Institutional involvement in the single-family rental market was sparked by the opportunity created by the wave of residential mortgage foreclosures in the wake of the last financial crisis. Since 2009, institutions have gobbled up roughly 200,000 homes while securitizations backed by loans on single-family rentals have hit the street. As the wave of big, cheap portfolio acquisitions fade and the hard work of creating a new business model begins in earnest, the question is whether institutions found a new asset class on which to create a long-standing business? Or was it just a good trade that will enable early players to take outsized profits while latecomers get frustrated by compressed margins?
Analysts say the long-term prospects for the industry depend on a handful of factors, including whether institutional players can continue to grow once housing prices recover to more normal levels, whether attractive financing is available for large owners and whether it is possible to efficiently control the costs of managing single-family homes.
Jeffrey Langbaum, an analyst at Bloomberg Intelligence, notes that some buyers are positioning themselves to be in the business long-term, while others are looking to cash out when the time is right. It is still to be determined whether this is a viable operating business, he said.
Proponents of the long-term business model point out that single-family homes have been a staple of the rental market for many years. Some 14 million single-family homes in the U.S. are rented, which is greater than the 12.5 million multifamily units nationwide. According to a research report by Keefe, Bruyette & Woods, only 5% of single-family rentals are owned by companies with 100 or more properties and only 4% own more than 250. The potential for growth for institutional investors is great, especially since single-family rental homes have an estimated valued of $2.8 trillion.
Vulture investors jumped into the sector as early as 2009 after housing prices burst. Blackstone has been the most aggressive, spending roughly $8 billion to collect a portfolio of 43,000 homes via its Dallas-based Invitation Homes unit. Augoura Hills, Calif., based real estate investment trust American Homes 4 Rent is the second-largest player with 25,000 homes. Other opportunistic investors that have single-family rental operations include Colony Capital via Colony American Homes and Starwood Capital via Starwood Waypoint Residential Trust, a joint venture with Waypoint Homes.
A good deal of the initial consolidation came from the purchase of portfolios of defaulted bank loans. Now that banks have largely cleared out their bad-loan inventories, growth will be much harder to come by. Some growth by the largest owners will come through consolidation. For example, in early July American Homes 4 Rent added 1,300 homes by buying Beazer Homes, which was seeded by private equity firm KKR in 2012.
Other firms, such as Waypoint Homes, are developing systems to grow through targeted acquisitions. The Oakland, Calif., firm started buying homes that plummeted in value in the Bay Area in 2009, accumulating 4,000 homes via 10 private equity funds seeded with funds from private equity firm GI Partners. Starwood Waypoint Residential Trust, a REIT launched earlier this year in partnership with Starwood Capital, owns more than 8,500 homes and 2,000 non-performing loans.
Starwood Waypoint co-CEO Gary Beasley said that firms principals saw an opportunity to buy distressed properties in the San Francisco Bay Area in 2009. Waypoint Homes sponsored a series of funds, including one with $200 million of equity from private equity firm GI Partners that was the first significant private equity investment in the single-family rental space. Beasley said the firm didn't envision new markets when it started.
We suspected there was a chance this could be an institutional asset class, but our focus early on was the opportunity to buy homes that were $400,000 at the peak and were now $130,000, he said, noting that they spent an average of $20,000 per house on renovation costs. Whether it turned out to be a long-term business or not, we were confident that it was a good real estate investment decision, he said.
While some of the bigger owners will focus on portfolio acquisitions and mergers to grow, Waypoint is buying homes in a highly targeted manner on a one-off basis. The firm has developed a proprietary acquisition process that involves teams in metros in which it has a foothold. The firm's system involves ranking neighborhoods and identifying homes that are underpriced. Currently the firm is buying about 60% of its homes through traditional retail channels or through direct relationship, with the balance coming from auction purchases, although that mix is dynamic and changes along with market dynamics, Beasley said.
Besides the reduced availability of bulk acquisitions, another impediment to growth is pricing. Unlevered yields have fallen from 8-10% or more for the first wave of acquisitions to 4-6% today. When home prices were steeply discounted, institutions faced a much smaller risk. If the cost of maintenance was higher than anticipated and cash flow from rentals proved less than anticipated, the first group of buyers could take comfort from the fact that the value of the homes had grown significantly. Going forward, with home prices rebounding in most metro areas, the margin for error to meet target yields has diminished.
