An interesting phenomenon took place after the housing bubble came to a screeching halt in mid-2007: People who lost homes were suddenly forced to rent. That brought attention to the rental market and multi-family REITs.
A second consequence of the housing collapse is that home prices dropped to levels not seen in years. This caught the attention of the professional real estate investor, leading to the creation of single-family REITs, something considered impractical up until now.
How can you play this game?
Single-family REITs at this point are generally private entities. However, you can expect several of them to IPO in the near future. Not surprisingly, much of the push for them comes from private equity firms that see an opportunity to leverage their capital with low housing prices and significant supply. In the past, investors have avoided single-family homes for several reasons, including low rental yields, higher expenses versus multi-family, inadequate financing and poor resale potential.
Western Asset Management published a report in October 2011 suggesting the gross rental yield of a single-family home that cost $220,000 in 2006 — at the height of the bubble — was 5.5%. In October 2011, that same house sold for $160,000 delivering an 8.3% gross rental yield.
A quick calculation shows that the breakeven point on this house as a rental unit is $210,000. That means with a 20% down payment at $160,000, the investor is looking at positive cash flow and more than a 100% return on equity once the price hits $210,000. Note: I haven’t included renovation costs, etc. I simply want to illustrate the economics.
The first company to take advantage of this opportunity was Waypoint Real Estate Group, an Oakland-based company that’s acquired more than 1,800 homes since its founding in 2008. It got a big boost earlier this year when private equity firm GI Partners agreed to invest up to $400 million with Waypoint, which plans to buy $1 billion in single-family homes by the end of 2013.
As recently as the end of 2011, Waypoint was earning 8% or more on its rentals, with 20% upside potential on top of that. These are the type of steady if not spectacular returns endowment funds love.
Oaktree Capital Group (NYSE:OAK) invested $450 million with Carrington Capital Management in January to find and acquire 4,000 rental homes. To date, it’s bought less than 300, preferring to go slow and avoid overpaying for properties. It intends to rent the typical house at 1% of the acquisition cost of the property (i.e., a $200,000 house rents for $2,000 per month) for five to seven years before selling.
Blackstone Group (NYSE:BX) has purchased 1,500 homes worth $250 million in Arizona and Southern California and plans to turn the assets into a publicly traded REIT or sell them to another company. New York-based real estate investor GTIS Partners expects to spend $1 billion on single-family homes by 2016. Chairman Tom Shapiro estimates the single-family rental market is $1 trillion, a number that’s sure to catch an investor’s eye. This market is much bigger than anyone realizes.
Most of the participants in the race to own the single-family rental market will undoubtedly be looking to sell their homes at some point to realize profits. They’ll do so by creating public REITs. The first to go this route is Two Harbors Investment (NYSE:TWO), a real estate investment trust specializing in residential mortgage-backed securities.
Included in its holdings are 2,250 single-family homes, which it plans to contribute to Silver Bay Realty Trust in return for equity in the newly formed REIT. Silver Bay will be managed by PRCM Real Estate Advisers, a subsidiary of Pine River Capital Management, and the same people who currently manage Two Harbors. Once this gets off the ground, you can expect a stampede of IPOs in the next couple of years.
This headline from Wednesday says it all: “US home sales jump 7.8% in August to highest level in more than 2 years.” The big money is pushing prices higher. It’s not often that private equity shines, but in this instance, these firms’ thirst for inventory is helping homeowners most affected by the real estate collapse to slowly pull their heads above water — and that’s definitely a good thing.
As prices rise, don’t expect the single-family rental market to disappear. It’s here for good.
As of this writing, Will Ashworth did not own a position in any of the stocks named here.