A healthy rental housing market is critical to meet the housing needs of a huge sector of our population. Multi-family properties, or apartments in layman’s terms, are an important sector of real estate. The multi-family sector provides housing flexibility for a variety of renters – young and old, renters by choice, as well as renters by necessity. At Kaufman Capital Partners, we like multi-family as an investment class because of the strong demand drivers and revenue diversification of having many renters. And like other investors, we have enjoyed and perhaps have been spoiled by the large returns achieved earlier this cycle in the apartment sector.
Often times, the real estate industry talks about housing statistics in a misleading way – as if there is only for-sale housing and multi-family rental housing. However, according to a study by Freddie Mac, there are nearly 43 million renter households in the United States. Of that number, only 18 million households live in multi-family (aka apartments). The reality is that the other 25 million renter households – or approximately two-thirds of the rental housing stock in this country – is actually in single family rental (SFR) homes.
Why is this even important? And why aren’t more smart people focusing on the single family rental sector?
First, I’ll tackle why it’s important. According to a recent Freddie Mac survey, only eight percent of traditional multi-family apartment units have three bedrooms (or more), compared to 60 percent of single family rental houses.
In many areas, if not most, apartment properties aren’t ideal living situations for families with children. Apartments work great for singles, couples and sometimes even couples with very young children, but then life gets more complicated. Obviously, some core cities such as New York City, for example, see exceptions to typical housing patterns seen in the rest of the country due to density, walkability and popularity. In addition, many economically challenged families are in the “renter by necessity” category and live in apartments. With all that said, most multi-family projects do not really cater well to the needs of families.
Market surveys show that SFR tenants strongly desire the privacy offered by a house with a yard and they really don’t want to have someone live above or below them. Single family rental housing has higher retention rates than apartments, as their residents become more tied to schools and neighborhoods. They have an industry retention rate of 70 percent compared to 50 percent in multi-family. So the question you might be asking is, why isn’t this category of renters buying houses?
A recent Freddie Mac research study finds that a large and growing segment of renters continue to believe renting is a more affordable option than owning, even as many renters are feeling the squeeze of rising rents. A Federal Reserve Study (published in January 2019) has linked rising student debt (now $1.5 trillion) to a drop in homeownership rates. Despite relatively low interest rates, many families are still unable to save a sufficient down payment to buy a house or have enough reserves for deferred maintenance when things break down. In other cases, people rent houses as a flexible choice, often due to more frequent job changes and mobility needs.
So why aren’t more people focusing on the single family rental sector? Unlike multi-family, where a critical mass can be found on one property, the operations of single family rental are much harder to streamline. The use of technology and operating systems are very important to obtain high net margins. Despite this, we believe the investment thesis for single family rental is very appealing, but the execution can be challenging. While this industry is very fragmented, it presents tremendous opportunities. Only one percent of the entire SFR market place is controlled by institutional players. In other words, about 99 percent of rental houses in this country are owned by “mom and pop” operators who don’t have economies of scale. We expect new institutional players will continue to emerge and consolidations will continue to occur for many years to come. As the Single Family Rental sector matures, we believe cap rates for large SFR portfolios will fall.
Single family rental is an investment strategy we like and we have invested in it using different structures. For example, we’ve taken an equity position in a private SFR company in the Midwest, which, over the past decade, has grown from a few individual rental houses to several thousand houses by streamlining and institutionalizing its property management. In another example, we provided a working capital facility to a fast growing SFR platform that had institutional capital relationships for large SFR portfolios. However this platform had a need for working capital to grow and was liquidity constrained due to large investments it was making in its state-of-the-art operating infrastructure.
It’s not an easy business. And, of course, there is a good reason why: It’s much easier for institutional money managers and their operating partners to place large chunks of money in the multi-family property sector compared to the single family rental sector. Thus – the challenge, thus the opportunity. The SFR industry is still in its early stages and we believe that this space will continue to become more institutionalized in the coming years.
Stay tuned for future blogs as we continue to explore other investment strategies that we believe have solid fundamentals. As always, please call (404-816-5534) or write (ckaufman@kaufmaninc.com) and let me know what you think.