Acquisition and Asset Management Strategies for Bulk SFR Portfolios
The maturing of the SFR asset class by Russell Schmidt The Single Family Rental industry continues to mature into a standalone subsector of the commercial real estate space. As the space gets more crowded and competitive, SFR investors will need to adapt and develop advanced acquisition and asset management strategies compared to the previous “buy everything and figure out operations later” strategy. Early movers such as Invitation Homes and American Homes 4 Rent were able to amass large portfolios of SFR’s at steep discounts beginning in 2012 due to a massive supply of distressed properties. Homes were repaired and turned into cash flowing assets and investors saw huge gains as housing values steadily rebounded over the following years. Today’s SFR landscape is shifting into the next phase, as the initial entrants that (correctly) bet on a sharp and quick rebound in values are now being joined by new capital willing to acquire at elevated price levels, sometimes even matching ‘market’ prices, to satisfy their yield and capital deployment requirements. The original SFR operators successfully demonstrated that capital can be deployed into the space at institutional-quality scale and efficiency, bringing in other institutional investors eager to match the strong historical proven returns the space can offer. Simultaneously, the rapid growth of SFR-specific debt lenders and tech-smart service providers have made it easier for new investors of any size to gain exposure to the asset class. Couple this with record-low mortgage rates, strong home buying demand from owner-occupants, and an already-constrained supply of houses, and the result is a strong downward pressure on cap rates and a lack of deals appealing to investors. Moving Forward What does this mean for SFR operators going forward? Those who bought 5+ years ago were able to acquire at such significant discounts that any operational inefficiencies had little effect in their total returns; asset appreciation has been so significant that marginal differences in collected rent or reduced operating expenses were dwarfed by approximately 300% increases in asset value. But as the SFR industry transitions from being a simple trade on undervalued assets into a long term buy-and-hold investment, investors looking to acquire today don’t have the same luxury of buying anything and letting appreciation cover up potential flaws in their acquisition and management systems. New and more nuanced strategies must be implemented in order to succeed in today’s more crowded and competitive SFR landscape. As one example, there is more attention on implementing consistent rent increases, even if nominal. A common school of thought among mom-and-pop landlords is that aggressively pushing rents leads to vacancies and costly turns, so therefore it’s financially smarter (and less of a hassle) to simply not increase rents and keep tenants for as long as possible. However, issues arise when after several years of no rent increases, landlords then attempt to increase rents now that they are 20% or 30% below market levels. The probability of having a tenant accept such a steep increase is slim, so the landlord is faced with either accepting a vacancy (which they were trying to avoid in the first place) or keeping the tenant and continuing to lag market rents at a significant discount. In contrast, large institutional operators have explicitly stated their intent to consistently increase rents, not only to continue growing cash flows but also to instill an expectation that rent increases are a normal and regular event. Acquisition Channels From an acquisitions standpoint, the state of the housing market has made it significantly more difficult to acquire properties with attractive yields on the MLS, especially in scale. Institutional investors have responded to this by looking elsewhere for volume. These new acquisition channels require new ways of thinking when it comes to stabilization and asset management strategies. One increasingly prominent acquisition channel is sourcing off-market portfolios directly from mom-and-pop landlords. While these deals offer immediate scale and pricing typically below market, they also present challenges of their own compared with MLS acquisitions. Unlike the acquisition of a multifamily building with 100 relatively homogeneous units, bulk SFR portfolios typically have a wide range of assets in different neighborhoods and with different styles and finishes. Owners usually aren’t interested in only selling a portion of their portfolios, so the buyer must be equipped to repair, stabilize, and manage the entire bulk even if some or most of the assets don’t fit within their typical management or buy-box strategy. As bulk acquisitions become a more important piece of the SFR space, it is important that buyers can optimize different strategies within one bulk rather than the singular viewpoint applied to MLS transactions. Implementing a multi-faceted acquisition and asset management strategy will result in more efficient management and greater total returns. Varying Strategies As an example, assume a portfolio of SFRs evenly distributed between Class A, B, and C. Rather than applying a single strategy for repairs (e.g. granite countertops in all units) and asset management (e.g. aggressively increase rents in order to maximize pro forma NOI prior to a sale to an investor in 5 years), applying several different strategies across the different buckets can result in a more optimized approach: Class A: Definition: Higher end homes all located in gentrifying neighborhoods with low existing cap rates Strategy: Continued appreciation / cap rate compression likely means that it will become too expensive for an investor to acquire in the future, so the likely exit will be to an owner-occupant. Less emphasis is needed on maximizing NOI growth, so focus can instead be placed on maximizing occupancy until value has appreciated enough for a sale. Class B: Definition: Institutional quality rental homes in neighborhoods where the rate of appreciation is unlikely to significantly outpace NOI growth, resulting in the asset remaining an attractive target for another investor Strategy: Optimize as a rental asset with focus towards maximizing NOI growth prior to selling as a package to another investor Class C: Definition: Lower end assets and/or outside of the typical institutional buy box Strategy: Optimize as a
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