Single-Family Investment Goes Institutional (Slowly)
Institutional investors hope to replicate the successes they have had in traditional multifamily, but the peculiarities of single-family rentals prove challenging to the industry’s largest players.
Demographically driven demand coupled with limited new supply over the last decade has created the need for more incremental single-family rentals, said Dana Hamilton, senior managing director of Pretium Partners. But many institutional investors are still reluctant to jump into this multifamily niche.
Whether it be Millennials, Gen Zers or even Baby Boomers, the number of renters increased by more than 23 million from 2006 to 2016, according to U.S. Census data. Today’s renter is looking for flexibility and a high level of service, so successful ventures in the single-family segment come with a series of unique challenges. As a result, few seasoned investors are willing to make a long-term commitment to this emerging sector. A Freddie Mac report published at the end of 2018 showed that only 1 percent of all single-family rental homes or approximately 188,000 properties were owned by institutional investors. On the other hand, roughly 88 percent were owned by very small investors with portfolios of 10 houses or less.
“The challenge right now is getting people used to the fact that this is a viable option for creating a housing product that is attractive and well accepted by lenders and long-term purchases,” said Brian Pearl, principal at Global City Development. In December, the company partnered with alternative investment firm Leste to launch a $2.5 billion housing platform that aims to deliver 10,000 single-family rental homes across the U.S. over the next five to seven years.
Multifamily investors and developers started looking into single-family rentals following the downturn, noted Jonathan Ellenzweig, senior managing director at Tricon Capital. “That downturn has facilitated the ability for ourselves and our peers to begin buying homes at a faster volume and build, scale and develop operating efficiencies,” he said. His company’s SFR vertical, Tricon American Homes, was founded in 2012 and last December it acquired 708 rental homes in Nashville, Tenn., for $210 million.
In recent years, the turnover rate in the SFR market appeared high, but that’s not something to be worried about, Pearl explained. “Some of these investors come in right when buying is very cheap and they know they’re going to get a capital appreciation and then exit,” he said. “It’s just a sign of what their original business plan was.”
Similar to multifamily, there are two main types of business plans for single-family rentals—the sprinkled model and the long-term venture. The first refers to acquiring properties to be turned around quickly as value-add projects and then selling versus developing or acquiring larger portfolios to hold onto as part of a long-term investment strategy.
Business plans aside, management is another essential point in this niche market. In multifamily, traditionally, there is onsite leasing staff that handles apartment tours, service requests and maintenance issues. However, this is not the case for single-family. A portfolio can comprise properties across multiple cities or states, without a centralized system connecting them. Even if the assets are part of a larger master-planned community, the chances of there being onsite staff are slim due to the complexity of residents’ needs.
Ellenzweig noted that communication is key and that in the past, residents in single-family rentals would have to track down individual landlords who then would have to track down services to fix whatever the issue was within the home. An example of a solution for this would be TriCon’s resident call center. This consists of staff located within that specific city or state that can answer resident inquiries about rent or maintenance requests. There are also apps that can simplify communication between residents and management, with a broader implementation of smart home technology throughout the properties. This goes back to creating a more flexible environment while also operating more efficiently.
“Location, quality, physical attributes and management are all very important drivers of value and return,” said Hamilton. “Sophisticated use of technology has enabled the best single-family rental operators to achieve margins comparable to those of the best multifamily operators—and there is likely more growth in those margins given the relative newness of the space.”
Unlike multifamily, there are not as many options for professional management companies that have abundant experience within this sector. “You can swap out managers in multifamily easily and with a wide range, but that doesn’t exist for single-family rentals,” said Ellenzweig.
Potential vs. challenges
Institutional investors’ interest in SFR has been rising proportionally to Millennials’ desire for the producs. According to Pearl, those between the ages of 25 to 44 are mostly interested in rental housing, as they want the flexibility to change houses or cities, without worrying about the cost and illiquidity of owning a home. There’s now a larger demand for highly amenitized master-planned communities that will serve people that once lived in Class A apartments in downtown areas. “We want to give them that same sort of lifestyle at a lower cost per foot,” he said.
The phenomenon of urban living in the suburbs has been described as “hipsturbia” by PwC and the Urban Land Institute in their Emerging Trends in Real Estate 2020 report. Basically, it’s live-work-play, walkable communities located in the suburbs instead of downtown areas. Hipsturbia is expected to spread around hip, lively cities with vibrant cores and an influx of young residents. The research mentions Evanston, Ill., and Tempe, Ariz., as such cool suburbs.
The appeal of SFR investment also lies in the asset class’ versatility. For example, with development, there are different potential exits. Pearl notes that if you see the market take off and prices increase faster than rental values, there’s the possibility to transition into a for-sale property or divide the assets and offer for-sale and rentals within the same community.
While the sector does not lack opportunity, expertise is essential. Knowing where to be geographically, choosing the right partners and deciding what type of investment strategy to implement are key for success.
“There is room for several players at this point,” added Pearl. “Single-family rentals require a different skill set than when it first started eight to nine years ago, but there is a lot of stability in terms of constructing a business around this.”