Publications

- July 1, 2019: Vol. 6, Number 7

Block by block: Single-family rentals offer steady performance and improving operating efficiencies, despite a fragmented investor market

by Beth Mattson-Teig

Opportunistic investors that raced into the single-family rental market a decade ago on the heels of the housing crash are finding the story has changed. Now, instead of bargain-basement prices, the sector boasts improved operating efficiencies that are helping to generate steady yields and attract capital with longer-term strategies.

Evolution of the sector has brought more transparency, with performance metrics that show a solid track record of favorable occupancies, rent growth and operating margins. More institutions are now stepping into this highly fragmented market, which appears to have a fairly strong tailwind for renter demand. “All bets are off if the economy hits a recession and capital dries up, but under the current scenario, there is still plenty of capital looking to invest in this sector,” says John Pawlowski, a senior analyst at Green Street Advisors.

Institutional investors make up a tiny fraction of the single-family rental market. According to Invitation Homes, of the roughly 16 million rental homes that are currently operated as rental properties, less than 2 percent — about 250,000 to 300,000 homes — are owned by institutional investors. Invitation Homes and American Homes 4 Rent are the two largest REITs in the market. Combined, they own more than 130,000 homes. Other big ownership groups that are committing capital to the space include Tricon American Homes, Progress Residential, and FirstKey Homes, which was formed by Cerberus Capital Management in 2015.

Tricon Capital Group, for example, made a big move into the sector in 2008, with news that it had launched a $750 million joint venture with two large institutional investors. Tricon American Homes is in charge of acquiring and managing the properties. The firm is actively buying in 12 markets across the Sun Belt, with a goal of amassing a portfolio of 10,000 to 12,000 homes that is expected to be valued at about $2 billion, including associated leverage.

“We just think that rental housing is a terrific asset class. It has performed so well for institutional investors, both public and private, over decades, and we see single-family rentals fitting right into that mold,” says Gary Berman, president and CEO of Tricon Capital Group. What has really opened up single-family rental to institutional investors is technology. “All of the things that power Amazon and Uber have essentially made single-family rentals possible to do as a scale business,” he says.

OPERATORS FIGURE OUT EFFICIENCIES

One of the biggest concerns institutions had when this sector first started to emerge is this was a property type that was not going to be easy to manage and operate, notes Sandeep Bordia, head of research and analytics at Amherst Capital. It is one thing to manage an apartment building with 200 apartment units, but it is a very different thing to manage 200 single-family homes that are more widely dispersed across a geographic area. “That is one of the reasons why some investors were less keen on this asset class in 2011 and 2012,” says Bordia.

Operators have brought in more technology, however, and concentrated portfolios in markets and regions. “Institutions have learned new and better ways of managing these portfolios over the last several years,” says Bordia. Amherst Residential has been an active buyer of single-family rental properties, acquiring more than 23,000 homes since 2012. The company has said its target goal is to purchase an additional 10,000 single-family rental homes by the end of 2019.

Growth in the sector, along with data from public companies, shows it is possible to operate these properties in an institutional manner with net operating margins that are reasonably attractive. In 2011 and 2012, for example, net operating margins were in the low to mid-50s and are now in the low to mid-60s, says Bordia. “So, a lot of institutions have gotten more comfortable with the idea that this is not just a trade to go out and buy on the cheap; you can manage these homes and create a business that generates steady income over the years,” he says.

Tricon is leveraging technology to create efficiencies both in managing and acquiring assets. One example is the company has created its own proprietary acquisition software that automates the acquisition process, which to date has focused primarily on buying single properties on a one-off basis.

To screen MLS systems for viable properties, the system uses an algorithm that includes 90 different variables, including home price, number of bedrooms, local school district and crime scores. “Ultimately, we’re trying to solve for a specific yield,” says Berman. Tricon’s target is to acquire assets that underwrite at 5.96 percent or better. On average, Tricon is buying between 700 and 900 homes each quarter, and expects to have a portfolio of about 5,000 homes by the end of the year.

TAPPING A STRONG RENTER POOL

Institutions also are attracted to the strong demand for rental housing. According to data from CoreLogic, single-family rental-rate growth appears to have stabilized at about 3 percent. CoreLogic credits the low rental-home inventory relative to demand as a key factor contributing to rent growth. The company analyzes single-family rent-price changes in 20 metro areas across the country.

Although single-family rental properties do see demand from a diverse renter pool, the properties appeal to an older demographic as compared with apartments. The typical renter on the single-family rental side tends to be in their 40s, the head of the household with children in school. “Once people move in and get entrenched in a community, they are much more likely to stay in the property for longer,” says Bordia.

