Capitalizing on Single-Family Home Assets: Key Trends to Watch

23 Oct 2023 Capitalizing on Single-Family Home Assets: Key Trends to Watch

Authored by RSM US LLP, October 23, 2023

 

The single-family housing market continues to evolve as corporate investors and families look to find their footing amid the shifting landscape. While speculation swirls around the future of commercial real estate, much less has been said about the residential market. Given the significant headwinds affecting housing, will the macroeconomic variables and other market uncertainties dramatically change the investment outlook for this sector? We’ll look at factors shaping market trends and the response from investors and buyers.

The current situation

The Federal Reserve has made it clear that interest rates will remain higher longer. Zillow data shows that over 80% of homeowners have rates locked in below 5%, providing little incentive to move. How might this change when rates begin to ease and pent-up demand is unleashed into the market?

Potential homebuyers face historically low affordability, with the highest mortgage rates in over two decades and elevated housing prices that have recovered from a short-lived dip in 2022. Despite these obstacles, single-family housing permits and starts reached 948,000 and 941,000 seasonally adjusted annualized units as of August 2023, an increase of 7.1% and 2.4%, respectively, from a year prior. New home sales climbed 11.9% year over year, to 714,000 seasonally adjusted annualized units, as buyers competed for limited options.

The U.S. housing shortage, estimated at over 3.5 million units, is a direct result of underproduction following the global financial crisis of 2007-09. Millennials who have reached prime homebuying age and baby boomers who want to stay in their homes longer are exacerbating the need for more housing. Meanwhile, resale inventory remains anemic as current homeowners opt to maintain their locked-in low rates.

Even as the market grapples with low supply, the long-term outlook for residential real estate remains positive. However, affordability and post-pandemic lifestyle preferences will continue to influence the decision to rent versus buy, with a growing emphasis on affordability, flexibility and convenience of renting.

The growth of single-family rental investments

The single-family rental (SFR) portfolio gained dominance during the Great Recession, when the housing bubble provided an opportunity for private equity to take advantage of a very distressed single-family market heavily owned by private investors and families. The current macroeconomic environment of elevated rates has increased borrowing costs and put homeownership out of reach for many in the market, securing steady demand for SFR products across the nation.

An April 2023 Urban Institute report estimated that as of June 2022, large institutional investors (i.e., those with more than 1,000 single-family units) owned 574,000 homes. The growth of SFR portfolios increased from 2020 through 2022 due to historically low interest rates, robust rent growth, increased occupancy and home appreciation. As SFR dominated the market with favorable fundamentals, large funds focused on strengthening operational alpha. Elevated property taxes and insurance costs demanded operational excellence and achievement of economies of scale on maintenance and management.

Build-to-rent expands on SFR’s success

The build-to-rent (BTR) investment thesis is centered on developing and operating purpose-built rental communities with an eye toward well-designed, professionally managed homes that cater to market demand. The BTR model is often described as a hybrid of conventional multifamily with all the great benefits of SFR. The demand for these properties started to increase during the pandemic when, as an alternative to buying, renters flocked to larger properties with backyards and more privacy and amenities, with annual sales of BTR communities spiking in 2021.

BTR developers nationwide are building at a record pace, with the South leading the charge by outpacing the next closest market (the West) by more than 2 to 1, according to data from RealPage Analytics. Across the country, BTR homes are included as a critical component of successful master-planned communities. The Yardi Matrix 2023 second-quarter report shows 6,600 BTR units delivered in the first half of 2023 and 50,000 units currently under construction. With 36,000 more units in the planning stage, the BTR market continues to grow at an impressive pace for 2023 and beyond.

Family office interest in SFR and BTR assets

As emerging real estate investment power players, family offices will continue to pour capital into this alternative asset class, fueled by the great wealth transfer that will occur over the next 10 to 20 years. The tax advantages of real estate make it a top choice for family offices, whose preference for income- and appreciation-oriented assets align with many single-family housing investment opportunities.

SFR funds offer family offices a unique opportunity to capitalize on economies of scale—which is critical in building margin and long-term operating profitability—through bulk purchases and bundled maintenance and management costs. BTR investments have a similar profile but require a less expensive build than conventional multifamily and offer better build-to-cap rates.

The outlook

Housing market dynamics—including historically low inventory, continued price appreciation, and changing demographics and lifestyle preferences—are reshaping the single-family investment landscape and opening the door to BTR and SFR opportunities. However, as with all sectors of real estate, higher interest rates and a tighter lending environment will continue to limit residential real estate investor transaction volume.

Still, an influx of capital from value seekers entering the market has led to more activity focused on the rental space. While SFR and BTR opportunities still make up only a very small percentage of the single-family market, we expect to see more focus on rental property portfolios as corporate investors and family offices continue to place their bets on residential real estate.

Tax trend: Single-family home assets

Developers, investors and owners of single-family home assets have various opportunities to realize tax benefits and increase the return on their investment.

Taxpayers looking to accelerate depreciation may benefit from a cost segregation analysis to boost their cash flows when purchasing or renovating residential real estate. Taxpayers also might be able to take advantage of state and local credits or clean energy incentives included in recently passed legislation, such as the Inflation Reduction Act. Separately, in a sale of residential real estate, a 1031 exchange may be an option to defer gain on exit of business property.

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This article was written by Crystal Sunbury, Gene Garcia and originally appeared on 2023-10-23.
2022 RSM US LLP. All rights reserved.
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