Single-family rental investment: An extended-core asset type

Emerging asset class

In the past five years, single-family rentals (SFR) have rapidly evolved from an asset class operated by “mom-and-pop” landlords to an opportunity for institutional investors. Single-family rental investment has moved from scattered purchases to an institutional asset class operated as a business model.

There are approximately 15.0 million SFR units in the United States, mostly owned by individual investors. About 45% belong to landlords who own just one unit and 87% own 10 or fewer units. Despite rapid growth, institutions (with portfolios of over 2,000 properties) own only 400,000 homes.

The limited existing home inventory coupled with the rising home prices across the country is forcing prospective home buyers to look at rentals to achieve their lifestyle goals. As renting continues to be a popular option among single-person households, growing families, and even downsizing baby boomers, there is an opportunity for institutional investor ownership of this valuable market segment.

Opportunity for Investors

As an investment, SFRs provide institutional investors with predictable cash flows, stable returns, and scalability, benefiting from the phenomenon that rents tend to increase even in a recession.

With MFR rental rates down 1.1% year-over-year and SFR rental rates up 3.8% year-over-year, SFRs have become a new profitable, sustainable, extended-core asset type.

Compared to multifamily rentals (MFR), SFRs also have higher tenant stability. From 2013 through 2018, tenants of SFRs had a 70% retention rate, while tenants of MFRs had only a 50% to 53% retention rate. This retention rate, together with the tendency for larger median household sizes and higher median household income, has led to the stability of the SFR asset class.

Build-for-Rent

Investors looking to enter the SFR market segment generally do so through scattered purchases or developing (or acquiring) build-for-rent (BFR) communities.

With constrained housing inventory and a shift toward permanent remote work, BFR communities present more opportunity in secondary and tertiary markets, as workers migrate farther from city centers. BFR communities are attractive to portfolio-level investors because they are easier to underwrite, have a low cost of capital, and are more efficient to operate.

BFRs are typically smaller and less expensive to build than new for-sale homes. Through BFRs, builders can scale faster, and investors can buy more inventory. In 2020, developers were on track to reach 55,000 to 60,000 new rental housing construction starts, compared to 40,000 in 2019, and a range of just 15,000 to 20,000 a few years before. Rental housing construction is expected to be the fastest-growing market segment and we expect over 100,000 BFR homes to be delivered in each of the next three years.

Challenges with valuations

Since SFR ownership has largely skewed toward individual properties, valuation estimates are traditionally completed on an individual scale. Historically, SFR investors relied on a Broker Price Opinion (BPO), a real estate broker’s estimate of the home’s value. The primary deficiency of a BPO is that it doesn’t reflect the actions of institutional buyers. SFRs are income-producing assets and they are purchased based on their ability to generate cash flow and returns.

As SFRs continue to be the preferred choice for many renting families, they are an increasingly attractive extended-core asset type for investors. While a BPO may suffice for a “mom-and-pop” investor buying a single property, this presents a challenge for an institutional investor attempting to scale.

Scalable valuation solution

Altus Group presents an alternative to the BPO and single-asset valuation models with the Discounted Cash Flow (DCF) technique. Through DCF, investors can determine the market value of large-scale SFR portfolios more quickly and accurately.

The DCF model is executed by a real estate appraiser and values a portfolio of properties together. This results in the cash layout to achieve the desired ROI and allows for comparison between SFR and other asset types in the investor’s portfolio.

The SFR valuation team at Altus Group provides its services for over 6,000 SFRs every quarter and uses a proprietary data platform that analyzes over 1,600 data points for every property.