Job instability, a rocky economy, and lack of credit for homebuyers have changed the real estate market drastically over the past few years, causing more of the population to look for flexible living options instead of being locked into an uncertain housing market.
From a risk-adjusted standpoint, single-family residence (SFR) rental investing has become the more popular option for those wanting to invest in the real estate market, providing a predictable return on equity due to the following factors:
- The increased number of people looking to rent rather than buy a home makes it easier for investors to find and keep renters.
- The increased number of distressed properties on the market that are selling below replacement costs, coupled with a lack of new housing being created, makes purchasing now to sell later a viable option for investors. As markets move back toward the mean and rental rates increase 3-5% year-over-year, investors will be able to see a positive return on investment coming from the appreciation of their asset(s).
- In addition to receiving a return in the future from selling the property, investors can cover costs of mortgage and maintenance, and even gain an additional return on investment with the rent payments of the tenant(s).
Investors who see the paradigm shift from a “fix and instant flip” strategy to that of a “fix, hold and rent” strategy, are in a unique position to capitalize on one of the fastest growing components of the rental market—single-family residence rentals.
And it’s not just “mom-and-pop” investors and service companies who are doing this. Over the past few years, a tidal wave of institutional investors has accumulated hundreds of thousands of homes. Recent data shows that institutional investors (defined for these purposes as entities purchasing at least 10 single family homes within a calendar year) purchased a combined total of 366,206 single-family homes from January 2011 through November 2013.
At the beginning there was no lack of supply. Single counties hit hard by the foreclosure crisis yielded thousands of potential distressed home purchases every month. Markets such as Memphis, Fresno, Charlotte, Atlanta and Phoenix saw large volumes of purchases from institutional investors early on in 2012. But as availability of inventory—particularly distressed inventory—started to dry up in some of those first-wave markets, primarily in the west, institutional investors moved into a second wave of markets, many in southeastern cities, such as Jacksonville, Fla.; Winston-Salem, N.C.; Tampa, Fla.; Lakeland, Fla.; and Macon, Ga.
Although the accumulation of single-family homes by institutional investors has created operational challenges and complexities never before seen in the market, most experts agree that SFRs are a sustainable business model.
Still, it is important to keep these 10 best practices in mind when investing in a SFR:
- Do your homework. Research the market you plan to invest in, or align yourself with a group that has local market knowledge and resources to react quickly in that market. Each opportunity must be evaluated independently for property condition, local hazards, and fit with investment objectives.Proper due diligence is critical, as operators embark on a long-term relationship with every home in their portfolio. Unlike an apartment building where an investor can acquire multiple units using a common set of resources, every SFR is different—even when they’re purchased as part of a pool of homes.
- Be patient. For every property they acquire, investors have to start with a pool of many more—as the housing market is very competitive. Even the most aggressive buyers only win a fraction of their homes.
- Rely on trustworthy on-the-ground resources. Investors need access to on-the-ground resources and experience to source a steady supply of homes, understand the appropriate value, assess the cost of required renovation, establish clear title, manage the escrow process, understand any HOA restrictions or other tax considerations that would impact the investor’s return on their home. It is also imperative to build strong vendor relationships (i.e., with maintenance professionals, etc.), or engage with a professional asset management company.
- Be available. Constant communication and follow up with tenants/occupants and leasing professionals is key. Set expectations from the start to avoid unnecessary issues (e.g. payment issues).
- Have a local presence. Property managers must have a strong, local presence to ensure positive rental outcomes, good tenant relationships, and low vacancy rates. Local property managers can manage tenant relationships and rent collection in such a way that tenant issues and delinquencies are resolved quickly. Customer service specialists can foster positive, collaborative relationships with tenants.
- Be discerning. Set up a protocol for screening tenant applications and make sure you hire only licensed agents to avoid unnecessary issues (e.g., fraudulent leases, etc.)
- Invest in operations to ensure high service standards. As the SFR industry becomes more mature, operating standards required by the market are likely to rise. Property managers must make investments in scalable operational processes and systems to achieve the required high service standards in tight timeframes. Managers must be able to rehab, rent, maintain, and respond to issues in a scalable manner.
- Know the costs. Costs vary across geographies and investor strategies. Where some investors prefer to purchase properties requiring only minimal rehab, others cast a broader net to include properties with meaningful amounts of renovation required. It’s important to consolidate administrative functions and optimize the placement of maintenance resources.
Below are the approximate costs:
– Rehab — $20,000 for distressed sales
– Leasing — 1 month’s rent
– Management — 7 to 8 percent of collected rents
– Maintenance — 3 calls per home per year with total cost less than $500
- Learn from experience. With experience and analysis, seasoned operators will find opportunities to improve performance of their portfolios. Operators will look back at their experience and find ways to hone in on mispriced properties. Those with large footprints will identify variations in expenses and investment returns across the country. Those working on behalf of investors will be able to advise their clients on how to make smarter decisions.
- Understand the risks. The SFR strategy is a bet—not only on the continued demand for rental housing and the strength of home price appreciation—but also, on a long-term path to liquidity for investors. Large firms bought heavily before there was a clear path to liquidity; betting that something would emerge, by public offering REIT, securitization, or simply a maturing industry of SFRs where stabilized portfolios could be sold to other players at non-distressed prices.
Thus far, the bet appears to be paying off. Public offerings of Silver Bay, American Residential Properties, and American Homes 4 Rent along with the first-ever securitization of rental homes by Invitation Homes—at a very low rate—have demonstrated that public market investors buy into the potential of SFR rentals.
With the influx of institutional capital, it is becoming harder for individual investors to compete and find the best investment opportunities on their own. Partnering with a company that is experienced in residential investing and property management can save investors time and money by providing them with local industry knowledge and in some cases a fully integrated service platform.