Inside SFR’s Boom Times

Throughout the pandemic, in commercial real estate, there were two commonly acknowledged investment standouts: industrial and multifamily. They made sense. An upsurge in e-commerce made the need for warehouses, distribution points, and logistics facilities paramount.

Then there was multifamily and its cousins, single-family rentals and build-to-rent. They’re hot markets and some big investors are balancing the categories to gain advantage from both.

WHY SFR IS DOING SO WELL

The success of SFR is, as they say in science and engineering, a special case of multifamily. To understand the former, you need to grasp the dynamics of the latter.

For any housing, there’s the basic dynamic that the US has failed to match population growth with housing expansion for years. On the single-family house side, according to a study commissioned by the National Association of Realtors, “While the total stock of U.S. housing grew at an average annual rate of 1.7% from 1968 through 2000, the U.S. housing stock grew by an annual average rate of 1% in the last two decades, and only 0.7% in the last decade.”

The National Multifamily Housing Council has said something similar about apartment units. While the US  needs “an average of 328,000 new apartments per year at a variety of price points,” only three times since 1989 has the country seen that level of construction.

Compounding an already difficult situation are three factors. One has been the pandemic and shift to working from home and hybrid. Many people, especially those with families, found they needed more space. Having kids in remote schooling only aggravated things.

Next is a shift in population. People have been moving to the West and South, according to the latest data from the Census Bureau. The top 15 fastest-growing cities and towns were in these regions. If there wasn’t enough housing before, then it is even less now because apartments and houses don’t shift locations with people.

Third, an “aging millennial generation” is experiencing an increased amount of new household formations. The Federal Reserve speaks to a “remarkable recent rebound in household formation.” People forming families need newer places to live.

So, there’s a lot of movement and increased numbers of families that want additional room. However, the financial realities of home ownership at this point are difficult. In the first quarter of 2022, the median price for a home was $428,700, according to government figures. A matching 20% down payment would be $85,740—an enormous sum when you realize that while prices have shot up, in May 2022, real income after rising inflation was down 3.9% year over year. And none of this accounts for higher benchmark rates from the Fed, intended to fight inflation, driving up home mortgage rates. By June 23, the average 30-year fixed rate mortgage was 5.81%, according to Freddie Mac. The combination makes many people incapable of buying a house and an apartment.

The result is an exploding market for single-family rentals. People need the space, the privacy, and can’t afford to buy a house.

“Maybe the American dream has to be retooled,” Marc Shuster, a private equity and venture capital attorney for Florida business law firm Berger Singerman, tells GlobeSt.com. “That could be one way out of the affordable crisis. That’s the problem with the fallacy of the 1990s and 2000s about owning your own home. It’s a stratification of a further divide. There just aren’t enough houses and the ones that exist are too expensive. The new homeowner, the 20-something family or single family, how in the world can they compete?”

BIGGER INVESTORS WANT IN

It’s those dynamics that make SFR such a strong market, separate from multifamily. Even as home for-sale demand has weakened, the SFR industry has remained highly optimistic about the future. They have products in high demand with low availability.

“The macro-overlay is why residential is about 47% of our $7.2 billion portfolio,” Allan Swaringen, president and CEO of JLL Income Property Trust, says. “The reason we find that attractive is that America has not been building enough housing since the global financial crisis.” The company has about 8,000 residential units, half multifamily and the other 4,000, SFR. The single-family units represent about a quarter of that value.

“The market was not an institutional market a decade or decade and a half ago just because of the complexities of managing it institutionally,” says Ramin Kamfar, CEO of alternative asset manager Bluerock. He characterizes the reasons as the “three Ts”: “tenants, trash, and toilets.”

“When you have different homes with different specs and are far apart from each other, the economies of scale aren’t there,” Kamfar says. Before the last ten years, SFR was a category that was dominated by mom-and-pop investors, and it remains so, although the pace of institutional investing has sharply increased. Bluerock has more than 21,000 apartment units and more than 3,750 single-family residential and build-for-rent units targeting the middle-market price point for quality with rents ranging from $1,500 to $2,300 on average.

“By our data as of the end of the [2021], there were about 14 million homes that were renter-occupied single-family homes in the United States,” Swaringen says. “Of those 14 million homes, all institutional ownership is about 3%. It’s a market ripe for aggregation and consolidation. It’s been a fragmented market for decades but it’s becoming a little more institutionalized. The institutional investing is accelerating,”

What’s catching more organized investor interest is a fundamental change enabled by technology. Its evolution has made SFR rental activity much more efficient. Swaringen notes that the sector used to be signs and banners. “You don’t do any of that to rent a single-family home [anymore],” he says. “It’s all done through YouTube videos. They can tour the building, the basement.” There’s online training on how to do maintenance. Drone videos give an overall view of a property and the surrounding neighborhood, and it’s all accessible on cellphones. “That makes single-family rents much more easily manageable.” Rental agents can typically work out of a call center. They don’t have to drive around.

