“Single Family Rental Communities in a Recession”
/By Brett P Holmes, Managing Partner
If you are anything like us, you are probably confined to your home seeing constant headlines about COVID-19 and its effects on literally everything. Unemployment is rapidly rising. The stock market is volatile. Travel has stalled. Nobody knows when this is going to end. Maybe this summer, maybe next year.
As real estate investors, that means that we have to explore scenarios to see how our favorite real estate sector - single-family rentals (SFR) - will fare in this market environment. There’s a lot of factors at play, so by no means is this an article on what to do or what will likely happen. The purpose of this piece is mainly to touch upon what a SFR is and how the asset class might perform during a prolonged recessionary environment.
To start, let’s talk about what a SFR is. If you’re a SCM investor or an active investor in the real estate space, you probably already know what we’re referring to. SFR’s have been an investment asset type for hundreds of years. However, it wasn’t until about a decade ago that they emerged as an institutional-grade sector within the real estate investment world.
Following The Great Recession of 2007-2009, thousands of homes were acquired at pennies on the dollar by large institutional investors who saw an opportunity to buy individual homes at a fraction of replacement cost. The yields were huge, but the risk also seemed high.
Fast forward to today and SFR’s are a well-established institutional asset class with major, multi-billion dollar players like Invitation Homes (INVH), American-Homes-4-Rent (AMH), Colony Starwood, Tricon American Homes, and many more. Combined, these groups are public and private and they own hundreds of thousands of SFR’s, yet they only possess a small percentage of the overall U.S. supply.
Before we dive into how these investment portfolios will perform in a contracting economic environment, let's differentiate between two main types of SFR’s.
Single-Family Rental (SFR) Portfolio: As described above, most SFR portfolios consist of scattered homes throughout varied geographical areas. The bulk of the SFR stock owned by AHR, INVH, and others are these types.
Tenant: Demographic profiles run the gamut, but most are households with low-medium income. Historically, most homes were purchased with price being a major factor and therefore we consider many of these tenants to be renters-by-necessity.
Location: Sites are scattered and homes were often acquired in a large portfolio. Management is difficult. Operators must build large economies of scale and employ tech-driven management systems to achieve healthy yields.
Appeal: The living experience appeals largely to families and multi-generational households. A house is better than an apartment because residents can enjoy more privacy and space.
Durability: Generally speaking, these homes tend to be older construction with deferred, more frequent maintenance.
Amenities: Most homes do not have access to specific amenities beyond their yards and nearby parks.
Built-For-Rent (BFR) Community: On the other hand, BFR communities consist of newly constructed subdivisions of homes designed specifically to be rented. While there is a spectrum of different BFR communities as well, many tend to be in higher end, affluent suburbs. Rising land, labor, and material costs have made it difficult to make economics work in lower rent environments.
Tenant: Profiles tend to be higher income households in order to meet new construction rents. Largely, we consider these tenants renters-by-choice since the largest demographic of tenants are the Millennial generation who can afford to buy a home, but prefer to rent. It’s “lifestyle as a service” and nearly all generations value its convenience and affordability.
Location: A single subdivision site, much like an apartment building. Management is simpler and more cost effective, especially from a maintenance perspective, and developers typically hire professional management.
Appeal: Residents get the living experience of a brand new single family home without the commitment, expense, risk, or maintenance responsibility.
Durability: Homes are nearly new, if not brand new. Maintenance is expected to be minimal for years to come.
Amenities: While some communities do not offer amenities, many do (including ours) and the amenity packages are designed to mirror those of Class A multifamily projects that exist in the cities.
Now that we’ve established the differences between SFR portfolios and BFR communities, let's talk about the current economy and how these investment properties are affected. Generally, we consider a “recession” to be an extended period of economic contraction. Output drops, stock prices fall, unemployment rises, etc. But how does that affect your SFR or BFR investments?
The key factors in a recessionary economy for landlords are rent collection and occupancy. Any meaningful change in the economy will have an impact on these two factors, which directly hit the bottom line. In a scattered SFR portfolio with lower income tenants, rent collection can be an issue. But, remember that many of these rental homes contain families. Families in SFR’s stay for much longer than apartments, averaging 7-8 years in fact. Heads of household will typically do everything that they can to keep their family in place. Since lower end SFR’s are mostly capped at supply, we don’t see a likelihood of vacancy rising too quickly.
On the other hand, for the BFR investor, communities are located in affluent suburbs where the tenants are choosing to rent (like ours in Maple Grove and Plymouth, MN). The alternative is often a home that costs $400,000 or more. In some ways, tenants in a BFR product have chosen the cheaper option: to rent rather than to buy. If anything, during a poor economy, individuals and families would rather rent and therefore BFR serve as a fallback or alternative to buying. We view this as a neutral factor however because if unemployment rises and wages drop then some residents may have to drop back to apartments.
In a weaker economy, rents are fixed or reduced, but tenancy in BFR communities has proven to be strong given its positioning within more affluent neighborhoods. In our experiences, supply is severely limited and the demand is strong. Current occupancy across BFR communities nationwide is around 97%. With SFR’s, it’s closer to 94%. We do expect some downward pressure on occupancy levels, but given the relative lack of supply, neither SFR’s nor BFR will experience the competition observable with multifamily apartments.
Finally, let’s consider the effects of COVID-19. While much has left to be seen and we don’t know the full extent of its effects, we do know that there will certainly be changes in consumer lifestyle habits and how people live. The migration into urban environments over the last decade has hit an inflection point and the Millennial generation in particular will continue to head back to the suburbs. As health and safety concerns come to the forefront, both renters and buyers will place even greater value on privacy and outdoor space.
People are still worried about the economy, however, and it’s difficult to say where home prices will be in the next several years. Our BFR offers a solution to all of these considerations. Individuals and families are able to maintain the lifestyle that they want without the commitment, expense, and stresses of home ownership. Residents gain the luxury of privacy and the newness of a BFR community. The amenity packages (in some cases) rival those of the Class A multifamily complexes from which many young tenants have experienced in the city.
From the investor’s perspective, BFR communities attract strong tenants often with high incomes ($125,000+ in our communities). Tenants often desire longer term leases because they plan to stay. All of our BFR homes offer a two-car garage and so tenancy becomes much stickier. Therefore, turnover is much less than equivalent apartment buildings. Although occupancy and rents have not been fully tested in BFR communities through a deep recession, we believe that there are many reasons to feel confident in an income stream that we anticipate to win out over multifamily and traditional SFR portfolios.
Wrapping it all up, it’s important to point out that we still do not know what is going to happen in the immediate future. As real estate investors, it’s our job to protect the value of our existing investments and to consider factors that affect the security of those income streams. As the economy moves through uncertain times, we will continue to monitor any material changes in the value of our private real estate investments.
We believe that built-for-rent communities will expand at a slower pace until the capital markets resume investment activity. We value the optionality inherent in these investments and the value that it offers to its residents. We anticipate steady returns throughout a trying time for many other asset classes like hospitality, office, retail, and even multifamily. Both SFR portfolios and BFR communities are here to stay and we believe that all investors should consider devoting some portion of their investment portfolios to this sector.
To learn more or stay up to date on our investment opportunities, please contact us at info@steelcitymgmt.com or sign up to the monthly newsletter for more content and regular updates!
Wishing you all the best,
Brett P. Holmes, Partner at Steel City Management LLC