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Slow Money Is Replacing Fast Money

The Single-Family Residential Rental Asset Class Is Maturing Quickly

Mark Fleming

This week, I attended the IMN Single Family Aggregation: The REO-to-Rental Forum in uncharacteristically overcast and drizzly Scottsdale, Ariz. The fact that there are now conferences for single-family residential institutional investors speaks volumes about the increasing maturity of this new investment asset class. From just a few well-known early entrants to a variety of participants with varying business models, and even securitization and the formation of real estate investment trusts (REITS), the single-family residential rental asset class is growing up.

To be clear, investing in real estate is far from a new phenomenon. It’s not uncommon to meet people who own multiple properties near where they live or in markets where they like to vacation. What is different is the aggregation and professional management of large portfolios of properties and, most importantly, the availability of institutional investor capital to fund the acquisition of properties. The combination of institutional and individual investor demand in recent years has been critical to the successful recovery of the housing market. Where would prices be today if investors had not been willing to buy distressed properties in the dark housing-market days just a few years ago?

But the times, they are a-changin’. The maturation of the market combined with rising home prices is challenging the profitability of the business. To see this, we measured single-family rental cap rates for a number of markets with significant investment activity in 2012 and again in 2013. Year-over-year August rates are a good comparison point, as it signals the end of the homebuying “season.”  The cap rate is the ratio of the property’s income-producing potential and the cost of acquiring it. We used market-level single-family residential rental rates and assumed one month of vacancy, leasing costs equal to one month’s rent, an 8-percent management fee and a 2-percent maintenance fee to determine the average single-family rental property income in each market. Acquisition cost was based on the average sale price with a 30-percent discount (assuming the investor is buying a distressed asset) and 5-percent rehabilitation costs.

The chart shows the 10 markets with the highest cap rates in August 2013. All markets but Charlotte, N.C. and Houston have had declines in their cap rates, largely due to the increase in home prices outpacing any increase in rental rates. Nonetheless, the implied return is still strong, especially if you add in the capital appreciation caused by house-price appreciation.

Yet, from talking to participants at the conference this week, the sentiment toward considering this asset class for long-term rental cash flow is clearly positive. The capital appreciation is less important. Participants at this forum continually talk about how to select the right properties and buy them at the right prices, how to find operational management efficiency and how to gain economies of scale, all in order to attract more investors and capital to the market. As the asset 

class matures, the “slow money” is replacing the “fast money” – a good sign for the long-term success of the single-family residential rental asset class.

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