“Generally speaking, institutional investors view SFR as complementary to multifamily and within the overall investible residential sector,” Kamfar says. “Both SFR and  multifamily have attractive, large investable markets and reach a similar broad national demographic cohort, mainly middle market renters seeking quality, maintenance-free affordable housing, and so you’re seeing both types of rental options in most of the same markets. For investors, mixing your allocation to both makes sense as there are different managers and operators for each with differentiated strategies and markets.”

SFR provides a form of diversification that can allow sophisticated investment management. Rather than being all in the same setting, “it’s in fragmented [micro] markets,” says Sourav Goswami, co-founder of Haystacks.ai. “We look at how the different areas within an [area] are going to perform relative to each other. We took that and layered it over a thousand-unit portfolio.” Strategic exits and purchases can add an additional 80 basis points of return. “Real estate’s a game of basis points. Real estate is much more about evolution than revolution.”

SFR ECONOMICS

The basic nature of house rentals also reduces pressure on owners and operators. “When you own a house, you have less contingencies to concern you as an investor than an apartment,” says Shuster, because the renter is responsible for significantly more than in an apartment building. They’re likely responsible for mowing the grass and removing snow, for the electric bill that powers air conditioning and the heating bill. “Things are a little more manageable. The investor class can [focus on] the types of single-family rental they think will be attractive.”

“I think it’s made the maintenance simpler,” Swaringen says. “It’s made the inspection of the house simpler. The leasing. It’s all done remotely and with videos, which is just not something you could have necessarily done ten years ago. With bandwidth increasing and technology increasing. It’s not been talked about a lot in terms of why the SFR market is attracting institutional capital because the efficiencies are making it more investable. In our apartment communities, most renters will call the maintenance man. The single-family renter maintains it to a higher standard. They’re comfortable taking care of it and fixing minor problems. A roof leak? They’re going to call our maintenance staff. But changing filters in furnaces, changing light bulbs, changing fuses, unplugging toilets, [they can often do that].”

Not only is maintenance lower, but there’s longer tenancy with greater retention. All that said, buying units and amassing a portfolio takes some serious planning.

“I would say the average home we own is about $150,000 a unit and we own apartments that are much more than that,” Swaringen says. The reason is the target market. “Most people are renting homes because they can’t yet afford to buy,” he adds, and those renting probably can’t afford enough to make a more expensive house profitable. “What’s most attractive to us is that a lot of millennials moving out of the urban core want a house, an additional level or privacy, a yard, a garage, but don’t have the down payment or don’t want to make a purchase.”

JLL IPT isn’t the only company working this way. Median prices that institutional investors pay are about 26% lower than the median prices in the same states, according to a National Association of Realtors study. About 42% of respondents said that “institutional investors were purchasing homes that needed repair.”

Another big reason they can buy at such low rates without bidding up values is because institutions tend to be quick buyers who pay cash, which is valuable to sellers. There’s next to no waiting period and zero chance that a lender will say no to a mortgage.

BUILD-TO-RENT

There’s also build-to-rent (BTR), “the darling of the investor class right now,” Shuster says.

Sands Companies has been building BTR communities since 2015, according to its president, Joe Morrison. “It’s managed with a professional management company that manages apartments,” he says. “We don’t really see ourselves as anything but an apartment complex, just pulled apart and put on the ground.”

Unlike a multifamily property, BTR requires more land and maintenance because not everything is in shared systems, so there’s more work to do. “They’re 500 square foot up to 1,600-square-foot cottages,” Morrison says. “They don’t face a road. They kind of face inward to a common park, face into each other.”

Like SFR, Morrison finds that the BTR tenants are more responsible. “I think people want to live in their own little unit,” he says. “They take ownership of it more than they do with an apartment complex. If you get people to take ownership of their units, they’re less likely to move out.”

The format does come at a price. “Multifamily is probably a little less expensive to develop and building a multifamily is probably easier to do because you’re stacking things,” Morrison says. “What we do is very hard to do, very intricate.” For example, running utilities to a group of separate buildings is completely different from wiring an apartment building. And then there’s the permission process.

“When you go into a municipality, you have to explain what you’re doing and they have to get onboard,” Morrison says. “You need to get buy-in from everybody. There’s no zoning to do what we’re doing.”

Morrison still thinks it’s worth the effort. “We get higher rent, people stay longer, it is still better when you walk around the neighborhood so I think the value will hold longer than tract homes down a road,” he says. “That’s what you’re looking for: how can I push rent year after year. We’re going to increase rent faster than anyone else.”

Not everyone is ready, though. JLL IPT is still waiting and watching.

“We have looked at it and we think it has some intriguing characteristics to it,” Swaringen says. “It’s about building a community that is designed to be a rental community. Our assessment in a single market area, if you can get 200 to 250 homes you can efficiently operate at that level in a market, it makes sense.” Building 250 units can happen relatively quickly, but BTR lacks one thing that JLL likes, which is geographic diversity across a city. “Build-to-rent is a very, very new phenomenon in the single-family market. It will be intriguing to see how it evolves. We’re going to watch that sector a little bit more and then see how it performs.”