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.