Single-Family Rentals as an Attractive Asset Class

 Since the global financial crisis, a new asset class has emerged that offers attractive yields – single-family rentals (SFRs).

SFRs represent more than one-third of all rented housing units in the U.S. John Burns Real Estate Consulting estimates that they now have a market value of approximately $4.5-5 trillion. Until recently, almost all of the approximately 12 million SFR assets were owned by individuals or small investors. However, following the financial and housing crisis of 2008, investment by institutions increased substantially.

Total returns to SFR assets have two components: rental yields and house-price appreciation. Andrew Demers and Andrea Eisfeldt, authors of the February 2021 paper, “Total Returns to Single Family Rentals,” constructed a data set containing rental yields and house-price appreciation data for SFR assets and analyzed the total returns over the period 1986-2014, and in a broad and granular cross-section across U.S. cities and zip codes. Following is a summary of their findings:

• Rental income (4.2%) and capital appreciation (4.3%) each contributed about half of the total return of 8.5%, and a Sharpe ratio of 1.14. Over the same period, the S&P 500 Index returned 10.7% but produced a Sharpe ratio of 0.52.

• Net yields (net of operating costs and fund expenses) were about 60% of gross yields.

• Rental income and capital appreciation were negatively correlated. High-price tier cities accrued more capital gains, while low-price tier cities had higher net rental yields. On average, yields were 6.1% in the lowest price quintile across cities and 2.4% in the highest price quintile. In contrast, house price appreciation in the lowest tier cities averaged 3.1% versus 5.5% in the highest tier.
• Within cities, lower price tier zip codes had higher total returns as a result of both higher yields and higher house price appreciation. In addition, within zip codes, house price appreciation did not increase with price tier. As a result, total returns declined with house price tier at the zip code level. However, house price appreciation in the lower tier zip codes displayed higher betas on city-level house price appreciation – the higher returns may be compensation for higher risk (vacancy and credit risk are likely to make rental yields riskier in lower price tiers).

• Rental yields were less volatile than house price appreciation. As a result, SFR assets with a larger return contribution from rental yields had higher Sharpe ratios.

• Debt investors may favor cities with higher dividend yields and therefore higher debt service coverage ratios. On the other hand, cities with higher house price appreciation may appeal to private equity investors seeking larger capital gains.

Summarizing, SFRs are an important asset class, providing diversification benefits and cash flow during a period where bond yields have been well below their historical average. While Demers and Eisfeldt examined data through 2014, the institutionalization of the SFR asset class has occurred largely since then. The result has been a steady improvement in SFR profit margins as operators enhance their platforms (particularly in the form of pricing tools, unassisted showing technology, field force management, and workflow management).

Larry Swedroe is the chief research officer for Buckingham Strategic Wealth and Buckingham Strategic Partners.

https://www.advisorperspectives.com/articles/2021/05/29/the-emergence-of-single-family-rentals-as-an-attractive-asset-class