Single-Family Rental Investing
What is Single-Family Rental Investing?
Single-family rental investing entails investment into low-density housing in attractive suburban and in-fill neighborhoods with multiple bedrooms and no shared spaces. The aftermath of the 2008 financial crisis left home ownership lower by 6% from its original peak in 2005 of approximately 70%. Each 1% drop in the homeownership rate equates to approximately 750,000 homes. In the years that followed, single family homes suddenly became a deep value investment opportunity, drawing the attention of some of the largest private equity managers and developers, where scale could generate significantly higher rental yields as compared to the more fragmented mom and pop owners. As such, institutional ownership of single-family rental homes had surpassed 240,000 homes and over $40BN of investment by end of 2018. In April of 2020, at the outset of the present crisis, activity within the asset class skyrocketed: one advisory firm reported a 650% increase in buyer and seller activity, while SFRs significantly outperformed multifamily in terms of rent collection in the early months of the pandemic¹.
Many investors in single-family rentals also operate at scale, either developing a set of distinct, architecturally cohesive units, investing into a portfolio of standalone residential properties that fit a specific renter demographic, or both.
While SFR investments entail development of, or investment into, standalone units, these assets often behave similarly to multifamily investments. Experienced single-family rental investment firms are typically adept at tailoring their rental properties to meet prevailing demand in the market. They have a clear, quantitatively backed understanding of the typical renter; are skilled at building for and marketing to their target demographic; and can efficiently return units to market and quickly re-lease them should a tenant leave. In other words, a developer or operator of a portfolio of SFR properties will seek a diversified tenant mix and adopt a comprehensive business plan to maximize NOI across SFR units in the portfolio.
Why Single-Family Rental Investing Makes Sense Now
Before the pandemic, working-class families struggled with housing affordability in markets across the U.S. In recent years, homeownership rates approached the lowest since the CBO began recording data, due to persistent supply shortfalls in many metros, stagnant real wage growth, and historically high student loan and consumer debt. Prior generations sought homeownership in the 25-35 year-old age demographic as a matter of social and personal finance convention. A 2015 report by urban.org showed that homeownership rates are both significantly lower among Millennials than older generations now, as well as substantially lower than prior generations when those generations were in prime homebuying age.
Millennials have, in recent years, sought to rent more affordable family-ready dwellings later in life. As this cohort settles into a quieter pace of life, including forming families, preferences have shifted away from dense multifamily housing in urban cores. According to Berkadia, renters are choosing to pay a premium of as much as 20% for private entrances and backyards relative to traditional garden apartments.
While millennials make up a large portion of single-family renters, older generations are beginning to turn to renting as well. Individuals nearing retirement age, or those already retired, do not want the burden of home maintenance and property taxes. Additionally, renting is attractive to retirees who have built up equity in their own homes and would like to cash out on that equity for retirement income. From 2006 to 2016, the number of renters in their early 60s increased by 84 percent—the most of any age group². Single-family rentals are ideal for retirees who do not want the strain of owning a home, but still want sufficient space and a yard for themselves and possibly grandchildren.
As mentioned previously, institutional interest in the SFR asset class has grown dramatically. SVN | SFRhub Advisors, a CRE brokerage firm focused exclusively on SFRs, saw a 650% increase in investment activity from mid-March to mid-April for SFR portfolios on their technology platform³. The supply of SFRs cannot keep pace with institutional demand, and the market is estimated to be undersupplied over the next ten years. This growing demand has led to the emergence of a subset of the SFR asset class—the build-for-rent (BFR) single-family rental. These are single-family homes that are built specifically for renters, not buyers. Often these homes are developed as communities that include a large number of homes, usually in the range of 75-200 per development. The homes are often identical, with only size and number of bedrooms varying, and the communities often include amenity packages similar to multifamily properties and on-site property management.
The Impact of COVID on the SFR Asset Class
The pandemic has accelerated this trend, with the renting cohort of millennials seeking more space, less dense neighborhoods, and lower cost of living as the current crisis has exacerbated both housing security and public health concerns for many renting families.
The single-family rental model offers a way for developers and real estate investors to provide value to renting families with cost-efficient and affordable family-ready units that can benefit from economies of scale in design and development. In many markets, the SFR model allows developers and investors to tap into the benefits of a diversified tenant mix while also working within the zoning constraints of high-demand rental markets. Demographic trends–which have also been accelerated by COVID–also support the model. Sunbelt metros like Phoenix, Albuquerque, and Dallas are exhibiting increased rental demand as families seek more affordable, spacious living arrangements than gateway markets can offer. These demand trends span income brackets: the pandemic has accelerated adoption of remote work in “creative class” industries, further bolstering demand among mid-career professionals who seek quality, family-ready rentals but are not in a position to commit to homeownership. Not all secondary and tertiary markets are viable targets for SFR investment; local economies that are predicated on tourism–like Las Vegas and Orlando–are viewed as riskier bets at the moment by institutional investors.
As the economic impact of the pandemic set in, industry leaders expected both positive and negative effects for the SFR asset class: economic hardship for renters would challenge rent collection and occupancy, but net migration into suburbs and smaller metros would boost demand for SFR units. By the end of Q3, the data had shown that the positives outweigh the negatives for the SFR asset class. Both occupancy and rent growth have exhibited strength in recent months:
- From June to July, SFR annual rent growth on lease renewals increased by 90 bps to 2.3%.
- According to the CBO, occupancy rates on SFRs held steady from Q2 to Q3 at over 95%, the highest level since 1994 and 5.6% above the low point in 2007.
Given these strong fundamentals, and relatively few distressed properties as compared to the financial crisis, competition for existing SFR stock may be fierce in some markets. Opportunities abound for experienced, well-capitalized SFR developers, particularly in markets such as Phoenix, with favorable job growth and demographic trends supporting increased demand in its rental housing market.
SFR vs. Traditional Multifamily
Traditional multifamily properties consist of buildings that contain units for several families or individuals under one roof. Apartment buildings, condo complexes, and smaller duplexes and triplexes are considered part of the multifamily asset class.
The multifamily asset class allows for greater economies of scale when it comes to operating expenses and maintenance. With all units located under one roof, property maintenance and operations are made easier as amenities that need upkeep are often shared. The most common example of this is a roof. Multifamily units all share the same roof. If that roof needs repairs, there is only one roof that needs to be fixed. Whereas, with SFRs, if a roof needs fixing, there could be ten other roofs that require maintenance.
While economies of scale favor the multifamily asset class, SFR scalability has reduced the gap in operating and maintenance expenses. SFR portfolios traditionally consisted of multiple single-family homes scattered across multiple geographic areas, but the emergence of the BFR subset has allowed for developers and investors to minimize costs while scaling their portfolios. Build-for-rent communities allow for economies of scale similar to those of multifamily properties.
The Bottom Line
Investors should view the single family rental asset class similarly to multifamily: both benefit from macro-level demographic and socioeconomic trends and both can offer a recession-resistant investment thesis. At the present moment, the dual influences of COVID-19 and low homeownership for the 25-35 year-old demographic may stimulate demand for the single-family rental model in some markets. The asset class was fueled by demographic trends that predated the current crisis, but SFR investment has accelerated throughout 2020, as some of the nation’s largest institutional investors have raised billions for their SFR portfolios.
As with any real estate asset class, the experience of the sponsor within the asset class and specific market or submarket is critical to success.
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