# The CIO Agenda: Single-Family Rentals in a Changing US Market

### People are looking for more living space in which to work from home. Is it time for investors to diversify their real estate exposure?

The US is undergoing a largescale shift in the way it approaches its residential real estate needs. Accelerated by the events of the past year, more Americans are making the decision to move away from densely packed, urban multi-family apartment units in favour of more bedrooms, more living space and outdoor backyards of their own.

In this episode of The CIO Agenda, Anthony Cazazian, Head of US Residential Real Estate at Man GPM, discusses why the low supply and high demand for single-family rental units stands to benefit the sector and how investors can better diversify their residential exposure with this uncorrelated return stream and inflation-resistant asset class.

Recording date: 15 July 2021

## Episode Transcript

##### Note: This transcription was generated using a combination of speech recognition software and human transcribers and may contain errors. As a part of this process, this transcript has also been edited for clarity.

Sandy Rattray:

I'm Sandy Rattray, CIO. Welcome to The CIO Agenda podcast. I'm joined by Anthony Cazazian ('Caz'), Head of US Residential Real Estate at Man Group Global Private Markets. Welcome, Caz.

Anthony Cazazian:

Hey Sandy, thanks so much for having me with you today.

Sandy Rattray:

So why don't we kick off and talk about the asset class for our listeners who might not be well-versed in US, residential real estate. Can you help define what we mean by single family rentals and how it differs from other types of real estate concepts?

Anthony Cazazian:

Absolutely. So I think when people use terms like single family rental or US residential real estate to me, it's almost, it's easier to just say US housing. So what are we ultimately talking about when we speak about US residential real estate or single family rentals or multi-family rentals or anything of that nature? We're just speaking about US housing and the way I think about US housing in general is it's the largest and most liquid real estate asset class in the world. It's valued at over $35 trillion and on its way to$40 trillion.1 And it is a, just a enormous market. And to break that down just a little bit to really get to your question about single family rentals in total, there's about 140 million housing units in the US and about a third of those are renter occupied units.2 And within that renter occupied segment single-family rentals represents the largest component and single family rentals by its purest definition or its narrowest definition generally speaks to single family detached homes, but a broader definition would also include sort of all one to four unit rental properties.

Sandy Rattray:

And so if I'm an investor and I'm interested in the asset class, then I probably know how about my individual home, maybe own my own home at some point, but as an institutional investor, what are the ways that you can get access to this very large asset class and clearly also the rental income that you're talking about.

Anthony Cazazian:

For institutions today, I'd say there are two to three kind of primary ways that capital is investing into the asset class. One is through public debt and equity markets. Although there are only a couple publicly traded SFR, single family rental companies in the US. Second way is really through private investments, typically through private real estate funds that are either fully dedicated to single family rentals or allocate a portion of the fund to single family rentals. And then of course within these fund structures, you know, there's a variety of types from open-ended to closed ended funds, commingled funds, funds of one, or, or, you know, separate managed accounts, et cetera, but, big picture, you have sort of public you know, investment opportunities and private investment opportunities.

Sandy Rattray:

If I put my sort of equity investor hat on, then certainly historically you think people thought, well, you know, one way to get access to the US housing market is to buy the equity of homebuilders. And there were plenty of home builders to invest in. So what's different about investing in the asset class directly versus going and investing in home builders.

Anthony Cazazian:

So when you're investing in home builders, you're, you're really investing in more of an operating business that derives its P and L and returns through the building and selling of homes. Whereas if you're investing in single-family rentals or other real estate assets, you're really investing in the hard asset and are focused on returns that are, that are driven through current income from rents and rent growth, as well as long-term capital appreciation, you know, which in the single family rental space we call HPA for, you know, home price appreciation.

Sandy Rattray:

I think many investors might think that the long-term trends in housing would affect home builders and physical homes, the price of physical homes in almost the same way. If there's more demand, that's good for the price of homes. It's good for investors in homes, but it's also good for home builders who whose margins will go up. So I'm just interested in being in, into how strong the correlation is between investing in the equity of home builders and investing directly in homes.

