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Single-Family Investment Goes Institutional (Slowly)

Posted on Mar 1 2020 - 9:17pm by 2!xMyNQ#FV8h4U
Institutional investors would hope to replicate the successes they have had in traditional multiifamily, but the pecularities of single-family rentals prove challenging to the industry’s largest players.

By IvyLee Rosario  ( Article

Whether it be Millennials, Gen Zers or even Baby Boomers, the number of renters increased by more than 23 million from 2006 to 2016, according to U.S. Census data. Today’s renter is looking for flexibility and a high level of service, so successful ventures in the single-family segment come with a series of unique challenges. As a result, few seasoned investors are willing to make a long-term commitment to this emerging sector. A Freddie Mac report published at the end of 2018 showed that only 1 percent of all single-family rental homes or approximately 188,000 properties were owned by institutional investors. On the other hand, roughly 88 percent were owned by very small investors with portfolios of 10 houses or less.

“The challenge right now is getting people used to the fact that this is a viable option for creating a housing product that is attractive and well accepted by lenders and long-term purchases,” said Brian Pearl, principal at Global City Development. In December, the company partnered with alternative investment firm Leste to launch a $2.5 billion housing platform that aims to deliver 10,000 single-family rental homes across the U.S. over the next five to seven years.

?w=300&h=225″ alt=”Atlanta, GA. Image courtesy of TriCon Capital” width=”300″ height=”225″ data-toggle=”lightbox” data-footer=”” />
Atlanta, Ga. Image courtesy of TriCon Capital

Multifamily investors and developers started looking into single-family rentals following the downturn, noted Jonathan Ellenzweig, senior managing director at Tricon Capital. “That downturn has facilitated the ability for ourselves and our peers to begin buying homes at a faster volume and build, scale and develop operating efficiencies,” he said. His company’s SFR vertical, Tricon American Homes, was founded in 2012 and last December it acquired 708 rental homes in Nashville, Tenn., for $210 million.

In recent years, the turnover rate in the SFR market appeared high, but that’s not something to be worried about, Pearl explained. “Some of these investors come in right when buying is very cheap and they know they’re going to get a capital appreciation and then exit,” he said. “It’s just a sign of what their original business plan was.”

Similar to multifamily, there are two main types of business plans for single-family rentals—the sprinkled model and the long-term venture. The first refers to acquiring properties to be turned around quickly as value-add projects and then selling versus developing or acquiring larger portfolios to hold onto as part of a long-term investment strategy.


?w=300&h=204″ alt=”Image courtesy of Global City Development” width=”300″ height=”204″ data-toggle=”lightbox” data-footer=”” />
Image courtesy of Global City Development

Business plans aside, management is another essential point in this niche market. In multifamily, traditionally, there is onsite leasing staff that handles apartment tours, service requests and maintenance issues. However, this is not the case for single-family. A portfolio can comprise properties across multiple cities or states, without a centralized system connecting them. Even if the assets are part of a larger master-planned community, the chances of there being onsite staff are slim due to the complexity of residents’ needs.

Ellenzweig noted that communication is key and that in the past, residents in single-family rentals would have to track down individual landlords who then would have to track down services to fix whatever the issue was within the home. An example of a solution for this would be TriCon’s resident call center. This consists of staff located within that specific city or state that can answer resident inquiries about rent or maintenance requests. There are also apps that can simplify communication between residents and management, with a broader implementation of smart home technology throughout the properties. This goes back to creating a more flexible environment while also operating more efficiently.

?w=300&h=210″ alt=”Image courtesy of Global City Development” width=”300″ height=”210″ data-toggle=”lightbox” data-footer=”” />
Image courtesy of Global City Development

“Location, quality, physical attributes and management are all very important drivers of value and return,” said Hamilton. “Sophisticated use of technology has enabled the best single-family rental operators to achieve margins comparable to those of the best multifamily operators—and there is likely more growth in those margins given the relative newness of the space.”

