With capital shifting from the more challenged office and retail sectors toward residential, investors are increasingly broadening their scope to include different forms of for-rent housing. Yet some wonder whether these new schemes are simply a repackaging of a familiar product, and whether doubling down in this segment creates unwelcome correlations in a downturn.
In a way, it comes as no surprise that investment managers are increasingly shifting focus to all things living. After all, physical space is at its most valuable when it satisfies a critical need — and perhaps no other period in recent memory has put more emphasis on the necessity of home than the pandemic. With residences having evolved to also serve as office, gym and the occasional happy hour spot, residential investments are replacing other property types in diversified real asset portfolios.
While a strategy predicated on following tenant needs is a logical one, some have rightly wondered whether increasing allocations to new iterations of traditional for-rent housing is inadvertently creating concentration risk. Yet a deeper dive into the demographic composition of these renter pools suggests that, at least in the case of traditional multifamily and purpose-built SFR, there is a case to be made for having both in a portfolio, as managers who elect to invest across the living spectrum may have a higher capture rate, retaining tenants through various life stages.
RENTER POOL INTERVALS
It is a generally accepted principle that demographics are one of the most important drivers of residential real estate demand. As such, being able to identify what future generations will want from their spaces is the investing “silver bullet.”
Part of figuring this out is a matter of simple arithmetic. We know to a fair degree how many babies are born each year; plus or minus 18 years later, those young adults will be moving away to expand their horizons at university. A few years later, their professional development will lead them to a city center to pursue their first job and their first urban apartment. Though the subsequent timeline may vary by generation, they eventually couple up, move to the suburbs and buy a house in which to raise a family.
This classic tale has clear guideposts as it relates to residential real estate demand intervals. While there are always exceptions to the rules, the age spans shown in the “Living schemes age spectrum” graphic accompanying this story, reflect the core profile of renters for the various types of residential real estate accessible to investment capital.
The spectrum denotes certain characteristics critical for investors in residential real estate:
- Certain residential subtypes have a much more finite useful life for an individual renter by virtue of specific limitations. For example, purpose-built student housing is dedicated exclusively to college renters (typically aged 18–22), while senior housing (for which there are further delineations at the sub-subtype level) is generally restricted to those aged 55 or older.
- The renter cycle doesn’t necessarily end at homeownership. There is a fair and perhaps counterintuitive degree of fluidity back to urban/suburban apartments and single-family rentals after homeownership, particularly for older households. According to the National Association of Realtors’ 2022 Generational Trends Report, sellers between 42 and 75 comprised nearly 70 percent of all home sellers in the 12-month period ending July 2021 and just half of the buyers, suggesting about 20 percent of homeowners are moving into some type of for-rent housing after they sell their home.
- Non-age-restricted renter cohorts tend to overlap to a certain degree. This accounts for regional variations in lifestyle preferences, household composition, income and job mobility, among other things.
It is this overlap that has given some investors pause as it relates to allocating capital into the purpose-built single-family rental market. After all, if the fluidity is the greatest between urban, suburban and SFR, are we not cannibalizing our own demand by owning some combination of all three?
THE THREE C’S: CANNIBALIZATION, CAPTURE AND CORRELATION
There is no denying that the growth in the SFR space is being fueled at least in part by renters transitioning from traditional apartments, as recent data from John Burns Real Estate Consulting confirms. According to operators they surveyed, half of new SFR tenants in the six months through Q3 2021 came from apartments.
This is largely to be expected when viewed through a demographic lens. While affordability headwinds to millennial ownership (whether by virtue of too-high for-sale prices, too little savings or some combination thereof) are well documented, it’s worth reiterating just how far behind they are — more than 25 million millennials, 42 percent of the largest generational cohort in the United States, are over the age of 35 — and yet, the age-adjusted homeownership rate relative to prior generations is roughly 5 percent below Gen X and baby boomers when they were the same ages, according to Apartment List’s 2022 Millennial Homeownership Report using data from the Census Bureau’s Current Population Survey Annual Social and Economic Supplement 1985–2021. This ownership gap is creating organic demand tailwinds for SFR that would otherwise be transitioning out of the rental category completely. So, rather than a cannibalization of traditional apartment demand, we describe the growth in SFR as an extended capture for investor capital.
Let’s assume we’re satisfied that adding SFR to a portfolio doesn’t cannibalize demand from our traditional multifamily assets. Still, most SFR investment today is focused in high-growth markets where such strategies are viable, predominantly in the South and West, markets that are also targets for traditional multifamily investing. How might the addition of SFR in the same markets affect portfolio diversification? Are these two residential segments’ performance sufficiently different from one another, or are investors unknowingly doubling down on the same fundamentals?
To answer these questions, we considered the correlations of rent growth trajectories of both traditional apartments as well as single-family rentals in a handful of high-growth markets in Georgia, Texas, Tennessee, Florida and Arizona from the past 22 years. The following takeaways are based on the results shown in the accompanying table above:
- Intra-market correlations are generally no higher than inter-market: The values denoted in the shaded boxes represent the correlation between single-family rental and multifamily rent growth in the same market. The correlation coefficient between Atlanta SFR rent growth and Atlanta apartment rent growth, for example, is 0.34. Atlanta apartments demonstrate a similar correlation level to SFR in Orlando, San Antonio and Tampa, at 0.37, 0.39 and 0.40, respectively. In fact, Atlanta apartment rent growth has shown a higher correlation to SFR in Dallas and Nashville than SFR in the same market. As a note to materiality, most statisticians note a correlation coefficient nearer to 1 as indicative of a strongly positive relationship — the lower the number, the less statistically significant the relationship between the two metrics.
- Higher correlations occur within subtypes across markets: Although not displayed in the table, we ran the same analysis across just SFR and just multifamily. What we found was that the correlation coefficients between SFR markets were materially higher than the correlation between a market’s SFR and apartment market, and the same holds true of correlation measures between different apartment markets. This seems to confirm that although SFR and multifamily are complementary flavors of for-rent residential, they exhibit fundamental cycles that are distinct from one another.
- Positive correlations to some extent should be expected: Although the correlations were higher between SFR markets than SFR and their local apartment counterparts, positive correlations were expected, as housing does not operate in a vacuum. The rate of household formation, cost of ownership, labor market dynamics and the relative strength of the macroeconomy all influence demand and, in turn, rental rate growth to similar degrees, such that most market sectors in a given country generally move in the same broad direction.
Given the forthcoming growth in the 30- to 45-year-old cohort as the crest of the millennial wave ages forward, it seems prudent for investors to contemplate adding exposure to asset types such as SFR that are poised to support this generational next phase. Given the more structural challenges curtailing greater homeownership in this cohort, the outlook remains quite favorable even against a moderating macroeconomic backdrop.
The data also suggest increasing investment in SFR need not be at the expense of traditional multifamily — rather, the two can serve as complementary but separate buckets in a broadened residential allocation, capturing a wider swath of the rental spectrum and offering housing solutions that cater to longer periods of a renter’s life.
Sabrina Unger is managing director, head of research and strategy, at American Realty Advisors, and Britteni Lupe is associate, research and strategy, with the firm.