I've been doing a lot of analysis lately trying to find neighborhoods in my area (greater Charlotte, NC). I've been trying to find homes that are on the newer side so maintenance isn't a huge issue, and SFR buy and hold makes sense. I noticed a disturbing trend--rentals which are priced at a level I didn't believe to be profitable are staying on the market an extremely long period of time.
After a little digging, I found several neighborhoods which appear to be completely saturated with rental homes. It seems as though the acquisition teams for some SFR REITs are buying literally everything on the market in many newer neighborhoods in my town, then renovating and dumping them on the rental market. The problem? The vacancy rate in these neighborhoods is already too high, and there is no meat on the bone unless you are buying for a lot less than anyone else.
Given the example in the Zillow screenshot above, you can see that there is plenty of SFRs to rent in this neighborhood. This picture is pretty indicative of a lot of newer areas of Charlotte.
Given my affinity for math and research, I decided to pull property sales and tax records on these 13 rentals, and sure enough—11 of them are owned by national REITs.
The average length of the listings is about 50 days. That works out to about a 15% vacancy rate—which takes the median monthly rent from an already weak $1540 to about $1310 expected revenue per home per month. Not quite worth the median $175k that these buyers paid for the properties from an individual investor perspective.
Let’s dive deeper and imagine you bought these 11 homes as an individual investor. We’ll make some other assumptions in order to keep this as close to an apples-to-apples comparison, too:
- You don’t have to invest a dime of your own money
- You paid the same amount the REITs did
- Vacancy Rate stays static at 15%
- You hire a property manager at 11%
- Repairs and maintenance are a very reasonable 7%
- Capex is about 8% since the homes are reasonably new
- Your mortgage rate on a 30-year fixed is 4.138% (more on why I picked that number in a bit)
- No PMI (no particular reason--I just like you)
The numbers should look roughly like this:
As you can see, you’re going to have to come up with a bit of cash each year, if you want to own them outright in 30 years. As a matter of fact, only one of these properties actually cash-flows, and just barely.
So how do they manage it? Pass-through bonds, and economies of scale.
Let’s look at the bonds first. Here’s an example of one instance where American Homes 4 Rent (AH4R) has issued about a half-billion dollars in bonds, at an average pass-through rate of 4.138% (there’s that number I used for our mortgage for comparison purposes). Like an interest-only bank loan, they pay only the interest until the debt comes due (in this case mostly in 2025, so they have 7 years left to hold bond-investor money).
Since the properties are bought outright with these funds, the REIT has a choice to make when payment comes due: issue new bond debt to pay off the old debt, or sell the property which has been collateralized against it. If rates are still low at bond maturity, they will likely do the former, but they can swap a certain percentage of properties within the portfolio during the term, as outlined in the terms of the debt—in these bonds about 10% of the properties can be replaced to balance the portfolio.
So, what about economies of scale? Instead of assuming maintenance people and property managers are charging you full rate, they have literally over 1000 properties in my city alone. That means staff instead of contractors, so let’s assume they pay a more reasonable 12% combined for Management and Maintenance than the 18% an individual investor might pay.
Okay, let’s see how these same properties work for them, assuming everything else is the same:
Essentially, they’ve created a $30k annual earned income on these 11 properties, which can be used to pay executive salaries, and passed on to shareholders as dividends—and they’ll earn another $300k in capital gains if nothing extraordinary happens--and remember, AH4R alone has over 50,000 homes in 22 states.
It sounds like a license to print money.
Risks do exist for these REITs, though. If interest rates rise, it may not make sense to refinance the existing debt, and they may have to flood the market with properties to repay. Since they have concentrated their purchases into pockets of major cities, it means it will be hard to command top dollar if you are selling 10 homes on the same block. If property values tank and interest rates rise simultaneously, they might not be able to sell assets for enough to repay bondholders when payment comes due. That’s a bad day for any publicly-traded company.
Another challenge they face already is self-cannibalization. Because acquisition agents are incentivized to keep acquiring property which fits their model, they often focus on the same areas—essentially turning entire neighborhoods into a rental complex. Then they are forced to compete with themselves when listing a new home on the rental market. If you list a brand-new home on the same street as a home which has been vacant 100+ days, there is a good chance fresh home will rent first, and the vacant unit will remain vacant. As a matter-of-fact, another hidden cost for these guys is that they often do the first-month-free deal to get a renter in, further eating into their bottom line.
So how do you compete with these guys?
You don’t really. Not unless you can get someone to give you lengthy fixed 100% interest-only loans with zero-down at a great rate.
Find another niche (older homes, BRRRR, multiunit, ugly homes, mobile units, condos). Find another neighborhood. Find another city. Newer SFR Rentals in newer subdivisions close to downtown is taken. At least it is in Charlotte, NC--by these guys.
Or buy right--Don’t pay market value if you see that a neighborhood is already saturated with rentals which have been on the market for 50+ days. The only way to guarantee you won’t have an empty home is to undercut them on price. The only way you can afford to really do that is if you found a screaming deal before they beat you to it.
