Categories: Education

What is SFR in Commercial Real Estate?

Introduction

Many investors are surprised to learn that the single family rental market has a larger valuation than the multifamily market.

According to the Single Family Rental: An Evolving Market report from Freddie Mac, single family rentals make up 66% of the total rental housing stock with a market valuation of over $4 trillion versus $3.7 trillion for the traditional five or more unit multifamily market.

Keep reading to learn why single family rentals are having a phenomenal year, and why billions of dollars are flowing into the single family sector.

What are Single Family Rentals (SFR)?

SFR – or single family rentals – are freestanding houses purchased by investors and rented to tenants, normally on a 12-month lease. Up until a few years ago, single family rental homes were mainly owned by mom-and-pop investors who purchased a house to rent in the same neighborhood or city where they lived.

Today, the single family rental market is attracting much more sophisticated private and institutional investment capital.

Many online platforms offer turnkey single family rental homes for sale already occupied by tenants, providing the investor-buyer with immediate cash flow the day escrow closes.

Buying single family rental property helps investors diversify investment portfolios and generate passive income. Roofstock has completed over $4 billion in transactions in less than four years, while Norad is offering investors passive income with short-term notes with 12% to 20% interest.

Both marketplaces are ideal for passive income investors who live in high-cost-of-living areas such as San Francisco and New York to invest in real estate remotely in relatively more affordable housing markets where prices are lower and yields are potentially higher.

Private equity real estate joint ventures are also attracting enormous sums of capital to invest in the single family rental market.

Recently, Atlas Real Estate teamed up with DivcoWest to form a $1 billion joint venture to acquire and renovate single family rental homes. Earlier this year, one of Canada’s largest pension investment managers – Public Sector Pension Investment Board – joined forces with alternative investment management firm Pretium to invest $700 million into SFRs in the southeastern and southwestern U.S.

According to Arbor, interest and investment in the single-family rental (SFR) housing sector was huge last year, even in the midst of a pandemic, with everyone from small-scale local investors to large-scale investment managers exploring investment avenues and opportunities.

As institutional investment alone nears $5 billion, the SFR sector continues to outperform nearly every other commercial real estate asset class.

Are you considering adding single family or multifamily rentals to your investment portfolio? Learn more about Smartland and our real estate investment opportunities.

Related Link: The Ultimate Guide to Investing in Rental Properties

Why Invest in Single Family Rental Real Estate?

Single family rental real estate can be thought of as a type of hybrid investment. While well-managed rental homes in the right market can generate consistently solid cash flows, the value of the property does not depend on the ROI.

For example, the market value of a shopping center or office building is directly tied to the annual NOI. The worth of these types of commercial real estate investments increases or decreases based on the net income produced.

Investing in a single-family rental home is similar to owning a net commercial real estate investment.

When the demand for retail and office space dramatically decreases and tenants leave, due to consumers shopping online or employees working from home, property values eventually go down as well.

With SFR investments, people always need a place to live, and increasingly to work from. Well cared for and managed single family houses historically go up in value over time because of the need for shelter, the neighborhood ranking, and amenities such as a good school district or parks and recreation.

Easier to Find

There are about 76 million detached single family homes in the U.S., nearly 12 million of which are occupied by renters, according to the Urban Institute’s Housing Supply Chartbook. That equates to one single family home for every 4.3 people in the country.

By comparison, there are only about 31 million multifamily properties. For the residential rental property investors, that means houses are much easier to find in every village, town, city, and urban area in the U.S.

Because there are more choices available, SFRs are well suited for any investment strategy, including new build-to-rent home developments and private buy-and-hold investors looking for affordable single family rentals to own in cities such as Akron and Saint Louis.

Affordable

The typical single family home value in the U.S. is $325,000 (April 2021), based on the Zillow Home Value Index. The Index takes all estimated home values for a given market and month, takes a median of those values, then makes adjustments for factors such as seasonality. Over the next year, Zillow predicts home values in the U.S. will rise by 11.7%.

While paying over $300,000 for a single family rental may not sound that affordable, most investors use conservative leverage instead of paying all cash. With a 25% down paymentQuestion Mark, the cash needed to buy a typical house to rent using financing is less than $82,000.

One of the advantages to investing in SFRs remotely is that prices for rental homes are very affordable in many suburbs, and secondary and tertiary housing markets.

For example, single family home values in Montgomery, Alabama are $119,000 while the value of a single family home in Akron, Ohio is less than $100,000. In smaller cities like these, down payments for a single family rental property would be about $27,000.

Profitable

Investing in a single family rental home is similar to owning a net commercial real estate investment.

Owners are still responsible for items such as property taxesQuestion Mark, insurance, and maintenance. But other costs like utilities and landscaping are usually paid by the tenant in a single family home, which means that SFRs can generate more positive cash flow per home compared to other types of commercial real estate.

Generally speaking, single family tenants also tend to take better care of the home they live in. Even though they are renting, tenants in houses tend to have a greater sense of ownership and stay in the property longer.

In fact, long-term renters stay in their rental home for an average of seven years, which helps to make single family homes more profitable by keeping turnover costs and vacancy expenses low.

Easier to Manage

Property management in a SFR is also much easier, in large part because everyone understands how a home “works.” While business tenants can be much more demanding, people renting a home simply want a nice place to live that is safe and well maintained.

