As co-CEO of Starwood Waypoint Residential Trust, Gary Beasley knows that traditional multifamily operators remain skeptical of his firm’s business model.
How can a scattered collection of single-family homes possibly deliver any of the same management efficiencies and, by extension, financial returns of a similarly sized apartment portfolio?
The affable Beasley sounds like he’s smiling on the other end of the phone. “It will take a bit of time to prove this market in the public forum,” he says mildly.
After all, Beasley, who oversees the public REIT and its Waypoint Homes brand with Doug Brien, are not planning on replicating the apartment industry in suburban form. Neither are they attempting to become the ultimate house flippers. Instead, they and their competitors are more interested in establishing a new institutional asset class—the single-family rental—for the growing number of Americans who no longer want the amenity-rich apartment lifestyle, but remain reluctant, or unable, to commit to a 30-year-mortgage.
The niche also appeals to institutional investors, many of whom are throwing big money behind the idea that Americans like getting more room, without giving up mobility, by renting single-family homes owned and managed by real estate professionals.
Just look at the players involved. Waypoint merged with Starwood Property Trust before going public earlier this year; it now has 7,200 homes in seven states. Other big players include Colony American Homes, which was launched by Colony Capital in 2012 and now has 16,000 homes for rent. But the top spot belongs to Dallas-based Invitation Homes. With its 44,000-house portfolio and the backing of global real estate powerhouse Blackstone, the venture is doing its best to prove the skeptics wrong.
“Two years ago, everyone said there was no way to buy 45,000 houses, but we bought them,” says Devin Peterson, a real estate associate with Blackstone. “They said we were not going to be able to lease them up, but we leased 27,000 new properties over the past year, and 97 percent of our properties are leased within 60 days. Everyone said we were not going to be able to manage this business. But our renewal rate is 70 percent.”
He adds: “We do believe this has the opportunity to be a long-term business.”
Of course, single-family rentals are not new. Single-family detached homes actually compose 35 percent of the country’s rental housing stock, according to Harvard University’s Joint Center for Housing Studies. So, nearly 15 million homes already exist as rentals, many of them owned by individual, rather than institutional, investors.
“It’s already a very large market, and it’s gotten larger over the last few years,” Beasley says of the single-family rental option. “People want more flexibility for their jobs and not have their eggs all in one basket.”
Buck Horne, a housing and REIT analyst with Raymond James in St. Petersburg, Fla., concurs. Single-family renters, he notes, are the fastest growing household type in the country, surging 27 percent since 2008 to 13.7 million today.
“This dramatic shift was born of an artificially inflated homeownership rate and subsequent foreclosure crisis, but, importantly, we believe these shifts are not transitory,” Horne says in a recent research note on American Homes 4 Rent, which went public in 2013.
Horne points to several reasons for this contention: concerns about tighter mortgage lending standards, higher student loan debt, changing attitudes about homeownership versus renting, and the need for many workers to stay mobile if they want to remain employed, which he sees as a new stage on the traditional American path from apartment renting to buying a house.
“From our perspective, these are tectonic shifts that will continue to create a growing need for young households with children (or large pets) to seek an intermediate step before qualifying for homeownership; i.e., the single-family rental,” Horne says.
The smart money appears to agree, at least for the foreseeable future. Blackstone, through Invitation, has spent more than $8 billion to build its portfolio. Waypoint dropped more than $318 million in just the first quarter of 2014 to purchase almost 2,000 homes. Colony American in April completed a deal that packaged the income and real estate values of nearly 3,400 rental houses into $513 million worth of securities.
The potential market for single-family rentals is a bigger demographic than many realize. According to various tabulations of Census Bureau data, approximately a third of today’s rental population is composed of two-parent or single-parent families with one or more children.
But as much as this group may want to rent, they may have a hard time finding a new multifamily property that fits their needs for more bedrooms, access to green space, and quality public schools. After all, in the past decade, Gen Y’s embrace of urban living has pushed multifamily developers to build high-density properties in prime city locations close to work, shopping, and restaurants, with rents to match.
These newly constructed rental units also have remained modestly sized. The median square footage of new multifamily rental units has hovered at just more than 1,000 square feet for every year since 1999, save one, according to the Census Bureau. (The lone exception happened in 2011, when the figure surged to 1,117 square feet.)
Single-family rental firms believe those factors are allowing them to experiment with a new asset class that occupies the middle ground. “We believe we are creating a property that is complementary to apartments,” Waypoint’s Beasley says. “We can offer an alternative to people who would otherwise be first-time home buyers.”
Others aren’t so sure. “I believe those living in single-family dwellings will generally prefer to own the home if they can,” says Dave Bragg, a managing director with research firm Green Street Advisors. “I don’t believe a secular shift away from renting [apartments] has occurred.”
Local Critical Mass
Much of the attention on single-family rental firms has focused on the size and reach of their deals, thanks to the 2012 decision by the Federal Housing Finance Agency to begin selling distressed assets in bulk. But that discussion has often overlooked how these companies are evaluating and reshaping those portfolios for their own use.
“One of the interesting things about this market is that it is so granular,” Beasley says. “If we buy a group of 400 homes, we may decide to sell 10 percent to 20 percent of them and relocate the capital.”
