Published in the March/April 2014 issue of REIT magazine.
IN THE LAST 13 months, five stock exchange-listed REITs focusing on single-family home rentals have raised more than $1.2 billion in initial public offerings (IPOs) to capitalize on a nascent housing recovery. Most recently, Starwood Property Trust (NYSE: STWD) spun off its single-family residential unit into a REIT called Starwood Waypoint Residential Trust (NYSE: SWAY).
The last year has also witnessed the rise of securitization of single-family housing debt in the form of deals from Colony Capital’s Colony American Homes and Blackstone Group LP’s Invitation Homes.
So far, investors appear cautious about delving into an untested market segment and uncertain about the long-term viability of single-family rentals if the economic recovery spurs greater home ownership.
The post-IPO performances of single-family REIT shares have generally lagged their debut prices. Undeterred, single-family REIT operators attribute their challenging start to the normal growing pains that all new industries experience and point to the early stumbles by emerging multifamily operators in the mid-1990s.
“We’re one of the pioneers,” says Stephen Schmitz, chief executive of American Residential Properties, Inc. (NYSE: ARPI), which owns more than 5,400 properties in 13 states. “We think as time goes on, people will begin to realize that this is a real asset class that’s worthy of investment.”
The business of renting single-family homes has been around for decades, but remains highly fragmented. Roughly a third of all rental properties in the U.S. are single-family homes. The weak housing market and enormous pool of foreclosed homes has lured in commercial developers, private equity firms and hedge funds. These investors are buying properties at bargain prices and renting them to families who desire the trappings of a traditional house without the burden of home ownership and obtaining a mortgage. The market seems ripe for the picking. Median home prices in the U.S. are down roughly 30 percent since the 2006 market peak, and 8.1 million homes have been lost to foreclosure in the last seven years, according to RealtyTrac.
Schmitz notes that one in 10 single-family homes is a rental unit, representing a $2 trillion industry. He expects demand for single-family rentals to increase given there are many people who won’t qualify for stringent mortgage loans or will continue to delay buying a home in a weak job market.
Some analysts say it’s too early for investors to make a definitive call on the viability of single-family REITs because they haven’t operated long enough to establish a track record, good or bad.
“You can’t look at what these companies report today and judge them accordingly. They’re building the business,” says Dennis McGill, director of research at Zelman & Associates. “Investors expected more when they probably shouldn’t have.”
Indeed, some investors are seemingly concerned by the low occupancy rates, high maintenance costs and the ability to compete with apartment operators.
Peter Martin, an analyst at JMP Securities says there are numerous challenges to leasing single-family homes, including the difficulty in removing existing tenants, costly renovations and scaling a national internal management platform.
“That is a very slow process, slower than we expected,” he says.
Gary Beasley, co-CEO of Waypoint, says single-family REITs are borrowing some lessons from multifamily operators on how to operate and manager their properties. For instance, Waypoint has small offices in some markets that are similar to resident service centers where tenants can pay their rent and leasing agents meet clients.
Dave Bragg, a managing director at Green Street Advisors, says concerns that single-family REITs will have difficulty controlling maintenance costs and efficiently operating clusters of homes scattered across different states are unfounded, for now.
We think the single-family landlords are doing a good job of managing maintenance visits, which would be one of the key cost areas,” Bragg observes.
Impact Of A Homeownership Rebound
Some investors keen on single-family REITs see the sector as a profitable investment for the next three to five years. Beyond that, though, many appear to have questions about the industry’s ability to achieve substantial growth. One major headwind is the possibility that a rebound in housing prices will dramatically shrink the inventory of distressed properties for operators to purchase. In addition, a stronger economy may entice the most financially sound tenants to opt for home ownership.
“There will be a smaller (housing) pie for them to acquire and grow their earnings and value as operators continue to buy distressed homes,” says Joel Beam, who runs the Forward Select Income Fund. He anticipates such an environment will lead to consolidation in the market.
In the meantime, “we see an opportunity to make money in the space for a couple of years if the economy continues to heal,” he says.
“Right now, we have a three-to-five-year investment horizon for the sector. Since housing prices are on the rebound, now would be a great time to invest,” says Jay Leupp, a portfolio manager at Lazard Asset Management.
Beasley says there is an opportunity for single-family REITs to consolidate existing rental homes beyond the distressed market. He also notes that Waypoint is looking at opportunities to build new rental homes.
Schmitz acknowledges the problems that rising home prices could create for rent growth and future acquisition opportunities.
“If home prices move up so aggressively that rents don’t follow, would it make sense to stop buying for a while? Yes, it would. Would it make sense to liquidate some properties and take some gains? It would, and we would do that,” he says
A.D. Pruitt is a freelance contributor to REIT magazine.