Owning a suburban home has long been part of the American dream. For today’s would-be homeowners, however, a combination of high existing debt and a lack of new credit has delayed or deterred that dream, so private equity has stepped in to fill the gap.
After the financial crisis, opportunistic private equity players bought single-family homes en masse to turn what was previously a mom-and-pop rental operation into a scaled, institutionally-accepted property type. While the concept of renting a single-family home is far from new, the advent of institutional ownership only occurred once construction stalled and house prices fell in the wake of the crisis.
According to the Mortgage Bankers Association, mortgage availability dropped 91 percent between June 2006 and February 2009 while demand for rentals increased. Demographic trends were also a factor, with older millennials, who were starting to move into the suburbs, less likely to buy homes than previous generations. It is against this backdrop the still-nascent single-family rental (SFR) market has evolved, an industry that is starting to gain acceptance despite initial investor doubts.
As one of the first to respond to this trend, Blackstone used capital from its seventh opportunistic vehicle, which closed on $13.3 billion in 2012, to found Invitation Homes, one of the earliest and biggest players in the space. Blackstone and its peers found an easy source of supply with a spike in foreclosures, and technological advances enabled buying at scale with less need for costly and lengthy due diligence. Investors bought homes for an average of $125,000, and spent about $25,000 per home on renovations – but the capital expenditures could vary wildly, says Fred Tuomi, CEO of Colony Starwood Homes.
“There was very limited time and due diligence – you couldn’t get inside; you had to pay 100 percent cash upon winning the bid; there were no negotiations,” Tuomi tells PERE. “You didn’t know what you had until you got inside. Some of the time it was a pleasant surprise; most of the time it was a real challenge. Looking back, this was an incredible opportunity to buy homes at deep discounts and create an irreplaceable portfolio at a highly attractive cost basis.”
Once homes were stabilized, technology decreased some of the traditional human capital costs in tenanting. Tuomi highlighted eliminating brokers, for example, as both cost and time savings. With smart home and smartphone technology, potential renters could schedule a viewing, unlock a house, show themselves around and apply to rent online, all without a broker or other employees physically present. After moving in, renters typically use an application or online portal to report maintenance and other issues, which the companies respond to through vendors who service local areas.
Despite ready demand, the earlier acquisition sprees saw housing advocates paint private equity buyers as the cause of the housing crisis or as bullies who crowded out individual investors. A chief executive of one of the biggest single-family rental platforms says multiple public pension plans refused to back the strategy at his firm, citing potential public concerns. Major industry players formed an advocacy group, the National Rental Housing Council, in 2014, and over time, perception concerns dissipated. Investors, though, still had other questions about scale, overhead and exit strategies for the largely unproven strategy.
“In apartments, you’re turning over more than half your units on average; we’re turning approximately 35 percent,” says Rob Harper, the head of Blackstone’s US asset management and a member of Invitation Homes’ board of directors. “We have less units to lease and tenants are staying longer. They’re very frequently married with kids and they don’t want to move because they’ve put the kids in school. They’re a stickier tenant base than you’ll find in multifamily where people are more transient.”
While tenant turnover seemed to be solved by nature of the business, other questions remained. Back in 2012 and 2013, general partners themselves did not always have a long-term exit strategy. Tom Shapiro, the founder of New York-based private equity real estate firm GTIS Partners, recounts how his firm bought homes and lots without knowing if they would flip the properties or aggregate them for a long-term business. Eventually, he chose the latter, creating Streetlane Homes, which now has over 5,000 units.
The market’s inflection point for investors came last year, say industry observers. Single-family rental platforms quickly gained institutional acceptance as Blackstone prepared for its January IPO, international capital came into the space and major players stabilized their portfolios.
Invitation Homes’ IPO followed other private equity-backed businesses going public. Greenwich, Connecticut-based Starwood Capital Group and Los Angeles-based Colony Capital teamed up last year to merge their single-family rental platforms into Colony Starwood Homes, which is the country’s third-largest landlord, managing about 29,000 homes as of March 31, according to the REIT’s first-quarter earnings report. The combined entity went public in January 2016. Overall, single-family rental home REITs bounced back in 2016 after a slow start to the year, with the asset class up almost 27 percent over the year, according to the National Association of REITs. Blackstone’s IPO, which raised $1.5 billion, was widely seen as validating the strategy.
“Blackstone did it right with a big, big portfolio. The other firms went public too early and needed a lot of acquisitions, so Wall Street took a disliking to the business,” Shapiro says. “Now, capital markets are accepting it, and institutional investors are more and more interested in the business.”
Interest stems from untapped ownership potential in the space: only one percent of the US’s 15.8 million units are owned by institutions, according to John Burns Real Estate Consulting, which prepared a market study ahead of Invitation Homes’ IPO. But the days of snapping up houses at foreclosure fire sales are over, leaving firms to ponder how to continue scaling their platforms.
GTIS’s Shapiro has long invested in homebuilding, a strategy other firms are now starting to embrace. GTIS has backed private and public homebuilders as part of a thesis that the housing market would recover post-GFC, buying, for example, the last 50 lots in a subdivision at a 10 percent discount to market cost. Shapiro says some firms are also considering building an entire subdivision to rent.
“The repair and maintenance numbers are so much lower if you can get homes in a single location with all new equipment,” he says.
Optimizing existing platforms is also an area of growth across the industry. Blackstone’s Harper says with homes about 95 percent leased, streamlining operations can be an area of upside.
“We’re still in the early innings of the maturation of the industry,” he says. “We have opportunities to drive revenue and cut costs, and also improve the services we provide to our tenants. It’s very compelling because if we enter a declining revenue or occupancy period, it’ll be nice to have things you can do to generate growth if the current macroeconomic tailwinds subside a little bit.”
But optimization may not be enough, John Pawlowski, a research associate at Green Street Advisors, says, predicting that if rent growth or net operating income starts to lag, investors may be more interested in multifamily again. He also cautioned the established players not to get too comfortable.
“The current big guys don’t have enough of a head start to preclude a handful of operators who are on their way,” he says. “There is a little more of an uphill climb to amass the scale you need to in a normalized housing price environment.”