Will Big Investors Buy More Single-Family Rental Homes?

April 16, 2014

Real estate investment trusts, hedge funds and private equity firms have snapped up 200,000 distressed homes and turned them into rentals over the past few years, hoping to generate returns via yearly cash yields north of 6% and long-term home-price appreciation.

But according to the National Rental Home Council, a new trade group established to represent large-scale investors in single-family housing, they control only a fraction of the estimated 14 million homes in the single-family rental market. The field is still dominated by small players — individuals and ad-hoc groups of small investors.

Large-scale landlords have nevertheless made their presence known. They're still probing whether rental homes can act as a bona-fide, sustainable asset class. They also pose deep-pocketed competition to smaller-scale landlords in the local markets where they operate. Renting's Public Face

Three house rental firms — American Residential Properties (ARPI), American Homes 4 Rent (AMH) and Silver Bay Realty Trust (SBY) — have raised $1.4 billion in initial public offerings since late 2012. In January, Starwood Property Trust (STWD) spun out Starwood Waypoint Residential (SWAY). All are publicly traded REITs that must distribute at least 90% of their income in dividends.

Other big single-family rental landlords are Blackstone Group's (BX) Invitation Homes unit and private Colony American Homes.

The IPOs and the recent emergence of a single-family rental securitization market, in which a landlord backs a bond sale with a rental income stream, represent bellwethers for the relatively young industry, says Stephen Schmitz, CEO of Scottsdale, Ariz.-based American Residential, who launched his homebuying strategy in 2008.

"When we first started buying homes, it was so brand-new that it took a lot of education" for Wall Street to understand the concept, added Schmitz, whose firm acquired roughly 4,300 single-family properties last year for $582 million, increasing its portfolio to more than 6,000 homes in Arizona, Texas, California and other states. "Today everyone knows the story, and the people who have spent time on it know that it's a real business and a growing business.

Some real estate investors remain wary of the single-family landlord strategy. The niche's lack of a track record poses a challenge in gauging asset value, rental rates, capital-improvement expenses and operating and management costs, said Scott Crowe, global portfolio manager at Philadelphia-based Resource Real Estate, a direct investor in properties and real estate securities.

"The idea of single-family rentals as an asset class is still unproven," he said. "That doesn't mean that it's not a good opportunity ... if demand is there, professional management may have a better outcome.

Wall Street appears uncertain, too: Shares of public companies in the single-family homes market are trading below or around their respective initial offering prices.

In a display of confidence, though, institutional investors have forked over $1 billion in debt to Colony American and Invitation Homes over the last six months in two single-family rental securitizations, a vehicle providing the landlords with low-cost financing to pursue more acquisitions.

Earlier this year, a Deutsche Bank analyst writing for the Commercial Real Estate Finance Council predicted the landlords could sell up to $5 billion in securitized bonds in 2014.

"Everyone in the space is looking at it because it's an efficient way to get money," said Schmitz, whose company has hired Deutsche Bank to explore potential securitization.

Narrowing Focus

Even with fresh coffers of cash, big single-family landlords have acknowledged that they'll need to adjust acquisition strategies in light of the improving housing market.

Property researcher CoreLogic notes that U.S. home prices notched a 24th month of year-over-year gains with February's 12.2% rise.

Landlords can still buy homes under replacement cost in some areas. But after their buying flurry of recent years, most big operators now focus on operations and management — prepping houses for renters and increasing occupancy.

Some REITs have already witnessed hefty price appreciation in certain markets, but REIT rules make them hold the homes for two years before disposal. Schmitz and Silver Bay executives note that harvesting the gains for redeployment may makes sense.

On a year-end earnings conference call in March, Silver Bay executives noted that the supply of cheap homes in its Western markets had all but dried up and that they would look in Florida, Texas and Atlanta. American Residential plans to "drill deeper" for deals in Atlanta and other communities where it wants to build critical mass, Schmitz says.

Competition has also stiffened at some foreclosure auctions. In Las Vegas, for example, auction homes sold for an average discount of 13% to market value in 2013, down from a discount of 24% in 2011, according to Irvine, Calif.-based RealtyTrac, an online marketplace for foreclosure properties.

Not only does the bidding competition affect potential profitability for institutional investors, but along with rising home prices, it also makes it tougher for local landlords to compete, said Daren Blomquist, a vice president at RealtyTrac.

"There are much thinner margins at foreclosure auctions, which is the primary place that institutional investors, at least, started out buying homes and where your mom-and-pop investors are buying properties," he said. "That's a pretty clear indication that the profit margins are being squeezed for smaller investors."