Unlike multifamily, there are not as many options for professional management companies that have abundant experience within this sector. “You can swap out managers in multifamily easily and with a wide range, but that doesn’t exist for single-family rentals,” said Ellenzweig.


?w=300&h=200″ alt=”Charlotte. Image courtesy of Pretium Partners” width=”300″ height=”200″ data-toggle=”lightbox” data-footer=”” />
Charlotte, N.C. Image courtesy of Pretium Partners

Institutional investors’ interest in SFR has been rising proportionally to Millennials’ desire for the producs. According to Pearl, those between the ages of 25 to 44 are mostly interested in rental housing, as they want the flexibility to change houses or cities, without worrying about the cost and illiquidity of owning a home. There’s now a larger demand for highly amenitized master-planned communities that will serve people that once lived in Class A apartments in downtown areas. “We want to give them that same sort of lifestyle at a lower cost per foot,” he said.

The phenomenon of urban living in the suburbs has been described as “hipsturbia” by PwC and the Urban Land Institute in their Emerging Trends in Real Estate 2020 report. Basically, it’s live-work-play, walkable communities located in the suburbs instead of downtown areas. Hipsturbia is expected to spread around hip, lively cities with vibrant cores and an influx of young residents. The research mentions Evanston, Ill., and Tempe, Ariz., as such cool suburbs.

?w=300&h=200″ alt=”Houston. Image courtesy of Pretium Partners” width=”300″ height=”200″ data-toggle=”lightbox” data-footer=”” />
Houston. Image courtesy of Pretium Partners

The appeal of SFR investment also lies in the asset class’ versatility. For example, with development, there are different potential exits. Pearl notes that if you see the market take off and prices increase faster than rental values, there’s the possibility to transition into a for-sale property or divide the assets and offer for-sale and rentals within the same community.

While the sector does not lack opportunity, expertise is essential. Knowing where to be geographically, choosing the right partners and deciding what type of investment strategy to implement are key for success.

“There is room for several players at this point,” added Pearl. “Single-family rentals require a different skill set than when it first started eight to nine years ago, but there is a lot of stability in terms of constructing a business around this.”

as the major threats to the affordable housing supply?

Ptomey: The major challenge is that in many areas of the country you see household formation and job creation at a faster rate than the housing that is being produced. Since we have substantial shortages, supply continuing to lag and not meeting demand forces prices to go higher and higher. Getting cities to plan to produce the amount of housing they need is a continuing challenge and a big driver of challenge in many parts of the country. In many higher-cost cities, a need to preserve any affordable housing that is currently there is a challenge, as well. Having sufficient production to meet demand is most important. Needs to be forward looking.

Khidekel: There are a lot of structural issues prohibiting supply. The cost of construction is up around 81 percent this cycle relative to the last. Class B construction has declined from 61 percent to less than 20 percent of new supply. There is an oversupply on the high end of the housing spectrum, despite the fact that over two thirds of the U.S. workforce earns under 80 percent of the Area Median Income. (Meanwhile,) 96 percent of what’s being built requires an income of $75,000 annually.

Hayward: The first threat is that there won’t be enough apartments for people of modest (means). Everything getting built is Class A, high-rent, in major cities. If you’re (willing) to pay high rents, you’ll have an apartment, but (who) is left behind is the local (firefighter), barber, cook, police officer. For them, there are not as many apartments.

Part of that is (the combination of) things happening in the marketplace: the three L’s. First … land is really expensive. The cost of labor is the next issue, where there isn’t an ample supply of labor and the labor in place is aging. Last thing is law–what it takes to get something new built out of the ground. We have to solve those three problems. There are programs in place trying, but that’s not for the middle income. There isn’t a place for them, and that’s the biggest threat.

Burns: A rise in interest rates. In September, we saw overnight short-term rates briefly spike to over 10 percent. This was due to a temporary lack of liquidity and has since been addressed by the Federal Reserve.

Diminished supply of soft money; most affordable housing transactions have multiple sources of funds in the capital stack. Failure of Congress to pass all or part of the Affordable Housing Tax Credit Improvement Act; the bill would expand the housing credit by 50 percent and increase existing incentives to encourage developers to build rental homes affordable to extremely low-income households and to families in underserved rural and tribal communities.

