The U.S. single-family rental (SFR) market is on the rise. U.S. residential rental rates grew by 12.6 percent in January 2022, the fastest year-over-year increase in over 17 years, according to the CoreLogic Single-Family Rent Index (SFRI). In tandem, SFR is projected to outperform other real estate sectors in the foreseeable future, fueled in particular by an increasing number of institutional investors who are investing heavily in the sector. According to RealtyTrac, investment in single-family homes in the second quarter of 2021 made up 15.4 percent of total single-family home purchases in the U.S., surpassing the historical range of 10 to 15 percent.
What else is behind the demand for SFR?
The growth of SFR has been driven by increasing levels of rental demand for housing product that is maintenance- and worry-free. In addition, other drivers have converged, and will continue to converge, to further boost consumer demand for single-family rental housing, including:
The lack of affordable starter home stock (1400 sq. ft. or smaller), which declined steadily in the 2010s, has helped cultivate demand for SFR housing. In 2020, there were 65,000 entry-level homes completed, but 2.38 million first-time homebuyers, highlighting the widening availability gap, according to Freddie Mac.
As interest rates have inched up in recent months, more individuals and families alike are opting to rent rather than buy. This trend will accelerate as the Fed continues to raise short-term rates to tame inflation. The opportunity to rent from a large investor that offers a consistent turnkey, well-maintained product is a compelling option for many.
Particularly in higher cost states, the recent move to limit the deductibility of mortgage interest and property taxes has dampened the demand for higher-end home buying and made renting more attractive. While this has had limited effect in the low-cost debt environment of recent times, it will potentially become more impactful if mortgage rates continue to rise, and particularly if the Federal government further erodes the tax-based “subsidization” of homebuying.
The growth of SFR, combined with very limited supply of homes, has resulted in the birth of SFR’s sibling, “built-to-rent” (BTR), which is helping fill the supply gap in single-family homes for institutional investors. These homes are purpose-built to be managed by the developer or homebuilder, sold to a third party or placed into a joint venture, often with a private equity firm or other institutional owner. The National Rental Home Council (NRHC) stated that BTRs comprised 26 percent of properties added to the portfolios of single-family rental home providers in the fourth quarter of 2021, compared to 3 percent in the third quarter of 2019.
It’s a classic case of supply and demand; the country’s housing inventory can’t keep pace with the demand for both owned and rented single-family homes. And there is a growing preference for renting over homeownership among Gen Z, millennials and baby boomers, in particular, according to The Urban Institute.
The SFR boom has gotten some critical coverage, mostly around the impact of the growth of institutional ownership and on home pricing. More specifically, the concerns are that there is artificial inflation of home pricing within markets if SFR investors acquire homes at above-market pricing; there will be less available housing stock for individual buyers; there will be fewer affordable homes for many consumers, and housing wealth is being transferred from consumers to corporations whose portfolios contain billions of dollars of SFR properties.
While the data to support these assertions are mixed and, in some cases, divergent, these points certainly deserve further analysis. For example, a February 2022 report by the National Housing Conference cited statistics from a Federal Reserve Bank report, which reported an approximately 9 percent increase in real house price growth and a 28 percent reduction in homeownership between 2007 and 2014, accelerated by institutional investor acquisition of Real Estate Owned (REO) properties. Yet, this statistic may primarily point to increases resulting from improvements made to these homes. A more recent RealtyTrac report found, on balance, that investors pay less for homes than consumers, countering a point that institutions overpay for homes, thereby driving up the prices of homes in order to gain market share.
Benefits of institutional ownership
More inventory through BTR
Institutional investors are building single-family homes and converting them to rentals. This creates more available housing inventory, often in master-planned communities, and typically in desirable locations. Many of these communities satisfy consumer demand for the flexibility of renting with a maintenance-free lifestyle and recreational and social common areas.
Positive community impact
SFR companies usually invest thousands of dollars in renovations and maintenance. This was evident in the beginning of the SFR trend in 2008 after the financial crisis, when institutional investors acquired many REO or foreclosed homes in poor condition, with capital needs too pricey for many consumers. Renovated, well-maintained homes confer a positive, stabilizing impact on communities.
Institutional owners answer to investors, boards, regulators, the media—and now, Congress. Sen. Sherrod Brown (Chairman of the U.S. Senate Committee on Banking, Housing and Urban Affairs) held a Committee hearing in February of this year titled “How Institutional Landlords are Changing the Housing Market.” He suggested that corporate landlords are focused primarily on profits, but institutional investors’ higher profile actually means greater scrutiny of their practices and business. This accountability will result in better maintained properties and higher levels of customer service when compared to mom-and-pop owners because of the greater resources available to the institutional players to respond quickly and effectively to tenants’ needs. In the long run, this means providing a better product for renters.
ESG and doing good
Environmental, Social, and Governance (ESG) refers to the corporate focus on investing in “doing good,” and SFR is ripe for institutional investors to produce positive social impact. For example, the nascent concept of “Affordable Housing Funds” focuses investments on affordable and low-income housing with the aim of reducing homelessness. An increase in this type of investment activity by large institutional players may mean lower short-term profits, but would counter the criticisms of SFR’s impact on real estate markets.
Josh Herrenkohl serves as a senior managing director in the real estate solutions group and leads the real estate business transformation practice at global advisory firm FTI Consulting. He can be reached at [email protected].