Anthony Cazazian:

You're on the home builders side, certainly if, if prices are increasing that can, that can benefit home builders, but there are other inputs that go into the equation. You know, many times when home prices are increasing, it also means that land prices are increasing and other costs whether hard or soft costs are also increasing for the builders. So it doesn't necessarily mean that builders margins are improving. There's, there's some, you know, devil's in the details there. The other, the other, I think thing to focus on as it relates to home builders is again, you are really investing in a company whose returns and profits are driven through the sale of homes, not through the long-term investment in homes, the long-term capital appreciation and rents and rent growth of homes, which is really the distinction when you're investing in single family rentals, as an example.

Anthony Cazazian:

And I think to take that one step further, when you think about public market investing versus private market investing, you know, one of the benefits is the differences in correlation to the overall market. And so when you invest in single family rental, you know, publicly traded companies, frankly, the correlation to the overall market, to the S&P 500, as an example or other real estate publicly traded sectors, the correlations are very high, whereas in the private markets, those correlations are much lower, particularly as it relates to single family rentals as a comparison to other real estate sectors.

Sandy Rattray:

Okay, great. So now let's move on and talk about the drivers of the market today. We're all, I think very aware that COVID has made many people reassess, whether they would like to live in big cities and typically in apartment buildings and move to places where they've got more space which might be a standalone house. Can you talk a bit about the shifts in demand for residential real estate and how much of this shift is being driven by COVID and how much of it is being driven by other things?

Anthony Cazazian:

So I think on the demand side, it's always important to start with what is driving long-term demand and in the us, you know, that's, it's, it starts with population growth and the US benefits from strong population growth relative to many other countries in the world. From there, it's important to really look into the different age cohorts and what drives those different age cohorts to reside in multifamily versus single-family. And the largest age cohorts in the US today is driven by the millennial generation. And the millennial generation, you know, is entering life's major milestone years of getting married. They're having children they're needing more space. And generally when you need more space in the US and in many other countries, if you're looking for three or more bedrooms, you're almost forced to look into single family residences, whether as an owner or as a renter.

Anthony Cazazian:

So there is a, long-term not only population growth in the US but demographic trend that is benefiting single family unit structures and looks to continue to be that way for the next decade or so. And really that was a trend that I've benefited the multifamily space over the past decade plus, and that is now shifting as, as our largest age cohorts, again, enter life's major milestone years, you know, grows into sort of that movement into single family unit structures. In addition, as it relates to COVID, of course, you know, as, as people needed to, you know, socially distance themselves, as they realised they had the ability to employ technology or had more flexibility around sort of their workplace and their desire for additional space in general, you know, that also benefited, you know, that change in consumer behavior benefited, you know, single family residences versus multi-family apartments.

Sandy Rattray:

And is that something you're seeing nationwide across the US or is it, or is it more focused on particular areas of the US?

Anthony Cazazian:

We're certainly seeing it in a lot of the, you know, top MSAs or metropolitan areas within the US you know, we tend to focus on the top 50 MSAs from a single family rental perspective today, and that translates into roughly million plus metropolitan population areas. And in those areas, you know, that trend is pretty apparent kind of across the board. So I wouldn't say it is regional or, you know, very market specific, but certainly in the busier, you know, larger population centers in the US you are seeing that trend.

Sandy Rattray:

One of the questions that I think many investors will have is: the US in particular has a huge amount of land. And as the demand for housing goes up, can't we just use more of that land? Does it need to push prices up? Or can we just expand the residential housing stock without needing to push prices up?

Anthony Cazazian:

Well, I think beyond the, on the fact that we are at a point where that there's just an absolute, you know, demand supply imbalance with, with supply of existing inventory being at all-time historical lows, you know, the fact that there is a lot of land in the US doesn't necessarily mean that there is demand to live anywhere. And so, while there is absolute desire to live in the suburbs to have more space frankly one is a need for more space. And to just as a result of having more flexibility in our lives, as, as advances in technology and other areas allow us to have more flexible lives. We still ultimately, or many, you know, homeowners or residents still want to be somewhat close to a city center. And generally you want to be, we, we find most residents want to be within, you know, 30 to 60 minutes of, of the nearest city. And that by definition then kind of limits the amount of land that builders will build on, and that residents will entertain sort of for, you know, future living arrangements.