Lastly, new Community Reinvestment Act regulations that affect the amount of capital available for preservation and development. Because bank investors in Low Income Housing transactions can receive the added benefit of meeting their obligations, they will pay a premium for these CRA area LIHTC credits and add much-needed equity to the sources of funds. Any effort to relax the CRA standards would tend to evaporate the premium banks pay for the CRA credits.

What encouraging signs of progress do you see in the private and public sectors?

Ptomey: I think what’s most encouraging in the public sector is the level of attention housing is getting these days, (from) mayors and city council members, even in the recent Democratic (presidential candidate) debates. It certainly hasn’t been an issue that got attention in the past. It’s encouraging to discuss it more, but what’s behind that is a larger challenge. Public policy changes over time will address these housing needs, like zoning changes. From a development perspective, we see them adjusting to provide product at a lower price point to repair the housing ladder.

Burns: There is a greater interest by institutional investors in affordable housing. For example, technology companies Apple, Google and Facebook have each announced large financial commitments to expand the inventory of affordable housing by direct investment outside of making LIHTC investments. (Another sign is) renewed allocations for affordable housing at Fannie & Freddie. To ensure a strong focus on affordable housing and traditionally underserved markets, FHFA directed that at least 37.5 percent of the Fannie and Freddie multifamily business be mission-driven, affordable housing. More emphasis on health and housing–some truly encouraging and positive steps are that major businesses and healthcare providers such as Kaiser (Permanente) and UnitedHealthcare are eager to help provide additional housing by providing capital apart from investing in LIHTC. These are most welcome investments as they may pair well with our usual capital sources to expand and grow the housing stock.

What more needs to be done?

Khidekel: There needs to be more institutional equity capital. There are lots of lending solutions, like the Community Development Financial Institutions and nonprofits stepping in to provide incentives, but that’s focused on the lowest end of the population from an income perspective. The biggest need is in the missing middle. We need more focus on the preservation and rehabilitation of housing, which is the bread and butter of the U.S. workforce. Lastly, we need more capital focused on this space, as opposed to debt.

Hayward: I’m a big believer in public-private partnerships. Let’s deal with major cities, with more cooperation between local governments and business. If cities can think about costs of land and get that out of the way so developers can make more units, they can still make a profit. For the existing stock, it’s trying to stave off existing stock from obsolescence. Owners need to rehab properties to keep the supply online. More owners need to do this, and they have to do it in a green way. Be cognizant of energy savings and conserving water to keep costs down … so rents don’t go high.

Are there currently significant incentives for private developers to build and preserve affordable housing? 

Ptomey: I don’t know about incentives. There is opportunity in building affordable and workforce housing right now. What we’ve seen is diminishing returns on luxury in certain parts of the country, but you won’t get same level of return if building affordable/workforce.

Khidekel: No. When you just provide one incentive but not others for developers, it’s mathematically impossible to make that housing work. Opportunity zone legislation hasn’t done anything to help the market. When there is affordable associated, it’s a small component, usually under 30 percent. It’s so hard and expensive to build today that you can’t make the numbers work.

Hayward: The most successful is the LIHTC program. You get the benefit of a tax code. Some of the other things are more local, such as states issuing bonds, but in my view it’s all about tackling the three L’s (land, labor and law).

Burns: If we’re considering the incentives for non-LIHTC private developer, these are presently limited only to economic incentives. In the affordable housing space, we automatically default to 60 percent of the Area Median Income as “affordable” as that’s where the incentive lies. A private, non-LIHTC developer might do a fantastic job of providing “affordable” housing by renovating a Class C apartment and renting it to tenants at or below 60 percent of AMI without ever looking at the maximum LIHTC rents.

Apple is the latest in a series of giant tech companies that have made a major financial commitment to affordable housing. Do you think these private sector initiatives make a difference?

