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Single-Family Rental: Opportunity for Sale?

Editor's note: This piece originally appeared in the August 2020 edition of DS News, now available.

With home prices staying steady and housing supply remaining short, the single-family home rental market has persevered despite the COVID-19 pandemic and is expected to remain on solid footing into 2021, according to those involved in the industry.

Single-family home rentals are popular for many reasons, not the least of which is the large down payment obstacle that many potential homebuyers find economically daunting. Additionally, many younger homebuyers want the option of being able to move as their careers dictate and renting a single-family home both allows for this freedom and provides some of the amenities of buying but without the long-term commitments.

In addition, multifamily apartments are becoming less desirable among renters for several reasons:

  • The oldest millennials reached age 40 this year. They are now in the prime family-formation years, so many want a place with a fenced back yard for their children and pets.
  • With the pandemic continuing, social distancing and limiting human contact is still a concern among many. That’s much easier to do in a single-family home than in an apartment in a multi-family apartment building.

“People value good, quality housing now more than ever,” real estate investment entrepreneur Tim Herriage said.

The consensus among the experts that DS News interviewed is that the first two months of the year were strong, unemployment was low, the economy was good, and interest rates were low. But everything stopped short for the early part of the spring as the economy shut down in wake of the COVID-19 pandemic. However, for the SFR market, at least, the pause was short-lived before things began picking up again.

Jeff Tesch, CEO of RCN Capital, said that even before the pandemic hit, many investors who had concentrated on house-flipping had changed their investment strategy to focus on buying and fixing up SFRs for rentals because purchase prices had appreciated to the point that they could make more on renting a property than from flipping it in most cases.

Though interest rates for SFRs trended up as much as 200+ basis points since January, they have remained steady more recently and could trend down slightly by the end of the year. However, interest rates are unlikely to drop below the rate they were at when the year started, experts agree.

By the end of April, those with the access to capital were able to acquire distressed assets at 75 cents on the dollar, said Sanjay Raghavaraju, Founder and CEO of 33 Holdings.

Even with the uncertainty and high unemployment caused by the pandemic, rent collections are running only slightly behind where they were at the same time last year and occupancy has remained steady, said Mike Tamulevich, President, National Brokerage for Marketplace Homes.

Alex Offutt, Managing Director, Constructive Loans, pointed out that landlords can evict non-paying tenants easier than a mortgage holder can foreclose on a loan, so renters have kept up with payments better than mortgagees since the onset of the pandemic.

Alex Hemani, CEO of Alex Hemani Companies, added that, even if a renter needs to be evicted, SFRs are so popular that there are 10 other potential tenants ready to move in and pay promptly. “The inventory that is available is flying off the shelf.”

SFR buyer inquiries started picking up in July, said Jeff Cline, Executive Director of SVN Advisors. Investors had held on to their capital once the pandemic hit and are now looking to invest it again. But many commercial investments, including multifamily housing and office buildings, are expected to have poor returns as people look for places to live and work with lower population density.

In addition to higher interest rates, lenders have increased reserve requirements and have more enhanced requirements for rent collection histories, occupancy rates, etc., than they did in the first half of the year, Offutt said. He added that some lenders are more likely to favor experienced SFR investors and provide them with slightly better loan terms.

“There are three primary things that we look for in an investor when making loans: an investor’s experience, assets, and credit,” said Josh Craig, Chief Revenue Officer for Lima One Capital. The company evaluates the properties as well, looking at the value of each as a stand-alone property and how attractive it is to other landlords. Loan leverage is another consideration.

The demand for and income available from SFRs is expected to continue for several years due to continuing strong demand and a lack of supply.

According to the Urban Institute: “After completing a major demographic study projecting headship and homeownership rates through 2030, we concluded that demand for rental housing over the next 15 years will dramatically increase—and we as a nation are not prepared.”

Urban Institute’s analysis projects that from 2010–2030, the growth in rental households will exceed that of homeowners by 4 million, with an increase of 13 million rental households and 9 million homeowner households. That’s five renters for every three homeowners. Compared with the previous 20 years, the increase in homeowners was almost twice that of renters, even with the housing crash: 8.8 million new rental households and 16.1 million new homeowner households.

The Wheres and the Whys

The most popular SFR regions are south of the Mason-Dixon line. Cline cited Charlotte, Tennessee; Orlando and Tampa in Florida; Phoenix; and Las Vegas. Others added that areas around Dallas and Houston are also attractive. The movement south has been dictated largely by higher taxes in northern states, though there are still some attractive SFRs there as well.

Tesch added that, in addition to those southern cities, there are some northern cities like Columbus and Cleveland in Ohio, as well as Detroit, that have good job markets (some robotics-related industries have sprung up near Detroit), with workers needing affordable homes and preferring SFRs to multifamily rentals.

Properties further out from city centers tend to be more popular because they offer more space than in tightly packed urban areas, Tesch said.

There is some movement out to rural areas too, Offutt added. However, the rural areas need to have high-speed internet connections. “The biggest concern that capital has with rural areas is the lack of comparables for appraisals.”

