Alternatives

Keeping Up With The Rent

Keeping Up With The Rent

Interest in the U.S. single family rental (“SFR”) market has grown amid rising demand for rental property and the sector could offer new opportunities for an increasingly wide range of investors, says Amherst Capital Management LLC’s (“Amherst Capital”) managing director and head of research and analytics Sandeep Bordia.

Single family rental is becoming an increasingly commonly used term in the investment lexicon, as increased U.S. demand for rental homes encourages investors and financial institutions to look at new ways of funding and investing in the SFR sector.

The growth of interest in the SFR market has its roots in the aftermath of the financial crisis of 2007—2008, when millions of U.S. homeowners lost their homes through foreclosure in the fall-out of the sub-prime and global banking crises.2

A radically altered post-crisis market—in which many who lost their homes have turned to rental—is also being buoyed by a range of other factors. These factors include shifting demographics, people deferring decisions to buy until later in life and even the rising impact of student loan debt, which makes it difficult for many younger borrowers to qualify for a mortgage.

According to Bordia, mortgage lending standards have also remained tight following the crisis.

HEALTHY APPETITE

Commenting on some of the factors fuelling the appetite for rental property Bordia says: “There are several long-term factors driving the popularity of rentals as well. The average age of marriage3 and having children has been going up for decades while real incomes have remained stagnant—making it harder to qualify for a mortgage.”

“There are a large number of households where people are unable to own homes but at a stage in their life where living in single- family homes makes more sense than living in apartments. The end result is that younger/newer households are more likely than prior generations to remain renters for a longer period in their lives. This is positive for single family rental demand.”

Bordia expects these trends to continue and says the current market environment bodes well for the SFR sector. While a rise in credit availability does hold the potential to disrupt the market, he thinks this is unlikely to happen in the short to medium term.

“In the next few years, I expect the improvement in mortgage credit availability to be very gradual. Even if credit availability improves faster than expected, it is likely that many of the ex-homeowners who lost their homes to foreclosures will not pursue homeownership aggressively,” he adds.

INVESTMENT OPTIONS

The avenues open to investors in the SFR sector include packaged options such as securitized debt arrangements in which investors own different parts of the capital structure in SFR securitizations backed by single family properties or other debt packages. These can include investments in buy-to- rent (B2R loans or funds that issue B2R loans). These are commonly commercial 7-10 year loans made to mid-sized investors and could be backed by between 5-20 properties. The SFR bond market alone is estimated to have reached US$12.65 billion in size.4

U.S. investors also have the option of gaining exposure to the sector through public equity or an investment in a fund, although Bordia adds single family equity products are still relatively new to the market.

An increasing number of market participants in packaged SFR investments are institutional investors5 but retail investors have also been able to invest through some of the publicly traded SFR equity. As with all investments, there are pros and cons in gaining exposure to the SFR market. According to Bordia, the investment gives exposure to real estate without the hassles of managing its often complex day-to-day logistics.

Bordia adds that SFR investments provide an asset that may generate attractive income even after paying for maintenance and management. A portion of this income may be tax deferred owing to depreciation of the structure part of the home value.

Commenting on the current health of the SFR market he adds: “Home prices in the U.S. may grow at 3-4% annually over the next 3-4 years, potentially boosting returns further. [Single family] home price fundamentals look decent and, in certain areas, have capitalization rates that are higher than what multifamily properties sell for. This could provide a cushion against downturns and more potential price upside.”

In addition, investment may be leveraged at better terms for a portfolio of SFR properties than can be achieved for individual investment properties.

The sector itself can also provide opportunities to invest in specific markets with strong fundamentals or diversify exposure to several local markets.

According to Bordia, controlling maintenance and management costs is critical to investment managers, as best- in-class operators have the opportunity to generate better returns compared to less efficient operators. Commenting, he adds: “Since properties may need to be reconditioned before they can be rented out, it is important to build in reconditioning/ marketing/leasing costs when purchasing them. Distinction must be made between investments on stabilized and non- stabilized properties as their risk-reward and economics can be quite different.”

On the downside, as with many other investments, the SFR market does face macroeconomic risks, such as home price declines and the more specific risk of investing in the wrong geographies or homes.

COST CONTROL

Another potential drawback, he adds, is that, by definition, SFR properties are dispersed over a bigger area than multi- family properties. As such, he says, it can be difficult to scale investments and build economies of scale in the sector.

Despite these potential drawbacks, Bordia remains upbeat about prospects for the SFR sector. Commenting on the development of the SFR market to date, Bordia predicts its development will be swift.

“Investment in SFR is a long-term investment at the level of ‘Mom and Pop’ type investors—but, more recently, institutional investors have taken a significant new interest in this sector. Looking forward, efficient operators who achieve economies of scale and have better access to credit than individual investors have the opportunity to generate better returns,” he said.

Looking ahead, Bordia believes new products could be developed to give investors the ability to invest in specific local markets or take other particular exposures across the SFR asset class. He adds that new products could also include investing in a particular house size (e.g., square feet, number of rooms, etc.) with greater price appreciation potential than homes based on current income characteristics.

Commenting on the trends currently shaping the SFR market Bordia’s view is that: “The bottom-line is that as U.S. household formation continues to rebound and homeownership remains low, demand for rentals, including single family, is anticipated to be strong. Strong rental demand, attractive current yields and expected positive home price appreciation (HPA) over the medium term should all bode well for the sector.”

1. CNBC. The top towns for real estate investors. May 9, 2016.

2. The Wall Street Journal. After Foreclosures, Home Buyers Are Back. April 8, 2015.

3. Source: U.S. Census Bureau, Current Population Survey, March and Annual Social and Economic Supplements, 2015 and earlier. Internet release date November 2015.

4. CRE Finance World. Single-Family Rental Securitization: Where Are We and Where Will We Be? October 18, 2015.

5. The Wall Street Journal. Big Landlords to Merge, Betting on Rising Rents. September 21, 2015. 

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Amherst Capital Management LLC is a real estate investment specialist.  Amherst Capital was established in 2014 as a majority-owned subsidiary of BNY Mellon, and is minority-owned by Amherst Holdings, LLC a financial services holding company with more than a 10 year history of utilizing its mortgage expertise to assist clients in navigating the real estate capital markets. Amherst Holdings is not an affiliate of BNY Mellon.

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