DNA of #CRE: The State of Commercial Brokerage in 2021 | ACCESS THE REPORT→

Why SFR Is Becoming a Favored Investment Strategy

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Investing in real estate is considered by many to be one of the best ways to create wealth. For most Americans, that comes in the form of owning a home. Homeownership is one of the most common ways for Americans to increase their net worth. Data recently came out from the Federal Reserve that shows that the average homeowner has a net worth of 2.8 times someone that isn’t. It is this connection between wealth and single-family home ownership that can make investing in single-family properties appealing to individual investors. In fact, the vast majority of the single-family home ownership stock is owned by what the larger real estate players refer to as ‘mom-and-pop’ owners. These landlords, by and large, have done well in the past decade. Single-family home prices and rental rates have been growing steadily but were given a boost during the pandemic as urbanites looked to single-family suburbs as a way to find less density and more personal space.

The profitability of single-family rentals has not gone unnoticed by the large landlords of the world; single-family rentals are one of the hottest asset classes for institutional investment. They have even been given their own acronym: SFR. Even with all of the money that large REITs, private equity, and pension funds are looking to deploy in single-family housing, they still are a fraction of the total market. Recent census data shows that 72.5 percent of single-unit rental properties are owned by individuals compared to only 30.5 percent of properties with 25 or more units.

Landlords with more than one hundred properties in their portfolio control only about 3 percent of the total single-family rental market. Experts have predicted that that number might double in the next few years but it still pales in comparison to the ownership by mom-and-pops. 

Now a new generation of mom-and-pop landlords are looking to purchase their first rental and the market can be intimidating. Inventory has remained low so homes in many areas are getting bids above their asking price. Most metros are showing single-family value increases in the double digits over the last year. 

Institutional investors are likely drawn to single-family rentals by their value in potentially generating cash flow. Large landlords that have long term hold strategies worry less about market appreciation and more about its relationship with cash flow. One of the main ways that this is calculated in real estate is with a capitalization rate, or cap rate. By dividing the net income from a property by the market value you can evaluate the property’s cost/benefit ratio. (If a house that costs $1,000,000 generates $50,000 per year, it has a cap rate of 5 percent. If the price goes down to $500,000, then the cap rate goes up to 10 percent.)

Even with today’s high home prices, single-family rental cap rates compare favorably to the cap rates of larger multifamily buildings. “Through the first half of this year, single-family rental cap rates averaged 5.8 percent versus 6.4 percent one year ago,” said Suresh Srinivasan, Chief Marketing Officer of Roofstock. “Compare that to cap rates for small multifamily properties that are currently 5.2 percent, with cap rates for the rest of the multifamily sector settling at about 5 percent. This means that SFR investments offer the best potential returns to investors, followed by small multifamily properties, and then larger multifamily buildings.”

Single-family rentals have performed well compared to other asset classes, both in terms of income generation and asset appreciation over the last decade. But, buying a single-family investment property is not without its risks. New investors to the SFR market, whether they be institutional or mom-and-pop, should have a well defined strategy and realistic expectations of what they want for a return, both in the forms of rent and asset appreciation. Homeownership has been a way for millions of Americans to save for the future. It makes sense that many that have benefited from owning their own home would want to increase their exposure to a potentially lucrative investment in single-family rentals.

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