Alicia Miller does not buy the consensus approach to institutional investment in single-family rentals.
“If I make between $60,000 and $100,000, why am I going to rent a $250,000 home out in the suburbs, not in the city, that I could potentially buy?” the vice-president of capital markets at the Denver-based investment firm Whitestone said.
While many in her age cohort have opted to pay high rents to live in city centers, Miller does not see that trend carrying over to the suburbs, particularly the far-flung locales where many build-to-rent communities are breaking ground.
“If I’m going to be in the suburbs, I’m going to own, not rent,” she said. “If you’re building homes for $250,000 and up, you need to charge a premium rent to make a decent yield. But why would I pay $2,400 in rent when I can pay $1,200 toward a mortgage?”
Homes today are selling for substantially higher prices than in Miller’s example. In the second quarter, the average sale price was $434,000, according to the US Federal Reserve, up $60,000 from one year prior.
That rapid rise is what justifies their rising rents and growth expectations, say proponents of the standard SFR model, which is to acquire clusters of suburban homes in growing Sunbelt markets, use economies of scale and emerging technologies to manage these portfolios like horizontal multifamily assets and charge premium rents. More recently, entrants have taken to building whole rental communities from the ground up.
Driving this trend is a belief that, plagued by a long-running housing shortage, stagnant wage growth and mountains of student debt, middle-income Americans who would have traditionally bought their way into the suburban lifestyle will now be willing to rent it instead.
Miller is skeptical of this thinking, not only as a competitor in the space, but also as someone who once fit the description of a model tenant in the standard SFR scheme. In 2018, she was 29 years old, earning roughly $60,000 a year and saddled with more than $25,000 in debt from student loans. But rather than rent, she opted to buy her first home, a townhouse in the Denver suburb of Arvada, for $285,000.
Miller said prospects for millennial homeownership are not as bleak as some portray them to be. With the support of a Federal Housing Administration loan, borrowers can purchase a home with a down payment of 3.5 percent. FHA financing is available to anyone with a credit score of 580 or better, which accounts for 84 percent of consumers, according to rating agencies Experian and TransUnion.
Whitestone is one of a handful of private equity managers challenging the typical SFR model with alternative approaches that are gaining traction in the space. Here are three of them:
The urban model
Whitestone, founded earlier this year, entered the SFR space with a focus on homes in blighted inner-city neighborhoods. It brings the properties up to federal housing standards and then rents them to low-income tenants with Section 8 government housing vouchers, which typically cover 70 to 100 percent of the rent.
While these properties cannot command class A rents, Miller said they are cheap – Whitestone’s first 100 homes cost an average of $69,000 each – and tenants are sticky, with the average Section 8 renter staying in place for at least six years, according to US Department of Housing and Urban Development, with elderly tenants staying nine years or more. Top standard SFR providers hang on to tenants for three or four years, PERE understands.
Whitestone’s first vehicle was largely a pilot program run with balance-sheet capital, Miller said. For its second fund, the firm tapped a few family offices to raise more than $20 million. Both vehicles invested solely in Kansas City, Missouri. The platform has achieved a 17 percent net internal rate of return, she said.
Miller said institutional investors have already expressed interest in the firm’s third fund, which will target $200 million and expand to other Rust Belt markets, such Cincinnati, Columbus and Indianapolis. And she expects other groups to follow in Whitestone’s footprint.
With multifamily, investors had initially targeted class A assets but shifted to class B and C properties as workforce housing became the most popular strategy within the sector, she said. “We’re seeing that same phenomenon in single-family,” Miller observed. “Everyone is going after the shiny unicorn, but when they realize people live in workforce housing, it will trickle down. We’re just getting there first.”
Subsidizing the suburbs
Dallas-based High Opportunity Neighborhood Partners is taking a similar tack by catering to Section 8 voucher holders. But, instead of acquiring homes in major cities, the firm targets the same desirable suburbs as the traditional model.
This model is distinct because owners of quality rental homes in good areas often shun Section 8 voucher holders, Grant Herlitz, founder and principal of HON Partners, told PERE.
“Landlords have effectively discriminated against these tenants for the last 40 years,” he said. “They’ve basically said they use credit as a proxy for character and they will not rent to these tenants because they have no credit. But clearly, a tenant that needs support from the government won’t have credit and government is paying the rent, so the credit is irrelevant.”
Because of these assumptions, voucher holders have been relegated to the lowest-quality housing stock, in failing school districts and high-crime neighborhoods, he said. For Section 8 tenants, many of whom have waited years for entry into the program and have been thoroughly vetted, these conditions perpetuate the cycle of poverty.
Herlitz called said his tenants who are Section 8 voucher holders are “class A, double-A-plus tenants,” who are grateful for the opportunity to provide their children access to good schools and communities. “They are contributing to society, they only want the best for their kids, and they take great care of the homes,” he said.
Herlitz said HON Partners is achieving the same market returns as SFR owners who cater to traditional tenants, if not better, thanks to the government subsidies.
Formed in 2019, HON Partners was seeded by its founders: Herlitz, Matthew Berke, an energy management executive, and Andrew Ludwig, who worked with Herlitz at the Howard Hughes Corporation. This past June, the firm formed a joint venture with a family office that has deployed $250 million of debt and equity. In total, HON Partners has roughly 400 homes.
Herlitz anticipates HON Partners will launch its first institutional capital vehicle within the next six months.
Institutional capital is also breathing new life into an old investment model: rent-to-own.
Supported by technology that helps identify properties and assess the financial stability of tenants, some firms are taking a more tailored approach to lease-option schemes.
One is New York-based Landis, which purchases homes chosen by its clients and then gives them the option to buy at a set price – usually 3 percent above the purchase price – within two years. Landis uses software to determine if and when a prospective client will be ready for homeownership. Co-founder and co-chief executive Cyril Berdugo said the firm accounts for more than salary and credit score, factoring in things like debt-to-income ratios. Founded in 2018, the firm claims an 80 percent conversion rate for renters becoming owners.
Landis focuses on starter homes between $100,000 and $400,000 in both urban and suburban areas, Berdugo said, and its clients have an average annual income of $45,000. The firm will provide financial coaching to clients to put them in the best position to take on a mortgage. “Every client’s path is unique, for some they need to work on their credit, for others it’s their down payment,” he said. “We give a tailored plan that is customized to the specific client.”
Earlier this year, the firm raised $165 million in venture capital from pensions, sovereign wealth funds, insurance companies, family offices and high-net-worth celebrities, including the actor Will Smith and the rapper Jay-Z. Berdugo said the platform has achieved core-plus or better returns while taking on core-like risk: “There is no vacancy, no capex and no leasing involved. And yet, we are able to get core-plus-to-value-add IRRs.”
In June, Blackstone acquire Home Partners of America, which has a similar business model. It partners with tenants to find homes of their choosing then allows them the option of buying within five years. The Chicago-based platform, which was valued at $6 billion, has amassed 17,000 homes and is now part of Blackstone’s core-plus BREIT vehicle.
Most platforms taking an alternative approach to institutionalized SFR have yet to receive the types of splashy commitments mainstream players have enjoyed this past year. Whether they do will largely depend on how well they continue to perform in the space.