The single-family home rental market is a segment that has, historically, been very fragmented both in its ownership and operations. The investment capital now flowing into this sector is changing that dynamic. What you’re going to see is a creation of much more professionally managed single-family inventory,
It is not about buying assets on the cheap and then flipping them. Instead, investors entering the space see a chance to gain a foothold in a growing investment niche and to institutionalize it. The single-family home rental market is currently estimated at between 11 million and 13 million properties nationwide. Yet the vast majority of those homes are owned and managed by small investors.
Why the sudden interest?
In the past, it was too time consuming for large investors to amass portfolios of homes to manage. Properties were only available in one-off sales and auctions. Today, however, investors can buy homes in bulk, meaning portfolios that can generate meaningful income streams can be amassed more quickly.
Banks, are selling larger portfolios of REO homes. As part of its new REO to Rental pilot program launched earlier this year, there has been some 2,490 properties including 2,849 units on the block earlier this year. There are 1,743 single-family homes, 527 condos, seven manufactured homes, one co-op, 118 duplexes, 36 three-unit buildings and 58 four-unit buildings.The winning bidders have not yet been announced, but the first deals are expected to close in the third quarter.
Investors also have been aggressive in going after individual sales, buying properties off the courthouse steps in trustee sales, finding properties on the multiple listing service that are listed as bank-owned or short sales, as well as working directly with banks that are moving REO properties off their books. Although the bulk buying enables investors to quickly grow large portfolios, some investors are wary because the portfolios are more competitively bid and properties are spread across a larger geographical area. Operating a dispersed portfolio magnifies the management challenges associated with single-family properties. Management of a large portfolio of individual homes can be a very intensive and cumbersome process. In most cases, investors are managing those challenges by utilizing a combination of technology, third-party management or building staff in a short list of local markets.
Single-family homes are on the radar with private equity investors for good reason. There is a robust pipeline of distressed properties that is allowing owners to buy property at a steep discount—typically 30 percent to 50 percent of replacement cost.
The volume of foreclosure filings in the U.S. totaled more than 2.8 million per year in both 2011 and 2012. Although the volume of home foreclosures dropped to 1.9 million in 2012, there were approximately 1.5 million active home foreclosure filings recorded during the first six months of 2013, according to a survey. The current volume is about five times higher than the rate of foreclosures that were occurring prior to the housing bust. In 2005, for example, home foreclosure filings reached just 532,833.
That inventory includes an ample supply of quality middle-class homes in good neighborhoods. Investors are finding that they can buy three-bedroom, two-bath homes, many of which were built in 2005 or later. At the peak of the market, these homes were selling for about $250,000, and now investors are able to buy them at prices averaging between $100,000 and $130,000.
The bargain basement prices certainly create an opportunity for potential appreciation when the housing market eventually recovers. In the meantime, strong demand from renters is creating attractive cash yields. Converting the foreclosures to rental properties is generating returns on an unlevered basis in the high single digits—about 7 percent to 8 percent. Depending on the level of appreciation that a home achieves, investors are projecting leveraged returns that could range from 15 percent to 24 percent.
The distressed housing sector is expected to continue to draw more capital and become increasingly competitive in the coming months. One question is how the inventory of foreclosure homes will hold up to the surge in demand.
Data clearly indicates that there are still millions of non-performing loans and delinquent loans on homes going through the foreclosure process, which will make their way into the REO inventory over the next 24 months. There is a lot of capital coming into the sector. So whether this is a one to two year strategy or a three to four year play remains to be seen.
Some investors believe this is more than a short-term boom, but a longer term opportunity as the single-family rental market gains a foothold as a more established investment niche. The primary reason that we got into the residential sector, in addition to the distress, is that there are really some compelling demographic trends formulating.
We think there has not been just a cyclical, but a secular shift in home ownership. Real Estate experts estimate that homeownership in the U.S., which reached about 70 percent during the peak of the housing boom, will likely fall back to 60 percent. That decline represents about 8 to 10 million families that for whatever reason—whether they can’t get credit or may choose not to own again—are now looking to rent a home. That isn’t to say that homeownership won’t rebound and many of these people won’t ultimately own homes when they can. We just think it is going to take longer than people think.