Disposition Strategy
Investors Need to Read the Market and Plan Accordingly
By Andrew Oliverson
While the real estate market continues its upward trajectory, a disposition strategy is not likely to be top of mind for most investors. However, there is no crystal ball to predict how the market will perform in the coming years. It is important to have an exit strategy in place now to be prepared for market changes that could put equity at risk.
A Brief History of SFR Strategy
Disposition is a word some investors may not have used since the Great Recession. But for many, that was the original game plan.
In the wake of the Great Financial Crisis, the housing landscape was nearly the reverse picture of today’s market. Excess supply and virtually no demand led to plummeting prices and a bleak outlook for real estate. That is when investors stepped in to purchase foreclosure properties with the intention of flipping them when the market recovered. At the time, disposition was a key part of the investment strategy.
As they waited for housing values to rebound, many of these investors leased the properties to tenants. They found that the cash flow, historically low interest rates, and steady price appreciation made it profitable to keep the rental properties and add more to their portfolios. Meanwhile, demand returned, and homeowners began to buy up the excess inventory. In time, this supply-demand imbalance attracted the attention of institutional investors who could aggregate large numbers of single-family rental (SFR) properties into what amounted to a new asset class.
Now, ten years later, SFR investors have enjoyed a surge in equity. Home prices in the United States have seen tremendous gains over the past several years. According to the Radian HPI, provided by Radian subsidiary Red Bell Real Estate, LLC, home price appreciation set a new record rising 12.9 percent year-over-year from November 2020 to November 2021. But while markets are still strong in nearly every region, there are indications that the torrid rate of growth we are seeing today may be beginning to wane slightly. For example, according to a Redfin report, more than 60 percent of property sales involved a bidding war in October 2021. That is a remarkable figure, but it is actually down from the all-time high of 74 percent set in April 2021.
These and other metrics surely have factored into forecasts like the Goldman Sachs report published in October 2021 that expect decelerating U.S. home price growth in 2022. The bottom line is that while the market is red hot now, at some point it is likely to cool. And when it does, SFR investors need to be prepared with strategy in hand to avoid losing profit and equity on their rental portfolios.
Reading the Market
There are a number of market dynamics that impact profitability for single-family rentals. Investors should be monitoring these and reviewing the impact on their portfolio as conditions change. One metric to watch is financing costs. The Federal Reserve has indicated that it may raise interest rates sooner than expected to curb the high rate of inflation. Higher interest rates increase the cost of financing for investors and could impact home prices by stemming demand from homebuyers.
Slower price appreciation is likely to impact rental price growth as well. And, if tenants are unable to make rental payments as COVID-19 assistance programs are lifted, SFR investors could face more impacts to their rental incomes. A recent Mortgage Bankers Association report found that renters were significantly more likely to miss their housing payment than homeowners. The rate of missed rental payments increased in September and October as pandemic-related unemployment and rental assistance programs continue to wind down.
Another metric to read is operating expenses. Supply chain disruptions and labor shortages have caused skyrocketing costs for renovations, and even regular maintenance and upkeep. Shortages can also lead to long delays, disrupting cash flow as properties sit in disrepair for months. Investors that acquired properties at the peak of the market may find themselves unable to recover their costs.
Planning an Exit Strategy
Investors who are tracking these metrics should consider putting a plan in place to determine the right moment to exit. A wise approach might be to engage a disposition agent to develop a customized strategy that will provide the best execution on the portfolio. While the sale of bulk assets can make sense for a quick exit, the current supply-demand dynamics suggest that a retail sale of each asset (i.e., one at a time) would provide the largest return on investment.
With an experienced disposition agent, an investor can customize the sales approach by asset type, locale, anticipated buyer, etc. The right partner can provide a value by taking care of every detail:
> Interface with auction companies across different regions and markets
> Ensure compliance with local ordinances such as vacant property registration, taxes and HOA management
> Manage repair and maintenance with a network of reliable contractors and vendors
> Leverage a distributed network of high-performing, seasoned real estate agents who specialize in selling investor-owned properties
> Provide marketing and valuation expertise to ensure properties are sold quickly for top dollar
> Employ technology and analytics to provide visibility throughout the sales process
The U.S. housing market has been – and continues to be – one of the greatest engines of wealth creation in recent memory. The conditions fueling this engine are not likely to change overnight. However, we are starting to see signs of slower growth, making now an opportune moment for investors to re-evaluate their strategy. At some point it may be prudent for an investor to realize the equity in their portfolio before market changes put it at risk, and when that time comes, they should be ready to make an exit with confidence that they have the right tactics and team in place to maximize execution.