Ptomey: I think we’ll see more in the future as long as there is the substantial undersupply we see today. Companies want to ensure employees have access to adequate housing. It’s helpful to a company to retain its workforce, and if you get to benefit from that, then it’s great at the household level. But unfortunately, the scale of the affordability challenge right now is (such) that these investments won’t make a dent in the overall (deficit). It’s a great impact, but at the end of the day policies need to be in place, paperwork needs to be done. If regulations are not in place to enable investments to have the greatest impact, we won’t have a good opportunity.

Khidekel: We will see more of it happening. It’s promising because it’s adding appropriate attention to the crisis. There needs to be recognition in order that having a sustainable business is having a sustainable workforce. In California, there is a huge issue. The problem with this is 1) it’s localized to specific areas for them, which is not a scalable solution; and 2) in order to make this work, they’d need to partner with nonprofits and municipalities to focus on the lowest segment, but the most at-risk workforce won’t qualify for that type of housing.

What are some of the out-of-the-box solutions that you would like to see the private and public sectors pursue?

Ptomey: Not sure there are any approaches at this point. Where progress can be made is where citizens and developers can address (the obstacles) blocking what makes these properties affordable. Enable more housing on available land, looking at ways to reduce construction costs, manufacturing products, get economies of scale at work, addressing labor costs, anywhere you can get technological changes to reduce the cost around the edges will be great. You have to really look at a policy level: What is the entitlement process, can it be compressed, being able to know quicker if you can make that development or not.

Khidekel: One is construction methodologies. The U.S. is behind Europe and Asia for modular construction. Materials are either constructed in Poland or China, but less than 4 percent (of those materials) are modular. We need to take these concepts and apply them to the problem. Manufactured housing is another potential solution. The difficulty is zoning and entitlement, but there are ways to partner with local governments to create more.

Burns: Crafting creative public-private partnerships to shoulder the affordable housing burden is a solution rooted in past success and primed for the future. The industry currently benefits from the capital provided by a number of institutional investors. We recently partnered with Kingsley Associates to interview decision-makers in institutional investment on barriers to increased investment in affordable housing and some possible solutions. Takeaways included the discussion around government barriers providing the industry with an opportunity to work with top housing advocacy groups to lobby Congress to simplify the rules and look for a different set of benefits to encourage more pension fund investment; the affordable housing ecosystem needs to develop more tools to communicate accurate information and create more opportunities to present the data; those in affordable housing need to use creative and thoughtful storytelling—in addition to financial returns—to engage investors; less restrictive zoning, and zoning bonuses and tax abatements for meaningful commitment to affordable housing development; and (fewer) delays getting permits and approvals.

How will rent control impact the future of affordable housing? Will it help or hurt the situation?

Khidekel: It hurts affordable housing because it reduces the incentive to do business in that area for developers and general investors, (which focus) on income levels that are too high relative to where the biggest help needs to be. Rather than helping population at risk, it forces real estate participants to exit the market. It’s putting people out of business in the industry.

Burns: I think it will hurt. Under rent control, many fewer units will be built increasing, the demand for apartments, with more Class B properties being upgraded to get higher rents.

What are some solutions for affordable senior housing?

Ptomey: There are a variety of things. ULI’s Emerging Trends looked at senior housing, and one (finding) is that many more Baby Boomers want to age in place, so there are a variety of ways to help make that happen. One (solution) suggested was accessory apartments. If you’re living in a larger home, and at some point you want to make part of it into an apartment, you could have someone live in the home with you if you need care, or rent out the space for additional (income). A certain number (of seniors) do want to downsize and that (creates) some competition with younger, growing families looking for bigger homes. Having the missing middle typology is also messing with the need.

Hayward: Two things.  1) The LIHTC program has some age restrictions for developments. Looking at that would be a good idea for single-family seniors wanting to stay in their homes. 2) There are a ton of seniors buildings out there, but they are not part of developments where mostly seniors live. They should be more cognizant of how those buildings are financed and help with that.

Burns: HUD needs to reinstate payments for services to seniors. For (Section 202 properties), the rents must be escalated to current market rates to support preservation.