That means in order to survive, institutions will have to develop efficient systems to maintain and rent homes. The industry's critics point out that it is much easier to manage and maintain a portfolio of multifamily properties all in the same location than a portfolio of houses with a variety of different systems that are scattered by location. Three hundred multifamily units can be run by one manager, said Bloomberg's Langbaum. Whether you can run 300 single-family homes with one manager as efficiently is hard to say.
The industry's long-term prospects are helped by the development of the financing market. Until recently, only a small percentage of single-family rental homes were encumbered, says Gabe Weinert, a senior v.p. with Johnson Capital, which has developed a correspondent program with private equity financiers that have originated more than $150 million of loans on single-family rentals. Today, debt for single-family rentals is available from a variety of sources that include specialty lenders set up by private equity firmsnamely Cerberus Capitals FirstKey Lending, which started lending in 2013 and already has a closing pipeline of $500 million, Colony Capitals Colony American Finance and Blackstone's B2R Financeas well as a few small and regional banks.
Both B2R and FirstKey offer lending products for small borrowersFirstKey will lend on individual propertiesand large portfolios up to $500 million. Noting that single-family rental homes encompass some $2 trillion of value, FirstKey Lending CEO Randy Reiff said the market potential is huge.
FirstKey was the first PE-sponsored specialty lender to enter the space, and its owner Cerberus chose early on not to pursue the strategy of purchasing rental homes. We decided that the greatest opportunity for us was in financing the entrepreneurial and mid-sized borrower who have historically lacked the ability to grow because no financing was available, Reiff said. It's an enormously under-financed market and an excellent opportunity for us and our clients.
Securitization is providing another means to finance single-family rentals. To date there have been five deals totaling $3 billion that are backed by single-family rental homes. Another $3 billion to $5 billion of issuance possible by the end of the year, with up to three deals in the pipeline by early August. Jade Rahmani, an analyst with Keefe, Bruyette, estimates that there is a potential for $30 billion of annual securitizations.
All of the deals issued to date have been backed by single floating-rate loans: two to Invitation Homes, two to Colony America Homes and one to American Homes 4 Rent. There have been no multi-borrower deals to date, but several are being developed. FirstKey, for example, is in talks with rating agencies and is aiming to launch its first securitization of $200 million to $300 million in the third [or fourth] quarter, made up primarily of larger, institutional loans of over $5 million, Reiff said.
As a new product with very little historical data, the loans have been underwritten relatively conservatively. The underwritten debt-service coverage, for example, for priced deals has been between 2.0 and 3.0, which means the initial cash flow is more than double (and in some cases nearly triple) the amount needed to make mortgage payments. However, it hasn't taken long for the market to move in a frothy direction, according to market players who note that terms already are beginning to get more loose. Some investors say newer deals have less equity, lower reserves, less amortization and more interest-free periods for borrowers.
|Breakdown of SFR Investor Ownership|
|Source: Keefe, Bruyette & Woods|
Some eyebrows were raised by the July performance update of the $993 million Invitation Homes 2014-SFR1 transaction, which was priced in April. The average vacancy rate of the pool jumped to 7.3% in May, up from 5.5% in April, according to Morningstar, with the number of vacant homes jumping to 475 in May from 353 in April. Some worry that the rapid increase is a sign of inherent instability in an asset class in which most tenant leases are only a year. However, Morningstar analyst Brian Grow said that the increase was expected because some 23.3% of the nearly 6,500 leases in the collateral pool expired through the end of May. Morningstar expects the month-end vacancy rate to stabilize and potentially decline, he said.
Eric Thompson, senior managing director at Kroll Bond Ratings, said with so little information available about historical performance, it's challenging to develop the assumptions used in arriving at sustainable cash flow, expected rental performance and potential recoveries relative to the value of rental homes, although copious data is available on owner-occupied liquidations. That is why the AAA advance rate to the broker price opinion is roughly 40%. Still, he said that while the single-family rental market might be new to securitization, it's not a new business, as rentals comprise roughly 10-12% of the nation's housing stock.
At the end of the day, the genesis for the involvement of many players in the securitization space may have been as a trade to capitalize on the downturn in home prices during the residential crisis, Thompson said. Given the volume of single-family rentals that are out there, however, it may be the case that these players have opened up a new source of capital for the space. I think the securitization market is here to stay...although what form it takes and how big it gets is hard to say.
|Institutional Investor Purchases of SF Rentals January 2011-March 2014|
||Purchases by Institutional Investors
||Percentage of Sales|
|Single-Family Rental Securitizations To Date|
||Initial Loan Term Interest Rate
||Issuer Cost Basis ($Mil)
||WA Monthly Rent ($)
|Source: Kroll Bond Ratings|