Yesterday I participated at a conference for family offices where I was one of the guest speakers on the topic of non-correlated investing. Different interesting panels presented as well on a variety of topics from asset based lending to new trends for family offices. One panel that caught my attention was a presentation on the increasingly popular strategy of creating funds around the idea of investing in single family homes for the purpose of holding and leasing.
I have noticed the rise in popularity of this strategy for a while now as it is mentioned and discussed in different events. This significant increase in recognition has forced me into more research as I usually get nervous when the market seems to lean in one direction.
The rise of these investment funds has been a stabilizing force in the healing real estate market providing a constant bid for mostly foreclosed properties. In the first stage of the process everyone is a winner: the market finds a source of demand, investors realize very attractive cap rates and renters can continue to enjoy single family home living style even though they could not afford to purchase.
What made the strategy appealing of course were the booming foreclosures which lowered home prices, raised cap rates and simultaneously created renters out of ex-homeowners. The long term viability of the strategy will depend on the flow of foreclosure going forward, the unemployment rate which will determine the aggregate level of renters and how difficult it will be to manage a patchwork of diversified properties as opposed to the more traditional residential REIT model built around the apartment complex structure.
The strategy’s popularity is already compressing cap rates and limiting investing options to certain geographical areas. Marketwatch indicates areas such as Phoenix, Atlanta, parts of Southern California and Las Vegas beginning to show a shortage of inventory. On the other hand, Chicago seems to be still well supplied with 200,000 homes in the foreclosure process and an additional 250,000 part of the shadow inventory being more than 90 days delinquent as Erik Workman of Mack and Cos states.
The rental market in general, apartments and single family homes, is on the rise as supply is being depleted. Bloomberg quotes effective rents for apartments rising 1.3% in the second quarter, the fastest pace of quarterly growth since the third quarter of 2007, according to a report released this week.
Rents in New York rose 1.7%, while rents in San Francisco and Seattle jumped 1.6%, according to Reis, a commercial real-estate research company. Effective rents are asking rents, minus any concessions the renter receives when signing a lease.
Additional statistics were recently released by the Census Bureau: the rate for rented homes declined to 8.6 percent from 9.8 percent a year earlier while vacancies for owner-occupied houses dropped to 1.9 percent from 2.4 percent a year earlier. Homeownership was 65.5 percent, down from 66.3 percent a year earlier and unchanged from the previous quarter
In conclusion the viability and profitability of this strategy seems to be constrained by geographical parameters and a capacity issue. Changes in the unemployment level will also determine how long the strategy will retain an outperformance; jobs coming back will probably force higher interest rates and motivate renters to become owners again. This dynamic could actually provide an exit strategy for the funds which could liquidate their inventory with a capital gain.