Diversifying With Picket Fences: Single-Family Rental Investments

We take a look at how single-family rental (‘SFR’) housing fits into a portfolio, providing both uncorrelated returns and geographic diversification, and possible inflation protection.


US population growth and demographics trends would indicate that demand for the single family rental sector is likely to grow over the coming decades, and that supply may well fail to keep up.
 

Read Article

Investors’ questions generally focus on similar themes: will this investment make good risk-adjusted returns and how does it fit into my portfolio? This article seeks to answer the latter question, explaining how single-family rental housing (‘SFR’) fits into a portfolio.

Long-term macro and demographic factors leading to record high demand and low supply stand to benefit SFR over the coming years.

In a nutshell, we believe investors should give greater consideration to including an SFR allocation in their portfolios for four reasons. Firstly, long-term macro and demographic factors leading to record high demand and low supply stand to benefit SFR over the coming years, with returns driven by both home price appreciation and rental income growth. Secondly, SFR provides an uncorrelated return stream not only when compared with other real estate sectors, but also when compared to other asset classes including stocks and bonds. Thirdly, SFR provides the opportunity to invest with experienced institutional investors that can build broadly diversified portfolios of rental homes across multiple US geographies, targeting the most attractive locations. Last but not least, SFR rents and home prices have grown quicker than inflation over the past 30 years and may therefore provide a degree of protection during inflationary times.

Macro Factors Driving SFR returns

Secular shifts that have been underway for almost a decade have accelerated during the coronavirus pandemic and are expected to continue for the foreseeable future. With the enforcement of regulation to curb the spread of the virus, physical retail was forced to give further ground to online. Similarly, demand for office space and urban apartments in multi-family buildings softened, as populations adapted to the ongoing change.

In the midst of all this change, SFR has been a bright spot. Americans continued to leave the urban core for the greater space offered by SFR in the suburbs. Both components of long-term returns from SFR ownership (home price appreciation and rental income growth) have continued, and indeed accelerated throughout 2020 and 2021 year-to-date, with occupancy rates at record highs (Figures 1-2).

Figure 1. US Median Sales Price

Source: National Association of Realtors as of December 2020, US Census Bureau as of December 2020, John Burns Real Estate Consulting; as of May 2021.

Figure 2. US Rent Growth Versus Occupancy

Source: John Burns Real Estate Consulting; as of May 2021 and US Census Bureau: Housing Vacancies and Homeownership; as of March 2021.

It is worth stating that coronavirus is not the only reason for this appreciation: long before the pandemic, the growing cohort of millennials provided a demographic tailwind to the asset class. Some 67.5 million Americans are between 20-34 years old, an age group which are likely to buy or rent SFR as they look to get married and have children.

Correlation to Other Real Estate Sectors

While performance has been positive, a potentially even more compelling reason to add SFR to a portfolio is the diversification benefits it provides.

A compelling reason to add SFR to a portfolio is the diversification benefits it provides.

SFR is the only real estate sector that is not correlated to the other core real estate sectors (Figure 3).1 This is driven in part by the fragmented ownership of SFR: just 2% of SFR is owned by institutional investors, with the remainder owned by retail investors – usually a small landlord with no more than one or two properties (Figure 4). This has a tendency to benefit SFR, as the absence of large flows of institutional money leads to a differentiated return stream compared to other real estate assets: SFR prices are driven by the availability of credit to homeowners and smaller landlords, as well as demand from families looking to live in such homes.

Figure 3. Correlation Matrix – SFR Versus Other Real Estate

Source: Bloomberg; between January 2001 and March 2021.

Problems loading this infographic? - Please click here

Source: Bloomberg CityLab, US Department of Housing and Urban Development and US Census Bureau, Rental Housing Finance Survey 2018, Man GPM estimates; as of June 2021.

SFR also has a low correlation to other asset classes, including equities and bonds.

Correlation to Other Assets

SFR also has a low correlation to other asset classes, including equities and bonds, which are widely held by investors, and also listed REITs. As such, private SFR investments should be additive to a well-diversified portfolio.2 This is true whether you look at the correlations over a 10-year, 20-year or even 40-year time horizon (Figures 5-7).

Figure 5. SFR Has a Low Correlation Versus Other Asset Classes Over 10 Years….

Source: Bloomberg; Between April 2011 and March 2021.

Figure 6. …20 Years…

Source: Bloomberg; Between April 2001 and March 2021.

Figure 7. … And 40 Years

Source: Bloomberg; Between April 1981 and March 2021.

Geographic Diversification

Importantly, at around USD30 trillion, the depth of the US housing market allows investors to pick and choose their locations, providing the additional protection of a geographically diverse portfolio. Not all US housing markets are alike: growing cities in the South and West, such as Atlanta, Charlotte, Houston and Las Vegas, have very different dynamics to more established areas, such as New York, Chicago or Seattle. Being able to invest in a large number of growing or established markets allows experienced institutional SFR investors to diversify their portfolio against regional downturns, selecting those cities with both growing housing demand and attractive pricing.

SFR has historically provided a degree of protection during inflationary times.

Diversification Into a New Inflation Regime

Finally, it is worth noting that SFR has historically provided a degree of protection during inflationary times. The existing supply and demand imbalance detailed above has already led to a situation where home prices and rents have risen quicker than general inflation over the last 30 years (Figure 8), with forecasts that this trend is set to continue.

Figure 8. SFR Rents and Prices Versus Inflation

Source: National Association of Realtors, as of December 2020; World Bank, as of December 2020; John Burns Real Estate Consulting, as of January 2021.

Conclusion

We believe investors should give greater consideration to including an SFR allocation in their portfolios for four reasons. Firstly, long-term macro and demographic factors leading to record high demand and low supply stand to benefit SFR over the coming years, with returns driven by both home price appreciation and rental income growth. Secondly, SFR provides an uncorrelated return stream not only when compared with other real estate sectors, but also when compared to other asset classes including stocks and bonds. Thirdly, SFR provides the opportunity to invest with experienced institutional investors that can build broadly diversified portfolios of rental homes across multiple US geographies, targeting the most attractive locations. Last but not least, SFR rents and home prices have grown quicker than inflation over the past 30 years and may therefore provide a degree of protection during inflationary times.

 

1. Note: SFR represented by S&P CoreLogic Case-Shiller US Index; multi-family by RCA CPPI Indices Apartment Index; commercial real estate by NCREIF Property Index; Office by RCA CPPI Indices Offices; Retail by RCA CPPI Indices Retail; and Industrial by RCA CPPI Indices Industrial.
2. Note: SFR represented by S&P CoreLogic Case-Shiller US Index; multi-family by RCA CPPI Indices Apartment Index; commercial real estate by NCREIF Property Index; US Reits by FTSE E/N All Eqty ReitTR Index; US equities by S&P 500 Index; investment grade bonds by Bloomberg Barclays Agg Index; and high yield bonds by Bloomberg Barclays HY Index.