The IMN SFR Conference has been the Single Family Rental Industry’s go-to conference for over a decade. I’ve been attending since 2010. While the profile of attendees has shifted over the years from predominantly fund and sponsor CEOs/Founders in the early years, to C-Suite Executives and Corporate Managers in the later years, to what it is now – a mix of vendors, Business Development Professionals, and CEOs and Founders. I still think the conference offers me an opportunity to find out what is going on from the ground level across the industry. This helps me to keep my ear to the street and identify opportunities and trends that will inform Strata’s business strategy in the months to come.
From the perspective of a highly specialized and boutique SFR and B4R brokerage, the way I attacked this IMN conference, was to focus on some key questions:
- Where is capital coming from?
- How is capital being raised by sponsors and operators and from whom?
- What strategies are being offered to attract that capital?
Answers here would provide insight into a strategy that has worked exceedingly well for me and Strata over the last decade – focusing on the buy-side to guide me on where to source SFR and B4R opportunities. After all, I see lots of brokerages finding great deals that ultimately don’t find their way to a buyer with a strategy that intersects with a particular deal. My thesis has always been that Strata is better off attracting deals for which we have a built-in and ready buyer base. Not a hard strategy to understand, but one that requires that I keep pace with the shifting market, lest we lose track of it and end up spending time putting out deals for which we can’t find buyers.
Now that I’ve shared my approach to this IMN conference, here are some takeaways:
What have fund investors been up to?
Most have spent the last year focusing primarily on operations, and while some have steadily looked at new deals, for no other reason than to keep their sourcing channels active and provide useful market intel to their LP investors. Many are waiting until the interest rate environment becomes more predictable to forge ahead with new acquisitions.
What are funds planning to do in 2024?
Now that interest rate indications from the Fed have pointed to no more increases, and there’s optimism about potentially decreasing rates, the outlook for 2024 for new acquisitions is better than in the previous 12 months.
Are buyers more or less active right now?
Many firms have concluded that they need to figure out a way to operate in this higher interest rate environment, which for some means lowering return expectations with investors. For others, it means employing lower leverage or all cash investment strategies. And still, others will remain on the sidelines and focus solely on operations until the environment changes.
Will funds get new deals done at current financing rates?
If there was a catchphrase I heard over and over again at this conference it was “Negative Leverage”. Concerning Build For Rent, where operators buy completed units (unless builders are willing to price deals at steep discounts relative to retail values), those are going to be negative leverage. Meaning the unlevered returns they provide fall below current debt financing rates. This creates a situation where the levered returns that can be achieved, if debt is used, will not be accretive to the deal from an overall return standpoint. Most investment firms are using leverage in their deals to decrease the amount of equity needed to do deals. But for most opportunities, using debt won’t increase overall returns and deals will continue to be difficult to get done.
The consensus from buyers was that unless a Build For Rent opportunity is in a “got to have it” location, meaning infill locations in markets that fall within an investor’s core strategy and with overwhelmingly positive growth indicators, those deals are not being pursued. Some investors are in the market using all equity and no debt, looking to capitalize on the lower competition that this environment affords. For those investors, sourcing Build For Rent opportunities is easier, allowing them to have a broader range of projects that could potentially fit, but those deals still need to be in locations that show good fundamental indicators such as high renter demand, proximity to employment, amenities, and transportation, as well as rent growth and appreciation.
My main takeaway from these conversations was that capital is in the market and will be on the lookout for deals that pencil at unlevered returns for finished new construction homes in the 6%-7% range. Overall, levered returns (IRR) for well-located projects need to be in the mid to high teens, and for projects that are in more marginal locations, those will need to pencil in returns at margins higher than that. So, projects from builders that can be transacted on at a higher discount to current market values are the ones that I need to focus on sourcing. No big surprise there.
Are buyers still buying SFR Portfolios?
SFR Portfolios from small and medium-sized operators are still of interest, but the Cap Rates that are being targeted are 150bps to 250bps higher than where they were before interest rates spiked. This means that SFR portfolios from operators that have successfully pushed rents are of high value because those portfolios can be sold closer to market value. Although, some discount will still be required. Other portfolios, which are the majority of the ones we see from smaller operators where rents haven’t been maximized due to necessary capital Improvements, will need to be priced at steeper discounts to achieve attractive Cap Rates. I did have several conversations with smaller investment firms that are targeting seller-financed deals in the new year. These are deals that can be bought from sellers willing to hold a note for a below-market interest rate. From a seller’s perspective, this gives them a better opportunity to achieve a higher price for those homes. Likely buyers for those deals still have to subscribe to the idea that rates will fall over their proposed hold period which generally ranges from 3-5 years. And while that includes most buyers today, it doesn’t mean every one of them will be buyers in the short term.
What markets are investors most interested in?
Overall, market selection hasn’t shifted much. Most investors focused on the top 40 markets with populations over 500k+ people. Strata’s main focus is on Southeast Sunbelt markets and various secondary markets. From what I understood from conversations, larger Build For Rent projects (100 units+) in outlying suburban submarket locations in larger cities continue to be the most highly sought-after. Smaller projects in infill locations within secondary and primary markets are also key targets. Several firms were open to looking at larger Build For Rent in secondary markets, but those firms seemed to be more discerning about locations, having well-defined cities and zip codes, making it a bit harder to source those opportunities without putting forth a more targeted and deliberate sourcing effort.
Will investors buy older vintage homes?
Value-add SFR strategies were more prevalent than in years past. It seems to me that firms looking to buy rental portfolios where higher returns can be achieved through renovation were of interest to some large and medium-sized operators. Good news for us since we have hundreds of portfolios like these that we’ve collected over the last several years. Those types of assets weren’t as in demand as they are today since most of the investors we work with were busy buying newer homes that needed less CapEx to increase values and rents. I think bringing more of those deals to market over 2024 will result in better conversion rates than what we’ve experienced in the past, allowing us to sell homes with older vintages, so we’ll be on the lookout for those types of portfolios.
The overall tone of the conference was markedly more positive than at the previous IMN conference in early 2023. From what I could hear, the fact that residential home prices kept up so well during this time of higher interest rates, and rental property performance remained relatively strong, investors see the asset class as fundamentally sound and still a good long-term investment. Firms that buy properties and operate them have a harder job in finding deals that pencil, which means transaction volume will be lower than in years past, but I predict that volume will tick up in the new year as investors come to grips with the reality of this new higher interest rate market we are in. While this will hurt firms that depend on transaction volume, like Strata, there is still plenty of room to make a killing in this market if high-quality deals and/or motivated sellers can be sourced: two things that I know Strata does better than most.