It’s much easier to find good property management companies, real estate brokers, leasing agents, and tradespeople who know how to work with single family rental property and tenants. This keeps operating expensesQuestion Mark lower than other commercial property types, because owning and operating residential rental housing doesn’t require a high level of specialized and expensive knowledge.

High Demand

As a recent article in Realtor Magazine reports, the demand for single family rentals is surging. Tenants are looking for affordable rental homes in good neighborhoods with the amenities and conveniences that the single family home lifestyle provides.

With working from home likely to become a permanent employment perk, renters are looking for space away from crowded and expensive urban areas and opting for SFRs in smaller and affordable cities in the Southeast and Southwest.

The high demand for rental houses is also generating healthy rent increases of 3.8% year-overyear, with residential vacancies down to just 6.8%, according to the most recent release from the U.S. Census Bureau (Q1 2021).

Easier Financing

Lenders generally view single family rental homes as a safer product to make a long on, compared to other types of commercial real estate. Because banks view SFRs as being less risky, interest rates are lower and down payments are more affordable for real estate investors. There are a wide variety of loan options for rental property, including:

  • Conventional loans originated by private mortgage lenders such as banks and credit unions.
  • Conforming conventional loans that follow guidelines set by Fannie Mae and Freddie Mac.
  • VA financing for veterans and their spouses
  • Blanket mortgage loans for multiple properties held under a single mortgage.
  • Portfolio loans for investors holding multiple single family rental homes.
  • Private money lenders specialize in short-term loans needed to repair and reposition rental property.
  • Private equity real estate funds provide real estate investors with debt financing in exchange for a fixed rate of return.

Lenders generally view single family rental homes as a safer product to make a loan on, compared to other types of commercial real estate.

Tax Write-Offs

Tax laws in the United States are extremely friendly to real estate investors. Items such as repairs and maintenance, property management and leasing fees, property taxes and insurance, and mortgage interest are fully tax deductible for SFR investors.

Residential rental property is also depreciated over a period of 27.5 years compared to 39 years for other types of commercial real estate. The faster depreciation of single family rental homes can help residential real estate investors shelter more income by paying less in taxes.

Normally depreciation is recaptured and taxed, along with any capital gains, unless an investor conducts a 1031 tax deferred exchange. By exchanging one investment property for another, rental property investors can defer paying tax on both capital gains and depreciation recapture.

Related Link: Top 10 Risks to Consider Before Investing in Private Equity Real Estate

The Best Single Family Real Estate

The best single family rental property investments all have several things in common:

  • Positive monthly cash flow after the rent is collected, and the operating expenses and mortgage is paid.
  • AppreciationQuestion Mark in property value, with housing prices increasing by 12.87% last year alone, according to the Freddie Mac House Price Index (FMHPI).
  • Tax benefits include write-offs for the costs of owning and operating a single family rental property, plus depreciation expense to reduce taxable net income.
  • Rental real estate is also a hedge against inflation, with home prices rising much faster than the CPI.
  • Lower tenant turnover in single family rental property keeps unit turn costs and vacancy expense at a minimum, creating a higher level of net cash flow.
  • Financing a SFR is much easier and less expensive than other types of commercial real estate, with lower interest rates and down payment, and a wider choice of single family loan options.

SFR vs. Multi-Family Properties

Both single family rental homes and multi-family properties are expected to perform well for investors in the upcoming years. When building a residential real estate portfolio of rental property, investors may want to consider a combination of SFR and multifamily assets. Here’s a quick comparison of how single family rental homes compare to multifamily investment properties:


Demand

In general, tenants may prefer a single family home to rent, except urban areas.

In urban areas houses can be hard to find or rents unaffordable for today’s Gen Z and Millennial renters.


Affordability

An SFR investor might pay around $325,000 for a typical single family home. Assuming conservative leverage is used, a 25% down payment for a single family rental would be $81,250.

The multi family buyer could easily pay more than $10 million for a 50 unit apartment building. Assuming conservative leverage is used, a $2.5 million for a mid size multi family property.


Profitability

SFR investments generate less total cash flow. However, when viewed on a per unit basis, SFRs have a higher level of cash flow.

Multifamily investments generate more total cash flow.


Management

Managing a single family rental is easier than multifamily property management, simply because there are 'moving parts'.

On the other hand, multifamily properties have multiples of everything, with potential management and repair issues increasing thirty, forty, or fiftyfold compared to one SFR.


Financing

Single family homes are much easier to finance, with lower interest rates and more affordable down payments. Depending on the market, investment houses can be purchased for less than $100,000.

Because the single family housing market is more liquid, lenders view loans on homes as being less risky. If a loan does go bad, the property can easily be sold to another investor or homeowner.

Since multifamily buildings cost more and require more experienced management, banks view apartment properties as higher risk, at least from a lending standpoint. Interest rates are higher, down payments are larger, and lenders expect multifamily borrowers to have prior success owning and managing multifamily investments.

Related Link: Multifamily Investing: Adding Value by Adding Amenities

Conclusion

The single family rental housing market is having a phenomenal year, and all signs suggest that SFR investments will be hot for years to come. Tenants prefer single family houses due to the extra space and having a place they can think of as their own home. Both private and institutional residential real estate investors are attracted to the SFR asset class because of the strong demand, rising rents, and ease of property management that generate higher ROIs and increases in market value over the long term.

Want invest single family or multifamily real estate opportunities? Contact Smartland to become an investor and leverage their expertise.

Related Link: How to Recession-Proof Your Real Estate Portfolio


Was this article helpful?
reaction thumbnail No

View More
Resources