Generally, retention rates are very high, and turnover rates are very low in single-family rentals. According to Invitation Homes, residents stay in its homes about twice as long as a typical resident in an apartment. The REIT also sees strong demand ahead as millennials begin to transition from apartment living to single-family-home living. The biggest demographic cohort right now is age 25 to 34, which is usually about the time that people start to get married, have children and need more living space.

In addition, today’s 30-something cohort is more heavily burdened with debt from student loans, credit cards and auto loans. Consumer behavior and preferences also have shifted post-recession to more of a “lock and leave” mentality, adds Michael Finch, a principal, founder and executive vice president of SVN | SFRhub Advisors, a dedicated single-family rental and build-for-rent brokerage firm.

In some cases, renters are willing to pay more to rent for the sake of convenience — they don’t have to worry about home repairs. Or if they get a new job, they can easily pick up and move across town, or across the country. It is a much more transient world these days, whether because consumers are unable to afford a down payment or prefer a more flexible lifestyle, says Finch. “From the three biggest age demographics in this country, we are seeing a huge shift to choosing to rent, and it doesn’t have the stigma that it once had,” he says.

INVESTORS WORK HARDER TO FIND DEALS

One of the biggest challenges for investors today is growing portfolios in an increasingly competitive investment market. Distressed buying opportunities have continued to disappear. According to Attom Data Solutions, U.S. foreclosure filings during first quarter dropped 15 percent over the prior year to 161,875 — the lowest level since first quarter 2008.

“There is still plenty of inventory out there; that’s not the issue. It’s more the price and going-in yield that is the negating factor in external growth right now,” says Pawlowski.

Yields are being squeezed due to the rise in home prices, agrees Finch. “It is a little harder to find the right deal, just because values have gone up. So you do have to be a little bit smarter and more strategic in your acquisitions.” Some investors have pushed into secondary markets and more workforce-housing markets, such as Kansas City, Mo.; Louisville, Ky.; and Columbus, Ohio, in search of higher yields, he adds.

Despite the fact we have seen a pretty strong recovery of home prices, it is important to note all of the reasons that single-family rentals did well initially — demographics, renter preferences, financials — remain firmly in place, notes Bordia. Even though home prices have gone up, they have not increased as much as values have risen in other property types or even equities. Multifamily properties, for example, are about 50 percent higher today versus the peak in 2006 to 2007, as compared with single-family homes, which are only 5 percent to 10 percent higher, notes Bordia. So, relatively speaking, single-family rentals are still attractively priced.

GROWING BUILD-FOR-RENT MARKET

Rising home prices and increased competition for existing homes are pushing investors to look at new construction. “The build-for-rent market is really in its infancy right now. On a weekly basis, we are talking with new capital groups — private equity firms, family offices, traditional multifamily buyers — that are all trying to learn and understand the space,” says Finch.

Some developers are constructing purpose-built rental neighborhoods, while others are selling off some homes within new subdivisions to investors for use as rentals. Dallas-based Bridge Tower Group has grown its single-family rental portfolio to more than 1,500 properties since first entering the sector in 2013. Although the firm continues to find good opportunities to buy existing assets and operating portfolios, the majority of its focus has shifted to development of purpose-built single-family rentals.

The company is in the process of completing the 175-home build-for-rent Brooklyn Village subdivision in the Dallas suburb of Forney, Texas. Homes in Brooklyn Village are typically three to four bedrooms and 1,750 square feet, and rent for about $1,800. They also have a second 175-unit subdivision that is starting to deliver its first homes in suburban Houston.

All of Bridge Tower’s homes are designed for the starter-home buyer, with the same features and finishes that go into a typical for-sale home, such as granite countertops and upgraded fixtures. “We want to build to the same standard and quality because it also helps us to value the house higher, and in case we need to de-risk at some point, we are able to more easily sell the product,” says Jackson Su, managing partner at Bridge Tower Group. Bridge Tower’s portfolio is at 99 percent occupancy, with steady rent growth of 2 percent to 3 percent.

One notable change ahead is Freddie Mac has agreed to provide agency financing on all self-contained build-to-rent communities. Once a community is built and leased, and has a trailing history of three months showing 90 percent occupancy, its owners will be able to use traditional multifamily paper on that product, which is a huge boon to investors used to using agency debt, says Finch.

“That agency financing hasn’t been available in the build-to-rent space to date, so I think the floodgates are just about to open for investment groups watching the single-family-rental investment market,” he says.

 

Beth Mattson-Teig is a freelance writer based in Minneapolis.

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