Valuations in the Single Family Rental Space
Here’s What’s Happening with Rental Investments
by Kevin Ortner
Housing prices continue to march upwards. But what’s driving prices in the SFR space? What is responsible for this boom, and should we expect more of the same in the months ahead? As Renters Warehouse CEO, I have seen a lot of changes in the housing market over the last year. Here are a few things that stand out.
There’s good news for investors who own rental property: the single-family rental property market has continued to thrive, despite the events of the last year. Nationally, 5.6 million homes were sold in 2020 –and the median cost of a home shot up 15%, increasing from $300,000 in 2019 to $340,000 by the end of 2020, according to the National Association of Realtors.
Both home values and rents alike have soared over the past year, and it is still very much a seller’s market. Demand is high, and there’s just not enough inventory to keep up.
Still, we cannot assume that home appreciation will continue at its current pace. It is safe to conclude that at some point appreciation will start to level off and growth begin to slow. At some point, we could start to see home value appreciation that is a lot more modest, rather than the extreme increases that we have seen over the last few months.
If this holds true, then you will want to keep in mind that you are paying for future appreciation today. It may be a slow housing price appreciation climb over the next 18-24 months. No one knows exactly when appreciation will begin to slow down, so investors should not assume that the next month will be the same as the last.
There are a number of factors that are at play, all of which are impacting housing prices. Here is a look at some of the things that we have noticed in recent months.
A Housing Shortage
Currently, there is a shortage of housing inventory. In fact, the U.S. housing market is short 3.8 million homes according to recent data from Freddie Mac.
While builders have started to increase output in the past year, up 18% from 2019, lumber shortages have made home construction considerably more expensive. A global lumber shortage caused by lower production in 2019 is one contributing factor. The soaring cost of lumber could easily add $24,000 to the cost of a new house.
And it is not just lumber that is on the rise, other costs are increasing as well, including labor. Labor costs, largely due to worker scarcity, have increased more than expected during the first quarter of the year.
New Homes Cost More to Build
Many builders have been telling us that we are starting to hit the affordability ceiling, with buyers and builders starting to max out. When this happens, it could put pressure on prices to slow.
Builders are building what can be sold. Values in almost all tiers of housing have risen, with housing prices increasing in most markets. In 99% of metro areas tracked by the National Association of Realtors, prices in the first quarter of 2021 increased over the same period last year.
Of course, these price increases are pushing out the first-time buyer. This is leading to an increased demand for rentals as more people opt to rent rather than buy.
For investors, there is still opportunity in affordable rental homes. There are a great number of renters who have lost their jobs or are still on extended furlough. With the hospitality and service sectors being especially hard hit and many places closing their doors for good, there are a great number of jobs that are at risk. While there will be opportunities for new jobs in many places as things slowly ease back to normal, we still have a way to go. These workers will still need accommodation, and affordable rentals will continue to be in demand.
The Institution-alization of the SFR Space
While SFR has long been an asset class that has been dominated by small investors, for a few years now we have been seeing this space slowly start to tilt toward the institutional investor. There are a few reasons for this. For one thing, institutional investors have the money to secure the best deals for themselves. They can buy materials at-scale and for a better deal than small scale investors, helping to mitigate costs.
Large and medium builders are buying up the small guys, or, in some cases just pushing them out. They can lock in lumber prices with a longer timeline than the small builder. This allows them to have a bigger market share and control the pricing as well. Some are building more homes and making a bigger profit.
Then there are the impact fees—the cost of doing business, and low rates that give institutional investors an edge. Institutional debt is almost always free. This, of course, is helping to drive prices even higher.
Additional factors are compounding to make SFR more challenging for the everyday investor. Eviction moratoriums have provided protection for tenants who cannot pay the rent, but often at the expense of landlords—forbearance for landlords is spotty. In many areas, it is also becoming increasingly difficult to manage a rental home, due to local legislation and changing laws. Landlords today need to continually keep on top of things to ensure that they are in compliance. These days, it is just not that cost effective to manage one or two properties.
Institutional investors, though, have cheap debt and the processes in place that allows them to buy and manage homes at scale, making these investments far more profitable –and feasible. We are seeing a flood of capital into these investments that is going to consolidate the SFR space.
Are Investors to Blame?
Many people have bought into the narrative that investors are to blame for rising home values; that investors keep would-be homeowners out of the housing market. Of course, the reality is that it is not quite as simple as this. At the end of the day, investors are buying to fulfill a demand. If there was not already a demand for rentals, then investors would not buy. It is a misnomer to say that investors are hurting the market. They are not. They are providing much-needed housing. If investors did not buy property, that would impact the availability of rentals, meaning less available rental housing and potentially higher rents as well.
What’s Driving Demand in Cities?
Despite the rumors, no, cities are not dead: at least not completely. Most of the out migration was already happening and was simply accelerated by the events of last year. There are, however, a lot of young people who are willing to move back to the cities to start their career. The landscape will be different, but in most cases, demand will still be there. People will always need a place to rent or buy.
That said, it is also worth paying attention to secondary markets as well. Many tertiary markets are experiencing significant demand right now. There has been an influx of people moving into what were traditionally known as second-home markets, areas with outside activities and plenty of space. So, it is worth keeping an eye on these locations as well. This includes places like Lake Tahoe, Cape Cod, Massachusetts, and Palm Springs, California. Vacation destinations are seeing increased demand now, and higher prices to match.
