It’s not every day that two industry titans, Barry Sternlicht of Starwood Capital Group, and Thomas Barrack of Colony Capital, partner on a deal.
But last month’s merger between Starwood’s Starwood Waypoint Residential Trust (SWAY) and Colony’s Colony American Homes (CAH), wasn’t just any deal. In joining together, Sternlicht and Barrack – who will serve as non-executive co-chairmen of the new combined company – have given the clearest sign yet of how much they want their single-family rental businesses to succeed.
The odds of success, after all, were much slimmer for SWAY and CAH as standalone firms. As separate entities, both SWAY and CAH – a private company that will be absorbed into its listed former rival – lacked scale. SWAY was formed in 2013 through Starwood affiliate Starwood Property Trust’s spinoff of its single-family residential business and subsequent merger with Waypoint Residential Group. As of June 30, the company owned approximately 12,500 homes in eight US states. Meanwhile, CAH, which Colony Capital formed in 2012, owned and managed approximately 19,000 single-family homes in the US. As a unified entity, however, SWAY and CAH now are in a better position to compete on a larger scale – that is, against the two largest players in the space, The Blackstone Group’s Invitation Homes, and American Homes 4 Rent, which own approximately 45,000 homes and 37,000 homes, respectively.
Industry observers have said that the public equity market for single-family rentals developed a little too early: with the exception of American Homes 4 Rent, all of the other companies that went public were not particularly large or mature at the time of their initial public offerings, with most in operation only for a couple of years. In many cases, these companies have had difficulty paying dividends to their shareholders because of their higher cost of capital and fewer liquidity options. None of the firms – including American Homes 4 Rent, the largest publicly-traded single-family rental company – have seen their share prices trade above the net asset value of their underlying properties.
Through the merger, however, SWAY is aiming for its future to look different. Now with more than 30,000 homes and an aggregate asset value of $7.7 billion, the combined company will be able to spread its costs over a much larger asset base and operate more efficiently, reduce general and administrative expenses (G&A) and develop greater economies of scale. Indeed, the deal is expected to achieve estimated annualized cost savings of $40 million to $50 million.
More importantly, being a larger company will provide access to cheaper equity and cheaper debt, enabling SWAY to better compete for investment opportunities in the space. The firm also will have a larger portfolio of stabilized assets, which will allow it to pay higher dividends to its shareholders.
The lesson is clear: if you’re going to be a larger player in the public markets, you need to achieve scale as quickly as possible. Cerberus Capital Management, the latest private equity real estate firm to enter the space, is a case in point. The New York-based firm became an owner of single-family rentals this year with the acquisition of Five Ten Capital, a company with more than 1,500 houses, in March, before going on to buy 4,200 homes from BLT Homes in June.
At the same time, single-family rental companies need to trim the fat where necessary. The combination of SWAY and CAH, for example, essentially eliminates an entire management team, which lowers the administrative costs of the unified company’s assets even further. It’s also interesting to note that even before the merger, SWAY already had been reducing its executive ranks, announcing the departures of its co-chief executive and chief investment officers in March. Invitation Homes also has been doing some streamlining of its own, culling a number of assets from its portfolio. Efficiency is the name of the game in the public markets, after all, and Blackstone is widely expected to eventually take its single-family rental business public.
Institutional owners of single-family rental properties still account for less than 1 percent of the total market, according to Sylvan Road Capital, a single-family residential investment firm. That said, the overall push toward greater efficiency means that what was a fledgling industry just three years ago is making major strides toward becoming more institutional. The sector is expected to consolidate further as more firms are finding it necessary to become bigger – or part of a bigger entity – in order to succeed. For this reason, you can expect that private equity real estate firms will remain among the most active investors in the space. The industry, after all, knows a thing or two about the survival of the biggest.