An Institutional Homebuyer Lost $200 Million. What Happens next?
Lessons and implications from VineBrook
Investing in residential rentals has been big business over the past few years. Fueled by historically low interest rates, investors large and small went on a buying spree from 2020-2022. This was bolstered by a generally healthy economy despite the global pandemic (even if today the vibes are off), and a lack of housing inventory that pushed both homes values and rents higher. The inventory challenge can be traced to both a period of under-building from 2008-2012 that the housing market never really recovered from, and the lock-in effect of current homeowners staying put rather than give up 3.00% mortgages (or better) to buy into a higher priced market with an interest rate of 7.00% of more. It has added up to appreciating home values and rising rents, which is, of course, a pretty healthy formula for profitability to the investor.
But now some of these buyers who were particularly active during the boom years are starting to struggle. The reasons are many and I plan to come back to them in a 2024 rental market preview article in the coming weeks, so stay tuned for that. For today, however, I wanted to bore in on one particularly notable example of an institutional buyer that is now losing money hand over fist and has started to liquidate a large portion of its real estate portfolio, and that is the case of VineBrook Homes.
The VineBrook Story
VineBrook Homes is an Ohio and Texas-based real estate company that specializes in acquiring and renting out single family homes. They are particularly active in mid-sized mid-western cities including Dayton, Cincinnati, and Indianapolis. Established in 2007, VineBrook grew rapidly from the late 2010s onward, including an acquisition of 951 homes in a single transaction in 2019. By the start of 2023 the company owned and managed a portfolio of over 27,000 homes.
Then the problems started. Complaints about poor management and bad living conditions mounted. Deferred maintenance caught up to the company in a time when construction and labor costs were also soaring. And much of the company’s debt has carried floating rates, which in an environment of rapidly rising interest rates was most unfortunate indeed.
In many of the communities where VineBrook operates, local officials began crying foul because of concerns from citizens about poor living conditions and non-responsive management. The City of Cincinnati actually sued VineBrook earlier this year, citing “claims of public nuisance, civil conspiracy, and intentional, repeated violations of both the Ohio Landlord Tenant Act and Cincinnati Municipal Code.” At the time, VineBrook owned approximately 950 homes in Cincinnati.
The Financial Loss
Amid this storm of variables, VineBrook is now facing a liquidity crisis. As a real estate investment trust, the company is required to file disclosures with the SEC. In its most recent filing report, VineBrook noted:
The Company has significant debt obligations coming due [on its portfolio] within 12 months of the issuance of the financial statements and does not have sufficient liquidity as of the issuance date to satisfy these obligations. In order to satisfy obligations as they mature, management intends to evaluate its options and may seek to: (i) make partial loan pay downs, (ii) utilize extension options contractually available under existing debt instruments, (iii) refinance certain debt instruments, (iv) obtain additional capital through equity and/or debt financings, (v) sell homes from its portfolio and pay down debt balances with the net sale proceeds, (vi) modify operations and (vii) employ some combination of (i) - (vi).
In other words, VineBrook does not have enough money to pay its debts and now needs to figure out what to do. And the problem gets worse: not only does the company lack cash flow to pay its loans, but VineBrook actually took a loss of $213.7 million through the first nine months of the year, a staggering figure for a company with such a significant real estate portfolio.
In order to meet its debt obligations, the company must ponder and execute several possible actions including selling off parts of its portfolio, which it now appears to be doing. One such place where VineBrook is liquidating is in Milwaukee. According to the Milwaukee Journal Sentinel, VineBrook bought up 1,000 properties in the city from 2019 onward, which made it the community’s largest single-family landlord. But now VineBrook is selling many of those homes. In fact, according to data from Lance Lambert of ResiClub, 31% of all homes for sale in Milwaukee right now are VineBrook homes. VineBrook is also actively selling in Pittsburgh, St. Louis, Dayton, and Cincinnati (on the heels of the City’s lawsuit).
What It All Means
There is not really data yet to support the notion that institutional homeowners are broadly selling, but there are these anecdotal examples like VineBrook. The positive thing for the company at this point is that the market for sellers is still very good. It is likely, in fact, that VineBrook will not have to take major losses on these transactions because current sale prices are still so solid (other than transaction costs can be significant when selling off so many homes at the same time, especially since many of these homes were bought only within the last few years, and if there are major deferred maintenance issues those could impact prices). All in all, it has the look of a fire sale, but without the significant drop in prices. Not bad for a forced sale.
The problem for VineBrook and entities like it and really for any property owners who might be compelled to sell, is what happens if prices drop substantially in the months or years ahead. In that scenario, a rental property owner (whether large or small) could suffer from the same cash-flow challenges as VineBrook plus have the potential of needing to sell at a loss in a down market. Hopefully in that situation sellers can at least sell for enough to pay off their debts, but highly leveraged borrowers who owe substantial amounts on specific properties or groups of properties may be playing with fire. This is one of the reasons why banks only lend 75% or 80% loan-to-value against real estate; if the bank has to foreclose, they just want to get their money back, and only lending 75% or 80% against the property’s value at the outset is one way to mitigate against a decline in the value of that property; if the bank needs to foreclose but the property value is down by 20%, the bank is still likely going to be whole.
As noted above, VineBrook owned over 27,000 homes at the start of the year. It now appears they own closer to 22,000 after selling some off with more sales to come. Even though they are operating on a much different scale from your regular local real estate investor, there are some key lessons that the smaller investor can take from the VineBrook challenges:
Don’t get over-leveraged. Guard against letting the debt obligations on a property outpace the income from it.
There will always be unexpected costs. Deferred maintenance, unexpected repairs, utility work: it can all get very expensive. The pro forma for a property acquisition showing typical income and expenses may look pretty rosy, but you have to always be mindful of a $15,000 boiler replacement or a $25,000 roof repair that can wipe out a year’s worth of net cash flow all at once. I am reminded of one of my favorite Ben Franklin quotes, “Beware of little expenses. A small leak can will sink a big ship.”
Expenses inflate. Repairs are expensive, but so too is insurance, property taxes, utilities, etc. Lately those things are inflating faster than rents, which tightens the margins for sure.
Be mindful of variable rate debt. At this point if you are borrowing today, it may actually make sense to go variable as there is more downside potential in rates than upside, but if you have existing debt with a floating rate component to it, which is the case on most commercial debt including for a lot of rental properties, plan ahead for the end of your fixed-rate periods and calculate ahead of time the impact on cash flow when a loan goes variable. For many borrowers, the math is going to be painful and they should be planning ahead. Sometimes this may involve planning to sell.
To be sure, there are many other institutional homeowners out there as well as mom and pop-types who are not struggling right now. It has been a good few years for real estate investors thanks to rising values and rising rents. There are not waves of selling taking place, at least not yet. But this is, in fact, a pretty good time to sell. Buyers are more cautious and more calculating and many are simply sitting things out as they wait for interest rates (and maybe prices) to ease back down, but there are still buyers out there for sure. If you are a real estate owner concerned about the next few years, thinking about selling while the selling is good is not necessarily a bad thought.
Ben Sprague lives and works in Bangor, Maine as a Senior V.P./Commercial Lending Officer for Damariscotta-based First National Bank. He previously worked as an investment advisor and graduated from Harvard University in 2006. Ben can be reached at ben.sprague@thefirst.com or bsprague1@gmail.com.
This is a busy time of year so I wasn’t able to put together a Weekly Round-Up this week. I hope everyone is having a happy and peaceful holiday season. Happy Hanukkah to our Jewish friends. See you next week!