The top considerations among potential tenants are properties that are in good neighborhoods with good school districts, experts agree.

As for the properties themselves, tenants and SFR buyers want homes with at least three bedrooms and two full bathrooms, according to experts. A fenced yard is another desirable option. While a house with a pool can command higher rent, it also has too much added liability and upkeep, experts agreed.

“With our company, we’re seeing increased demand for a renewed floor plan, with a closed-off kitchen and improved soundproofing,” Craig said. There is some demand for quiet office space, because many both within and outside of the SFR space expect the work-from-home trend that spiked during the height of the pandemic to continue. Homeworkers have proven to be more productive, according to many studies, and fewer workers in the office means companies can downsize expensive commercial spaces. Good internet connectivity is at more of a premium than ever before.

Renters and SFR owners also prefer countertops, floors, etc., that are easy to clean rather than higher-end surfaces that might be harder to maintain.

Renters and landlords alike prefer properties with easy access to parks, trails, and other outdoor amenities, Craig said.

The Build-for-Rent Factor

“Build-for-rent is really continuing to take off,” Cline said. Builders see a promising market due to the attractiveness of SFRs compared to multifamily and the challenges involved with homeownership.

“These are purposely built communities to be rentals long-term,” Cline said. “Most are designed to be mid-to-lower priced so they can be affordable. They’ll have slightly smaller square footage and slightly less interior finish (i.e., good, but not top-of-the line appliances, etc.) than a retail for-sale home.”

SFRs typically should return about 1% per month over expenses, many experts agreed. However, Tesch said that while that rate might be achievable for those who bought properties a few years ago, the acquisition cost has risen to the point that an 8–10% return is more realistic.

Some investors will accept a lower cash flow in exchange for better appreciation, Craig said.

“A lot of investors are looking at a 20- to 30-year plan. They can buy properties as a college savings plan for their children. You have positive cash flow, and you have a third party paying down your balance. You have good yields and tax advantages. Build-for-rent homes may achieve a 25% to 35% internal rate of return (IRR) in many markets,” Cline said.

Other SFR owners will invest in the properties for the option of renting or selling, depending on market conditions. If real estate prices are depressed, rental could offer the best return, but if prices appreciate sharply, then the best option may be to sell some properties, then purchase others when the market cools off again.

Depending on the property, rents can range anywhere from $1,400–$2,000 per month. Experts caution that charging higher rents will provide better returns but will also reduce the potential tenant base. If the rent is too high, the owner risks the property being vacant for an extended period.

Accessory Dwelling Units (ADUs) are gaining in popularity as homeowners with extra land look to maximize their rental income, said Seth Phillips, President of ADU Gold.

ADUs are dwellings like carriage houses, “granny flats,” or other separate dwelling units built on a property that already has a home in place. They are popular in areas where the cost of land is prohibitive, Phillips said.

They can enable the owner to greatly increase ROI because they’re building on “free” land, Phillips added. While rental income is the most popular goal, “it’s also a perfect opportunity for a family [different generations] living together with each having their own private space.”

However, only about two-thirds of states have approved ADUs.

While the property owner typically will live in the main unit, with the tenant in another, other owners will have two ADUs on one property and will live somewhere else. ADUs cannot be bought or sold separately from the main property.

Scaling an SFR Business

Butler offered the following tips for scaling an SFR business:

  • Make sure that every deal supports itself.
  • Keep your finger on the pulse of the business. Know your cash flow; check it monthly.
  • To limit “playing whack-a-mole” when working with multiple properties, use a property management system.

However, scaling may be overrated, Herriage countered. He said it is more important to get good at owning one property, then two, then three. Otherwise, focusing on scaling will only expose the owner’s inefficiencies.

“Make sure you have a solid team in place,” Raghavaraju added.

Butler also stressed the value of education—not college courses, but real estate industry education. “I’ve probably spent $250,000 on education during the course of my career learning from experts. You need to do your homework”

While Butler admits there are some poor seminars, they can also prove to be valuable because an investor learns tactics not to pursue. He also found a broker’s license to be valuable.

Danny Kattan, Founder and CEO of Sell2Rent, said a broker can help an investor scale an SFR business, but it’s also essential to know what your leverage options are.

“You need to be organized with your borrowing,” Kattan said. “You have to realize that it will take time.”

“Set goals,” Butler added. “If you shoot for the moon and miss, you still land among the stars.”

Butler’s goal when he started his business was to make 20 offers a week, even though he had a full-time job. He eventually grew his business to the point where he could forgo the job. He advised those in the business today not to forgo other employment until their rental income is 1.5 times the amount they are making on a job.

Property Management Challenges

A property manager will simplify an SFR business, said Dani Beit-Or, CEO of Simply Do It.

Any property manager needs to be thoroughly vetted, however, said Jay Tenenbaum, Co-Founder and VP of Capital Development at Scottsdale Real Estate Investments. When the company purchased a portfolio of properties in Evansville, Indiana, it also inherited the legacy property manager, who presented several problems. There was improper accounting, a portfolio property that was kept off the market, and other issues. A new property manager has cleared up those problems.