Sandy Rattray:

And then one final question on demographics and how the asset class is going to shape up in future years, COVID has clearly been a factor causing people to move from cities to outside cities, but we've now got a population in the US which is pretty highly vaccinated. And so could we have the reverse effect of people wanting to get back into cities?

Anthony Cazazian:

So I guess I'll point out two quick things here. I think one, again, I point to the long-term sort of trends, one US population growth to the demographic sort of trend of the millennials aging and needing more space. And that is not something that COVID, you know, or the effects of COVID or the changes in consumer behavior as a result of COVID, you know, we'll be able to sway kind of from one end all the way to the other end. The other thing I'll say is, as, as people get used to more space and Sandy, I don't know if you've you've ever experienced this on your side, but if you ever try moving from a lot of space to very little space, it is very hard, right? It's easy to move from a small amount of space to, to a larger space, but the reverse is incredibly difficult. So I think it will be interesting to see what unfolds kind of over the next couple of years, but I don't think, you know, anything that we're speaking to as it relates to this question really overrides the larger macro and demographic story that is at fault here.

Sandy Rattray:

Just to dig into the asset class itself a little further. So as an investor, how should I think about single family rentals compared to other types of real estate, both in terms of the long-term shifts, but also in terms of how, how, how correlated is it with other parts of the real estate market?

Anthony Cazazian:

So what's exciting I think from my perspective is when I think about single family rentals and US housing, I again think of it as the largest and most liquid real estate asset class in the world, by definition to me that that is exciting. And in terms of, you know, its correlation to other real estate sectors, it's really interesting. So if you invest in multi-family rentals or office or retail or industrial, what you'll find is broadly, those sectors are very highly correlated to each other, even though they are very different asset types, they're all very highly correlated to each other across markets over time. Whereas single family rentals is frankly the only sector from our perspective that is not highly correlated to those other sectors. And part of that is driven by the fact that the ownership base of single family rentals is today retail dominated and driven only two to 3% of single family rentals are currently institutionally owned.3 And there's a different, you know, there are different dynamics and drivers that, that impact the asset class in different ways than the other real estate sectors. I mentioned. So I'd say in terms of what makes single family rentals interesting, it's the fact that it is, you know, early innings of institutional investment in the asset class. It is the largest and most liquid real estate asset class in the world, from my perspective, and as a result, there are a lot of opportunities to achieve really attractive risk adjusted returns.

Sandy Rattray:

Let's dig into the location aspect to the asset class a little bit more because if single family rentals are not particularly correlated with other parts of the US real estate market and how correlated are single family rentals from one part of the US to another, there's this low correlation stem by state or by city.

Anthony Cazazian:

So certainly each market has its own drivers and characteristics, but there are many markets in the US from a single family rental perspective that trend in the same direction and are, you know, certainly correlated to each other that said, when you really dig into some of the metrics that we focus on, you know, there are certain markets that are more attractive at certain points in time than others. And some of the metrics that we look for translate into total population, population growth, household income, growth, rent, growth, home price, appreciation, occupancy levels, rent levels obviously home values and yields the age of the housing stock within a market you know, school school rankings in general, major employers and employment centers, things of that nature. And so you'll certainly see differences across markets but certainly there's also, you know, a lot of markets that exhibit from a single family rental perspective, you know, a high degree of correlation to each other as well.

Sandy Rattray:

We'll dig into all that data. In a moment, as you know, Pedro is one of my favorite things to play around with before we get to that. Many of us of course have very strong memories of the 2008 correction. And before that, I think people thought of us residential real estate is something which should be in jeopardy rising for 50 years and not particularly interesting, suddenly prices accelerated. And then you have this enormous correction and stuff in the market. So how should we think about the susceptibility of the US housing market to corrections? And secondly, if there are corrections in the equity market, then how should we think about the impact of that on the housing market?

