The Fed just raised interest rates half a point to the highest level in 15 years. In its ongoing battle to slay the inflation beast, the Fed just raised interest rates again. That makes it seven times in 2022 that the Fed has raised rates, with more promised for 2023. None of this should be a surprise, as the Fed signaled at the end of 2021 that it would raise rates in 2022 to combat inflation.
The result of the Fed’s rate hikes has been a slowdown in home buying as mortgage rates have climbed. What hasn’t slowed down is rents, as rates have been growing at breakneck speed in 2021 and 2022. Maybe that explains Wall Street’s sudden interest in the single-family residential real estate market.
Wall Street had always shied away from the single-family residential market. It didn’t appeal to institutional investors enough to lure them away from multifamily, which was ideal for taking advantage of economies of scale. Private-equity giant Blackstone was the first public company to dip its feet in the pool in the aftermath of the Financial Crisis, but they couldn’t get any banks to lend to them to pick up single-family homes.
However, against the advice of some of the biggest billionaire investors in the world, Blackstone forged on with private funds. Now, a decade after its first purchase in Phoenix, Arizona, Blackstone’s experiment has morphed into an institutional-grade asset class. Economist.com
Institutional interest in single-family rentals snowballed in 2021. According to John Burns Real Estate Consulting, a research firm, institutional investors bought up to $45bn of single-family homes in America, up from $3bn the year before. Even as the housing market has cooled, institutional investment is still pouring in, with firms including Goldman Sachs and J.P. Morgan Asset Management following in Blackstone’s footsteps. Economist.com
Why single-family homes and why now?
Here is a rundown of the appeal to institutional investors (Source: Economist.com):
Between 2016 and 2021, annual returns from family rentals (of 21%) have outperformed those of senior housing (7%), offices (5%), shopping malls (-1%), and even multifamily (12%), according to Green Street, another research firm.
Unlike mom-and-pop investors, who tend to own no more than a handful of homes, institutional investors hold hundreds if not thousands of homes to take advantage of economies of scale on the acquisition, renovation as well as the operations parts of the business.
Aging millennials and a growing Boomer rental market account for much of the growing rental demand. As millennials approach their late 30s and early 40s – a coveted demographic for landlords – many want better schools for their children, space for pets, or finally have enough money to dump their housemates.
In America, population growth in this age category will nearly double over the next five years. Aging baby boomers are also renting in higher numbers.
Residential rental real estate has been the ideal counter to rising inflation in recent years, which can explain the explosion in institutional interest in 2021.
COVID revealed the value of residential rental real estate when this real estate segment was spared the impact of pandemic-related lockdowns on offices and shops and has proven to be a relatively high-yielding hedge against inflation as rental rates across the board have been able to keep pace or even exceed inflation. Toptal.com
Advancements in technology in the residential real estate space have enabled institutions to scale and manage their portfolios more efficiently, which was once exclusive to multifamily.
These improvements have not only enhanced the ability of these institutions to analyze the market, speed up research, streamline due diligence and make smart decisions more quickly but also to reduce costs associated with property management.
Wall Street is a self-preserving institution, and it’s not surprising that it’s turned to real estate for security in times of uncertainty to insulate its portfolios from volatility.
Wall Street’s interest in single-family has been largely ignored by the investing public. But, if the average investor had been paying attention to the housing market, they would have realized that the biggest contributor to rising home prices wasn’t individual home buyers but institutional investors. These big investors were taking advantage of the benefits of rental real estate that sophisticated and wealthy investors have been taking advantage of for decades to pad and protect their portfolios.
In times of uncertainty, smart investors turn to cash-flowing real estate because no other asset has provided more certainty over time.
According to Barron’s, what 100 years of the real estate market have taught us is that while the broader market experiences extreme volatility in times of uncertainty, real estate is typically sheltered from the storm if investors are willing to ride out minor hiccups (minor compared to broader market plunges).
Investors who understand this can ride the wave of certainty real estate provides to predictable, reliable inflation-insulated, recession-resistant cash flow and appreciation.