If using a property manager, it’s best to use someone who is local, Tenenbaum said. “A national firm is going to use someone local anyway.”

Beit-Or said he uses a comprehensive list of 60 questions to vet a property manager, weighing not only the responses themselves but also the type of response.

A good, local property manager will also help an owner stay on top of tax laws, which are different from county to county and from city to city, Raghavaraju said.

“The number-one problem is local government,” said Mike Butler, Founder and President of Vista Properties. “They assume anyone is a landlord has plenty of money. If you have any Section 8 properties, they are very pro-tenant.”

Butler recommends owners get involved in property owners’ groups, local boards of Realtors, etc. in order to protect their rights.

Transformative Technology

Various technologies enable an owner to handle the intricacies of single-family rentals without the need to get involved in all the details.

“The technology that is available today is mind-blowing,” Hemani said. “People can make their payments online and print out a voucher from the screen; if they need a repair, they can log right in and request a work order; if they want to see a property, they can go to the lock box, key in a code, and have access to the property—no one else has to be there. They can digitally sign any documents. There doesn’t need to be any physical contact.”

There are also technologies that enable a prospect tenant to virtually tour a property, an advantage for anyone moving in from a remote location.

It’s critical to have a comprehensive solution, said Inaas Arabi, VP of Single-Family Rental for RealPage. That software should enable the user to list and lease vacant properties, screen tenants and vendors, manage assets and tenants, accept payments and manage maintenance, offer financial reporting, and handle any additional property management needs.

There are a host of different property management software programs available, designed to help SFR owners track leases, residents, and maintenance tasks, as well as collect rent and manage finances to reduce costs and streamline operations. Some are designed for single-family properties and may be preferred by owners of different types of properties.

Arabi added that some larger SFR owners may opt to buy different “point” solutions for to handle collections, property management, etc., but it can be hard for those different solutions to communicate with each other unless the property management platform supplies an open application programming interface (API) as a communication bridge.

Scottsdale REI is ready to launch the beta test of its own proprietary software, REIBLADE, this month, which is designed to help investors outperform at what Scottsdale REI considers to be the six “success activities” of real estate investing—acquisition, capital raising, investor management, asset management, analysis and performance, and property sales.

Investment management software can also help SFR owners with financial reporting, Raghavaraju said. Arabi added that having automated financial reporting and records makes it much easier for a borrower to receive credit approval for property loans.

Automated rent collection, through a comprehensive program or through a point solution, enables a tenant to log in to make an electronic payment, providing the SFR owner with immediate access to funds rather than waiting for “a check in the mail,” while also providing automated ways to charge late fees and a paper trail for collections, evictions, etc.

Technology provides SFR owners with transparency when examining vendor pricing for services such as electrical work, plumbing, etc., said Roman Rusev, CEO of Field Complete and Founder of U.S. Legacy Development. This way, owners can see how a contractor’s prices stack up against the average for a given market. Owners can also see online reviews of contractors to help determine if they have a track record for good work.

Beyond online ratings, Rusev said that owners should look for contractors who provide detailed line pricing for different jobs, not just a total price. “Otherwise it’s a fire just waiting to happen; that means they don’t know how to price the job.”

Rusev added that owners now look for multitrade contractors who can provide an array of services, rather than one contractor for plumbing, another for electrical work, another for heating, etc., even if a particular job is expected to need only one of those disciplines.

Finally, “Smart” appliances, particularly thermostats, are starting to make their way into SFRs as tenants look for things that can simplify their lives. These devices can also help building owners determine when connected appliances like furnaces need attention. Reporting capabilities in property management portals can similarly help determine if an issue is a nuisance (i.e., a pinhole leak in a water heater) or an emergency (i.e., a much larger leak in a water heater), Rusev said.

Outlook for 2021

Though there is some caution due to the many unknowns involved in the COVID-19 pandemic, most SFR stakeholders expressed optimism for next year because the underlying factors boosting the market in the last few years will continue to be prevalent—renters looking to move out of multifamily housing; millennials, particularly those with children, becoming a more prevalent portion of those needing affordable housing; and an ongoing shift of construction with more devoted to build-to-rent properties.

Homeownership rates to continue to decline as people look for more flexible housing arrangements, Offutt said. “People are less inclined to be tied down [to a house] today. They want flexibility so that they can move without complications,” he said.

However, Butler has a more muted outlook. He said that he expects the economy, and therefore, the SFR market, to soften into the election as enhanced unemployment benefits end. Recovery could take a while, so some landlords might need to decrease rents slightly.

About Author: Phil Britt

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Phil Britt started covering mortgages and other financial services matters for a suburban Chicago newspaper in the mid-1980s before joining Savings Institutions magazine in 1992. When the publication moved its offices to Washington, D.C., in 1993, he started his own editorial services room and continued to cover mortgages, other financial services subjects, and technology for a variety of websites and publications.
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