the norm in recent years.

We'd like to see more investor interest in more speculative mortgage-backed securities. More interest in more speculative issues would indicate more risk taking by investors and a more liquid, more inclusive lending environment.

Courtesy of Jessica Regan.

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