Three Things to Know About the Fastest Growing Segment of the US Housing Market: Single Family Homes for Rent

By Laurent Bouzelmat and Diane Abruzzini

In the decade that followed the 2008 recession, multifamily real estate development exploded in popularity. 2018 is the first year since 2011 where the US will see fewer multifamily units built than in the year prior, according to a Yardi Matrix study (summarized here). This was due to a number of factors, from rural-urban migration to loss of consumer confidence in the housing market. Now, in 2018, the supply of new single-family homes has not matched demand; that competition continues to drive single-family home values higher. According to US Census Bureau data, the number of Americans living in all  rentals  has dramatically increased to almost 37%. During that same period, the number of owner-occupied properties decreased.

Marketwatch explains single-family rental investing in an effective way:

“It is like an inflation-adjusting bond with an equity kicker. The rental income less operating expenses generates current distributions – like the coupon on a bond – and rents can be adjusted annually [as most leases are for one year], providing inflation protection.”

  1. Low Supply, High Demand

Today, the number of Americans living in a rental unit is at an all-time high since 1965. A research study by NAREIT shows a 30% annual growth rate in SFR over the past three years – about double that of multifamily –  making it the fastest growing sector of the US housing market. You’ve heard it before: millennials, the largest generation in the US, are not buying housing at the same rates as their predecessors. Student debt, entering the job market during the recession, and loss of confidence in housing markets all drive this trend among young adults. Retirees and empty nesters contribute as well, liquidating their homes in order to downsize and fund retirement.

Developers over the last decade have largely focused on multifamily development. More than half of owner-occupied US housing stock was built before 1980, and the median age of that housing is 37 years old, according to the 2017 American Community Survey. The Wall Street Journal attests that this housing shortage is also due to a “decades long push for young people to go to college”, whereas fewer attend vocational schools and enter such blue collar professions as the construction trades.  The trend toward higher rates of college education has not only attributed to a decrease in skilled construction labor, but has also contributed to increased debt load on the younger generations, restricting their ability to purchase single-family homes. In addition to heavier debt burdens, the cost of housing has been rising at higher rates than wages. In 2017, the S&P CoreLogic Case-Shiller US National Home Price NSA Index rose 6.3%, two times the rate of income growth.

Home construction, specifically for single-family “starter homes” has slowed to nearly the lowest level in 60 years. Multifamily has gained popularity as US residents become increasingly concentrated in urban areas, making land in these areas rise in value. The National Association of Home Builders estimates construction of 900,000 new homes in 2018, which represents only 70% of demand based on population growth. This low supply coupled with increasingly high tenant demand has contributed to the growth of the single family homes for rent asset class over the past decade.

  1. Operating Margin Potential

Fix-and-flip is a process that many Americans are aware of: to purchase an undervalued property, put in some updates, improve curb appeal, and sell, hopefully at a profit. Single family homes for rent (SFR) as an asset class is fairly new and small compared to, say, multifamily, which provides more potential for large scale efficiencies of scale. However, single-family homes, especially detached housing, offer some values not always available in multi-family rentals, including (generally) basement and attic space, garage, personal laundry room and privacy.

Commercial real estate technology advancements have really boomed lately, leading to new types of smart home technology, on-demand maintenance, drone property tours and more. Many of these technologies help SFR managers and fund managers to achieve better operating margins. This creates a dual strategy: fix-and-flip for quick appreciation potential, coupled with improving margins for rental cash flow.

Some innovative commercial real estate technologies to keep an eye on:

  • 3D, interactive and virtual property tours, e.g.. Smarter Listings by EveryScape
  • Virtual reality 3D models for prototyping, e.g. Realnex
  • Automated post-close services, making investor management more efficient, ex Investor Management Services.
  • Automatic rental payments, e.g. Schedule My Rent, Appfolio.
  • The “Ubers” of property management, connecting service providers with properties in need of service, e.g. Servus.
  1. Diversification and Inflation Protection

When an investor places funds in a multifamily unit, the location and infrastructure are crucially important. Local employers and schools, occupancy rates, and access to amenities all affect the value of a multifamily investment. When an investor invests in a fund of single-family homes for rent, there is slightly more diversification. These properties often (but not always) span across multiple geographic regions, vary in proximity to urban locations and large employers, and require differing amounts of updates. While all real estate investments are risky and most are illiquid, SFR funds do offer extra diversification, which can absorb poor performance of certain components of the portfolio.

Unlike many other non-real estate asset classes, SFRs and multifamily rentals are more protected against the risk related to rising interest rates. An increase in rates is often correlated with inflation for ‘useful assets’, which is a category that real estate falls into. There is a strong correlation between rents, interest rates, and inflation. When interest rates rise, an SFR manager can adjust rental rates annually, while experiencing higher appreciation on the asset itself.

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