Investors in single-family rentals (SFRs) have always played a significant role in the U.S. housing stock, accounting for about one-fourth of all rental units prior to 2008. In the recovery since then, private equity firms and larger investors recycled foreclosed homes into rentals, boosting the share to about one-third of the market. But it remains a sector that is closely held, mainly because it requires a large initial investment and is illiquid. Ownership of single-family residential investment real estate is restricted to fewer than 10 percent of all households, the vast majority of which own one or two houses. In contrast, ownership of stock, including through retirement plans, mutual funds, etc., exceeds 50 percent.
This article will outline the advantages of investing in this sector.
Out of phase with other real estate sectors
Amidst growing concerns of a cyclical downturn of the overall economy, many sectors of the commercial real estate are already showing signs of peaking. According to Nareit, only multifamily and healthcare REITs eked out small gains, while other major REIT sectors fell by as much as percent in 2018 (Chart 1).
Meanwhile, housing prices for the low- to mid-price homes rose 9 percent during the year.
Equal or better returns with less volatility
And the recent performance advantage is not a one-time phenomenon based on the strong economy and housing market. Since 1996, the average annual, total returns for the SFR sector exceed those of every other commercial real estate sector except multifamily and self-storage.
And it did so with a lot less volatility as measured by the standard deviation of total returns. As a result, the SFR sector is much more efficient in producing returns for a given unit of risk (Chart 2).
The concepts of standard deviation and efficiency may seem a bit abstract to some, so let’s look at a picture of actual annual returns to show the differences in Chart 3. Which path would you rather be on, especially coming up on a downturn?
Better returns than stocks or bonds, too
So single-family rental investing makes a lot of sense compared to other real estate sectors. How does it stack up against more traditional investments in stocks or bonds? Pretty well.
Average returns that are much more stable and higher than even equity returns over the past 22 years.
So residential real estate deserves a place in all investors’ portfolios. That fact that returns are essentially uncorrelated with other real estate investments and only modestly corrected with stock returns (.10), while negatively correlated with bond returns (-.18), bolsters this argument.
How to invest in SFR real estate
Traditionally, the vast majority of SFR properties were owned by “mom-and-pop” investors who owned one or two properties. And despite all the headlines of the past six-seven years, that is still true. The chart below shows that more than 83 percent of the properties are owned by investors owning five or fewer properties. These investors account for 98 percent of all SFR investors.
But even this widespread ownership of SFR real estate accounts for only about 10 percent of all households, far short of the 50 percent or so that own stocks.
Some of these individual investors inherited houses, while others kept their house as a rental after job-related relocations. Others bought through so-called “turn-key” operators such as Memphis Investors, which buy renovate, sell, and property manage for individual investors. But most simply bought a house or a few as a way to enhance cash flow for income with appreciation potential for a retirement nest egg.
Operating costs for these small investors are high, as much as 10 percent of gross rent for property management services, along with marked-up maintenance and repairs costs, and with leasing commissions. The alternative “do-it-yourself” approach is costly in terms of time.
Newer operators such as Roofstock, HomeUnion, and Real Wealth Network are essentially turn-key operators on a national scale. There are many others that operate regionally or locally.
All of these providers, however, restrict ownership to those who can afford roughly $100,000 to buy an entire house for cash or can at least make a substantial down payment of $25,000. And they can be expected to earn on average over a long period the 10 percent total return cited above.
Shares of stock in public REITs
At the other extreme, investors could gain exposure to the SFR sector by buying shares in the publicly-owned REITs such as Invitation Homes and American Homes 4 Rent. These stocks are trading around $22-23 per share, so anyone with a brokerage account could afford to buy at least a few shares to get real estate exposure. However, the average annual total return for Invitation Homes stock (INVH) since going public in early 2017 has been 8.7 percent (2.3 percent dividend, 6.3 percent appreciation) and American Homes 4 Rent (AH4R) has done even worse, with a 7.2 percent average annual total return since August 2013 (0.9 percent dividend yield, 6.3 percent appreciation).
Both of these returns are below the 10 percent average annual total return on individual properties since 1996.
Local syndicators have long been forming partnerships, pooling capital to buy portfolios of houses. Of the entities that own 25 or more houses, 65 percent are corporate entities. While it’s not easily known how many members comprise each LLC, it is clear that the larger the portfolio, the more likely that it has multiple members/investors. It’s also more likely to have higher yields and lower operating costs than individual direct ownership.
Many members may be local, which gives them the advantage of being able to drive by and actually see the properties and they are familiar with the local economy and neighborhoods. On the other hand, these investors are not diversifying away from their investments in their primary residences and other local real estate businesses.
It’s hard to learn about these kinds of investments in cities other than your local residence at this time.
Roofstock is offering a new program called Roofstock One, which allows accredited investors to buy into a partnership to purchase a single rental house. It’s really just syndicating an individual house with turn-key services.
Unison and Point offer a different way to invest on a fractional basis, albeit with owner-occupied homes rather than rentals. In exchange for cash now, the homeowner gives up a share of any future appreciation. There is no current cash flow payable, which may not be appealing to many investors. Since you only get your principal and any appreciation upon sale, the holding period may be many years.
Raising relatively small amounts of money online (usually less than $5 million) is the province of crowdfunding, made possible by the JOBS Act of 2012. There are more than 100 sites available for consideration, but their focus is commercial real estate.
Realty Shares and Realty Mogul both launched with some SFR offerings, but no longer do so. In fact, Realty Shares, with more than $100 million in venture capital funding, recently stopped listing new projects for investment.
A new strategy
Each of the above strategies has strengths and weaknesses. However, there is one common weakness across all of them, namely, that the offerings are driven by listings of available investments. This limitation makes it hard for investors to find projects/properties that meet all their investment criteria with respect to geographic areas and other risk categories.
Focusing on the buyers, however, could give a completely different dynamic to the investment process. Pooling money from like-minded investors would assure each of them that they would get an investment that would best meet their preferences by searching for opportunities that are not currently listed. This approach fits the common real estate maxim that every property is for sale at the right price.
But as yet, there is no such investment vehicle. Stay tuned!
Douglas Bendt is president of Bendt Enterprises, a consulting firm based in Boulder, Colo. He specializes in market analysis, acquisitions and dispositions in the single-family rental sector. He can be reached at [email protected]