Anthony Cazazian:

So on your first question, what I'd say, and this is a personal belief, and everyone will have a different view on this potentially, but I don't think we are going to experience a housing crisis similar to the one that we experienced in 2006, 7, 8 and so on. And I think there's one fundamental difference that exists today relative to the housing crisis we experienced. And that is that there's now an institutional bid for single family residences, whereas in the past that did not exist. And so not only do you have owner occupants, right, homeowners that you know, buy and sell homes, you have retail investors that buy and sell homes as investment properties. And now you have true institutional investors that have been investing in this asset class really starting, you know, in 2010, 11 and 12. And that institutional interest has only grown frankly to levels today I have not seen before.

Sandy Rattray:

And that institutional interest in housing, it's obviously a relatively new thing. It's not being entirely without control policy. And there are people that have said that the advent of institutional buyers of residential real estate crowds out people, families that want to buy their own home. What's your response to that?

Anthony Cazazian:

There's certainly a lot of headlines around this topic. I would say institutional capital, one is an extremely small percentage of the overall US housing stock. So when we say, you know, institutions own roughly 2% to 3% of the single family rental market that translates, you know, in the context of 300, you know, 250 to 500,000 homes just using round numbers here, very round numbers that is out of a total US housing stock of 140 million units. And within single family rental units, just single family detached, you know, you can think of that out of roughly 16 million units. And so it is a very small percentage but there are a lot of headlines around this issue.

Sandy Rattray:

So Caz, could you explain to us why institutional investors seem to be more interested in the asset class now?

Anthony Cazazian:

Yeah, that's an interesting point. So I've been in this space for the past decade or so, and I've never seen institutional interest as high as it is today. And I think there's a reason why, you know, there were some early institutional but many remained on the sidelines. And really there were four big questions that they needed answered before they thought about allocating capital into the asset class. And those four questions are really one: post housing crisis, was this a trade or was this a business too? Could these, you know, rental homes be acquired and managed in scale? Three; what would an institutionally owned single family rental portfolio look like over time from a returns perspective and KPI perspective.

Anthony Cazazian:

And I would say over the last decade, those three questions had been answered in the eyes of many kind of institutions, but the fourth question hadn't been answered, and that was how would an institutionally owned single-family rental portfolio perform in a downturn, in a recession, in a stressed environment. Q1 COVID and the asset class has outperformed almost all real estate sectors.4 It has been extremely resilient and in the eyes of many institutions, you know, that was enough to effectively answer that last remaining question. You know, also with the understanding of where we sit today from a macro and demographic perspective and supply sort of demand perspective that really encouraged institutions to say, you know, what it is time to dig in and research the asset class and allocate capital into the asset class and diversify. You know, if I'm an institution and I have US housing exposure only through multifamily rentals than I should, you know, now's a good time to diversify that exposure into single family rentals as well.

Sandy Rattray:

Let's move on and talk about data a bit. You talked a number of times in this conversation about how much data is available and the certain level that might be people think, well, you couldn't invest in this asset class in a very data-driven way. There's a huge amount of information available. If you standardise the home to a reasonable degree, you can describe the numbers. Talk us through a little bit how data-driven you can be in residential real estate.

Anthony Cazazian:

So I would say, you know, 10 years ago it was, reliant on a lot of public data and indices that were, you know, published on a monthly or quarterly basis. I think fast forward to today, again, with institutional capital and focus on the asset class, everyone has realized that this is a very, it is, it is so granular that data and technology can be incredibly helpful in analyzing this asset class for both in, from an acquisition perspective and sourcing perspective, as well as, you know, a market selection perspective. And lastly from an operational and property management and asset management perspective.

Sandy Rattray:

So that's very interesting in terms of the amount of data and especially the growth of the data residential real estate in the US and it almost sounds as though there's more data about houses than there is about companies. Of course, we've got lots of people that are doing great data-driven investing into public equities. So can you see a world where investing into us housing becomes almost systematic?