What type of homes are these firms keeping for rental purposes? It’s remarkably consistent, given the variety in the housing stock, but according to single-family rental executives, the ideal asset is a three-bedroom, two-bathroom house in a good school district and close to jobs. “You get greater long-term appreciation,” explains Peterson of Blackstone, which prefers its rentals to be located in infill neighborhoods over new exurban communities.
Not only are many of these rental properties older than some might expect, they also tend to be smaller and more humble. In contrast to apartment firms that have become accustomed to luring the affluent renter-by-choice with high-end properties, companies like Waypoint are interested in moderately priced homes.
“We like three-bedroom, two-bathroom homes with 1,700 to 1,800 square feet in middle-class neighborhoods with very high rental demand,” Beasley says. “Once you get above a $250,000 home price, your rental yield tends to be low.”
The next challenge for these firms is achieving some economy of scale. “If you have enough concentration in a market, then you can do it,” says Rick Graf, president of Pinnacle Management, which oversees more than 135,000 multifamily units and has considered entering the single-family management business, as well. “But if you have a scattered-site concept, then from a maintenance and leasing standpoint, you have got to have a solid network, otherwise it is going to be very operationally challenging.”
Single-family firms agree and say their acquisition and management strategy takes that reality into account. “We didn’t want to buy a portfolio of 3,000 homes scattered around the country,” says Peterson. “We are highly concentrated in 14 markets. We don’t have any markets with less than 1,000 homes, and in 12 of the 14, we have at least 2,000 homes.”
Bragg approves of such efforts. Institutional single-family investors are “smartly focusing on achieving economies of scale and providing a high level of customer service,” he says, noting how the sector is borrowing many of the multifamily industry’s best practices.
At Waypoint, the threshold for a minimum number of homes in a market is lower—just 250 homes—but the company relies on technology to make it work. “This business could not be run without heavy use of mobile and cloud technology, which allows us to minimize ‘windshield time,’?” says Beasley, referring to the time that maintenance workers and other employees might otherwise have to spend driving between the office and various properties.
The comment illustrates how these firms, as young as they are, have quickly embraced the power of technology to create an efficient operating platform. Invitation Homes, for example, encourages residents to apply online, view photos of available homes, pay their rent, schedule maintenance requests, and renew their lease. What doesn’t Blackstone have? Revenue management software for its 44,000-unit portfolio—but they’re working on it. Waypoint already has its own proprietary revman system, basing it on the firm’s own rent data and third-party sources.
“There’s no off-the-shelf product for this market,” says Beasley. “Single-family rentals are much less of a commodity than apartments. You can have five houses in the same neighborhood, and they’ll all have a different floor plan and a different vintage.”
Such investments in asset acquisition and property management are producing results. Single-family renters, who tend to be more tied to schools and neighborhoods, are staying longer than the traditional apartment renter; retention rates hover around 70 percent on these properties, which leads to lower leasing and make-ready costs for single-family firms. Meanwhile, rents are on the rise: Peterson says Blackstone is seeing 4 percent rent growth.
“Rental rates for single-family homes are about 30 percent less than the comparable multifamily rents on a square-foot basis,” he says. “That might have been the right gap when this was a mom-and-pop business, but now, with institutional management, I think that gap should compress.”
Despite the investments single-family rental firms have made in their operating platforms, though, analysts and others still wonder if this business will survive into adulthood. After all, the institutional sector didn’t even exist a decade ago because it wasn’t seen as an attractive investment.
“From an investment perspective, it remains unclear that single-family rentals will be attractive to institutions in a normalized housing market,” Bragg says. “I think that there will be large single-family rental property management firms to fulfill the needs of small mom-and-pop investors, who have always owned single-family homes. [But] because single-family homes have historically been more valuable to owner–occupiers than investors, it is unclear that large ownership groups will exist in 10 years.” But there’s no clear exit strategy for these companies and their investors, either. “This remains to be seen,” says Bragg. “It could be individual home sales, stay private, or [an] IPO.”
Unfortunately, several of the IPOs for these firms have been disappointing, despite the fact many of these ventures, including Blackstone’s Invitation Homes, are being built to be “IPO-ready.” American Homes 4 Rent, for example, expected to raise $1.25 billion through its 2013 IPO, but it fell far short of that goal, generating just $706 million. Colony American planned to go public in 2013 but has postponed its IPO indefinitely. Waypoint Homes also delayed its intended IPO, going public in 2014 only after merging with Starwood Property Trust.
There are other options besides IPOs. Just as multifamily owners do, these institutional investors could sell their portfolio (or segments of it) to other institutional investors as an operating business. They could dispose of homes that have seen strong real estate appreciation or whose markets have weakened. They could also sell these homes to owner–occupiers or smaller investors.
“We intend to hold these assets for a long time, but we are constantly looking at the value of the home versus the income it generates,” says Beasley. “It’s a capital allocation exercise … if something makes a good rental home, then we’re going to be looking to keep it.”
If none of those work, these firms could just sell the properties. “The great thing about this business is that if a multifamily property loses tenants, it loses a lot of its value,” says Peterson. “The benefit of investing in a single-family home is that it doesn’t trade on a cap-rate basis. Even if it doesn’t have a tenant, it still has resale value.”
Alison M. Rice is a writer in Arlington, Va. She has covered residential and commercial real estate since 2000.