I went into this latest SFR conference with one simple goal: explore what buyers in the market are doing given the current economic and rate environment and see if I can uncover some common themes that overlay across investor classes. What I found out was eye-opening and will drive Strata’s brokerage strategy for the balance of the year. Here are the key takeaways.
The Party Is Over
If “the party” that people affectionately refer to having happened over the last decade can be described in any particular way, I’d describe it as a “land/property grab” fueled by the largest institutions in the US pumping money into the SFR segment to acquire homes that fit a pretty narrow set of criteria. This drove acquisitions in a relatively small number of markets overall. That buying strategy trickled down from large investors to small, creating massive competition for homes that fit that narrow scope. Those homes were generally mid-priced homes that had rent potential between $1200–$2500, with submarket attributes that veered toward the lower-middle to upper-middle end of the rental market. In other words, starter and move up homes for people making at or above the median income for the area. Yeah, that party is over. By and large, the institutional investors that drove that strategy are still buying, but sporadically vs programmatically, either through off-market acquisitions or builder-direct relationships. So that buying has tamped down to a small parentage of what it was, and the buying habits of smaller players whose plan was to eventually exit to those larger players has waned in lockstep. The time when grabbing hold of those types of mid- to higher-priced mid-range properties has passed, with the exit potential to larger players now a bit murky and therein all of the firms that had strategies to feed that machine now have to find another strategy to subsidize those sales. That includes private investors, and all support services including rehabbers, lenders, and closing services. Everyone, including Strata, needs to find another way to replace transactable units that fit that mold.
SFR Is Going Back to What It Was … an Industry of Niches
Capital drives activity, and now that the bulk of the capital is done with the “property grab” that has been happening for the last decade, it needs to find its way to a highest and best use. What’s changed over the course of the last decade in SFR is that smaller operators with niche business plans have become larger, with the ability to both attract larger sums of capital and put their infrastructure to use on a larger scale. Strata spoke to more than a dozen of these operators at the conference, each with a nuanced strategy that focused more on asset type and geography vs volume. From our perspective as a brokerage, that ocean of buyers we were tapping into has dried up into hundreds of lakes, and it is our charge now to look at our resources and match them to the strategies that we think we can help those operators execute on. And there is no shortage of options. Like I said, the capital is still there, it’s just pointed in a variety of different directions now.
DSCR Will Drive Smaller SFR Portfolio Sales
When institutions are buying with rock bottom cost of debt, figuring a portfolios DSCR isn’t a key concern, since the price of a portfolio, even above fair market value (assuming rents aren’t that far below market) isn’t really a key concern. But for buyers that rely on market rate debt, now in the mid 6% to 8% range, DSCR (the ratio of Net Operating Income to Debt Service in a portfolio) is a major item. Generally at current interest rates, assuming rents are at or in range of market, reaching a stabilized DSCR of 1.2 requires some discount on the properties, unless homes have been very well operated and rents pushed to market, and even then at current rates, discounts are generally needed. Given the need to branch out to smaller investors that take on market rate debt when buying an SFR portfolio, the key to making deals work for the best quality operators is getting pricing in line with a 1.2 DSCR. Once that is done, you have to figure out the discount needed to get there and then it’s up to the owner to rationalize whether it’s a trade worth doing. Strata will be talking to lenders to figure out whose loan programs can be attached to our portfolio sales to set pricing at the most favorable price for our sellers. I suggest when sellers are thinking of a sale, figuring out exit pricing based on DSCR to be a first step. If further structuring needs to be done to bridge the gap for buyers, best to structure deals appropriately ahead of a disposition.
Builder Relationships Are High Value
The math for a builder as it pertains to selling units to investors vs retail buyers is simple … figure out cost to sell, which today includes a rate buy-down along with marketing, brokerage, and closing costs. Those costs today will range anywhere between 10% and 15% of a home’s value. So a sale to an investor (in bulk) in that discount range makes sense, assuming all of the sale costs above are being absorbed anyway. So if you are a buyer looking for newly built homes, and the return target can be reached buying in that range of discount, those buyers become valuable assets to builders and those builder relationships become high value. The key is finding a buyer that has a buy mandate that aligns with a builder with assets to sell. Easier said than done. That makes having a top-notch broker that has those builder relationships established a hot commodity. Good news for Strata 🙂
On The Horizon For Strata SFR
Strata will be on the lookout for buyers with acquisition strategies that align with potential sellers in whatever market they are pursuing and that we can point our resources and relationships toward. We want to hear your current buying strategy. You’ll be seeing us “marketing” those buying strategies to potential sellers in the months to come. In my analogy, if the fish in the big ocean now live in hundreds of lakes, then we need to decide what we are going to be fishing for, and those buyers and buying strategies are our bait.
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