Anthony Cazazian:

I'm going to approach this question in a slightly different way, because I think what's interesting from my perspective is I can see the American dream changing. And what I mean by that is that the American dream for many was to, you know, own your own home, raise a family, have the, you know, have the yard of the picket fence and have that sort of stability. I actually think single family rentals is going to be part of that so-called American dream in the future where people, you know, the stigma of owning versus renting has been changing and will continue to change just like owning a car, you know, has turned into leasing a car and people are going to, instead of think about the American dream as home ownership, it's going to be more about financial stability. And whereas I think home represented that financial stability in the past ownership, in homes as an investment property can provide that financial stability.

Anthony Cazazian:

And by renting yourself, you also have the flexibility to move where, where job growth goes, or, you know, with families as families evolve and move, et cetera. And so by definition, you know, to your question, Sandy, I think retail investors will continue to grow, and it'll be almost programmed with a very long-term view on this. It'll become part of everyone's investment portfolio. And then from an institutional perspective, to your point, as it relates to data and technology, it is going to become very programmatic for institutions to have allocation to single family rentals over time.

Sandy Rattray:

So we're all aware for many services out that we can pretty much type in your address, and it tells you what value your house is. How accurate are those systems or accurate are those processes. And we near being able to accurately give a fair value for properties using data. And it would also be interesting to learn where that doesn't work. I suspect it doesn't work very well in for high end homes which, for example, tend to be more focused more in the mass market home size.

Anthony Cazazian:

Yep. I think that's that's right. I would say, you know, publicly available sort of automated valuations, you know, that you might come across on Zillow, you know, tend to be most accurate first with single family detached homes that are not necessarily, you know, brand new or newly built and are during a time in the market where home prices are somewhat stable. So today given our current kind of supply demand imbalance where home prices are increasing far above, you know, are outpacing historical averages. We tend to find those types of valuations to not be that accurate, or certainly less accurate than when we are in a much more stable market.

Sandy Rattray:

Then maybe it was my final question. Can you take us through how institutions are valuing the asset and how that differs from how individuals might value their own homes? Is there a difference between a one investor type than another here?

Anthony Cazazian:

It's a really interesting question at this particular point in time, actually. So historically when you think of, you know, residential real estate how, how was it valued? It was valued typically by a licensed appraiser that would go out and visit the home and look at sales comps. And most of those comps were based on other owner occupiers, you know, buying a home and where those homes traded with institutional capital coming into the space and investing in the asset class. You know, the initial thought around valuation was to just kind of follow the historical methods, but fast forward to today, and as institutions, en masse, larger portfolios, they are now looking at this asset class and saying, well, this is a long-term rental portfolio that is producing a consistent cashflow stream, and we should value these larger portfolios similar to the way we value other real estate sectors, whether that be on a discounted cashflow approach on a cap rate basis, et cetera. And so we're at a very interesting point in time where you're starting to see a almost an ARB, if you will, or difference in valuation methodologies that implies different values for homes, whether you look at it from a single home appraised value versus a large, you know, stabilised portfolio valuation using a different valuation methodology.

Sandy Rattray:

Thank you for joining us today. As we've been talking about the world's largest asset class, US residential real estate, how the demographics of the US provide long-term support for that asset class, but also how institutions are starting to get more heavily involved as the asset class itself institutionalises and more data becomes available.

Anthony Cazazian:

Thanks Sandy really appreciate it.

Sandy Rattray:

Thank you to our listeners. You can follow The CIO Agenda on Apple Podcasts, Spotify, and other podcast platforms to receive each year. Goodbye.

1Source: John Burns Real Estate Consulting; as of Q2 2021.
2Source: John Burns Real Estate Consulting; as of Q2 2021.
3Source: Bloomberg CityLab, October 2019, US Department of Housing and Urban Development and US Census Bureau, Rental Housing Finance Survey 2018, Man GPM estimates.
4Source: John Burns Real Estate Consulting; as of June 2021.