The Future of Housing: Our Outlook for Single and Multi-family Investments
Demographics and cultural changes, along with technological advances in property management, have led to vast improvements in performance and institutional investor accessibility to the single family-rental sector.
We estimate 15.5 million housing units will be built in the 2020s, up from 3.9 million in the 2010’s.
During the 2020s, we expect apartment rents will average 3.2% growth per year, single family rents will average 3.5%, and single family home prices will average 4.5%.
Although demographics suggest larger format apartments and single-family homes will be increasingly preferred to smaller studio and 1-bedroom units during the decade, much of this shift in demand may have already occurred as households sought more space for remote-working in 2020 and 2021.
Introduction
The past year capped off another decade of significant change in how institutional investors view the residential investment sector, and also signaled what is likely to come. Specifically, the single-family rental sector is following the same path toward institutional acceptance that apartments navigated in the 1990s and 2000s, and we believe this is being driven by two factors. First, demographic and secular shifts point toward a medium and long-term increase in demand for larger format rentals, such as single-family homes1 . Second, and perhaps more importantly, advances in information management platforms have made smaller investments accessible to investors with billion or trillion-dollar portfolios.
We believe the institutionalization of single-family rentals (SFR) which began in the early 2010s may near full maturity as an asset class by 2030. This could cause several things to occur. The most noticeable effect in the short term may be a compression in SFR yields as the market moves from small private investors who expect double digit levered returns, to institutional investors who may be comfortable with a higher single digit levered returns, due to both economies of scale and a lower average cost of capital. Yield compression could, in turn, put downward pressure on the homeownership rate as renting becomes more affordable relative to owning an equivalent quality home. This increase in the ratio of renters could translate into a larger investible universe for rental housing.
In the medium to long term, we believe the most significant effect of the institutionalization of SFR will be a rise in popularity of master planned rental communities, as opposed to traditional construction of more disparate homes or neighborhoods built for owner-occupiers. To understand where the SFR investment sector is headed, we believe it is important to first understand the history and current state of the more established rental apartment sector.
A Brief History of Housing
Institutions have been investing in apartments for a relatively short period of time. Although some large institutions (such as MetLife) can date their ownership and management of apartments to over 50 years ago, the sector wasn’t fully embraced by institutions until the years following the savings & loan crisis in the early 1990s. In 1980, for instance, the nascent National Council of Real Estate Investment Fiduciaries (NCREIF) tracked the performance of just 9 apartment properties (4% of the NCREIF Property Index at the time), compared to a broader set of 80 office properties (30% of the NCREIF Property Index at the time), whereas today the two asset classes are closer to equal representation in the NPI (see exhibit 1).
Before the 1990s, institutional investing in the apartment sector was challenging due to a lack of transparency, the need for large staffs, and a lack of reliable and regionally scaled property managers. At the time, reporting standards from NCREIF, as well as early publicly listed REITs, gave investors only a basic level of transparency. As investment track records lengthened and national property management firms were formed and consolidated, more capital was allocated to the apartment sector. This resulted in lower required yields by investors, and the risk premium ascribed by investors relative to the earlier-to-institutionalize office sector also evolved. Between 1985 and 1995, apartment yields traded 50 bps above office assets. Over the subsequent decade apartment yields traded on average 70 bps below office yields.2
By the early 2000’s, the institutionalization of the apartment sector advanced to include a broadening of investible cities. Initially, markets like New York City, Chicago, and San Francisco had a critical mass of liquidity and transparency, and captured a majority share of capital. Since that time, investors slowly but steadily increased their apartment allocations in markets like Austin, Denver, and even smaller markets like Raleigh and Salt Lake City. In 2021, institutional investors have a notable presence in more than 50 U.S. cities, versus a concentration in around 3-5 cities in the 80’s and 90’s.3
We believe the next stage of institutionalization of residential real estate investing is a broadening of rental property types to include single-family homes.
Residential Rebirth
Following the subprime mortgage crisis of 2008, a small number of institutions believed depressed home prices created an opportunity in the SFR sector. Institutional investors, however, had few direct paths to owning equity in single-family homes. Much like apartment investing in the 1980s and earlier, investing in single-family homes as rentals was challenging. However, improvements in software and the ability to scale property management companies have made the SFR space easier to access in a relatively short amount of time.
In terms of transparency, the public REIT sector now offers investors around a decade of performance history for SFR. In addition, a growing number of specialized data vendors have been collecting and reporting on information that allows investors to understand market conditions and more consistently underwrite opportunities. Lastly, in 2021, the NCREIF Research Committee created a Single Family Rental Task Force that has been tasked with evaluating how to categorize and benchmark the sector4.
Based on our view of the volatility of historical returns, and our outlook for demand and supply growth that we will discuss next, we believe single family rental yields should be slightly below apartment yields. In practice, however, we estimate that single asset single family rentals are trading at a 5.5% cap rate, and portfolios are trading at a 4.5% cap rate. Built-for-rent communities, which represent a very small share of the single family renal investible universe and are thinly traded, may be trading with return expectations that are on par, or slightly below, where apartment assets are trading.5
The investable universe is large and growing, which will provide institutional investors with the ability to achieve meaningful portfolio allocations to the sector.
Near Term Prospects
Residential investors enjoyed a strong year in 2021, despite mixed macroeconomic pressures. In our view, there are cyclical and structural conditions exerting price pressure on U.S. housing.
Examples of temporary / cyclical COVID-related conditions include factors that limited housing supply last year, such as seniors remaining in their homes rather than moving into group facilities, thus reducing the supply of existing single-family houses for sale. Supply was also limited through September 2021 by eviction and foreclosure moratoriums. We expect these conditions to abate in 2022 and 2023, which should modestly ease inflationary pressures in residential real estate markets.
There are, though, longer-term structural factors that have led rents and home prices to outpace wage growth in recent years. On the supply side, new construction was low last decade. The U.S. housing stock increased by just 0.3% per year from 2010-2020 versus a 1.4% average annual increase in each of the 3 prior decades.6 At the same time, population growth and household formation progressed at a steady pace, driving housing occupancy (the number of housing units per U.S. household) to the highest level since the 1970’s (exhibit 2).
Additionally, low interest rates have kept monthly mortgage payments relatively low for would-be home buyers, driving down for-sale home inventory and driving up prices. This had a secondary effect on rents, and could help support fundamentals even as some of the temporary COVID-related factors mentioned above reverse.
Taken together, we believe home price appreciation, apartment rent growth, and single-family housing rent growth will remain elevated, but could moderate somewhat as the cyclical conditions mentioned above begin to dissipate next year.