Carving Out a Niche - SFR Portfolio and Build-to-Rent Brokerage

February 19, 2023

Is the United States evolving into a renter society? Institutional investors, or the "smart money," firmly believe we are well on our way. Homeownership levels peaked at 69.2% in April 2004 but have since steadily declined. The decline in homeownership stems from many factors: lack of supply, decreased affordability, higher interest rates, and inflation. In addition, technological advancements and data have also allowed institutional players to enter the market effectively. Technology has lowered the costs of underwriting and management, resulting in increased returns and scalability. So if you are an individual or small LLC holding a 5+ unit portfolio of single-family rentals, how do you sell to an institution? Or are you better off selling each property individually?

The Rockval Team sat down with Adam Stern to discover how he carved a significant niche in this emerging industry. Stern is the CEO of Strata SFR, the premier brokerage for single-family rental (SFR) portfolios and build-for-rent (BFR) advisory. Founded in 2020, Stern and his team connect existing portfolio owners and build-for-rent suppliers to a diverse array of professional SFR real estate investors committed to gaining exposure to the single-family rental market. Around 8.5% of homeowners own between 2-100 properties, Strata’s target market.

Wall Street - America's Landlord

Before 2010, institutional funds focused most of their real estate investments on multifamily or general commercial primarily because the net operating income margins on multifamily were much higher than SFR. But with the advancements in technology and rising rental prices, SFR operating margins began to increase, allowing SFR to become a viable investment vehicle. As a result, Blackstone, J.P. Morgan Asset Management, and Goldman Sachs were a few heavy hitters who deployed copious amounts of capital into the market.

List on Zillow or sell to Invitation Homes?

As a small LLC or individual portfolio owner of SFR, it begs the question of whether to sell the portfolio individually or as a whole. A respective owner would have difficulty connecting with private equity; this is where Strata comes in. Strata SFR provides a professional service that allows owners to sell their entire portfolio to institutional buyers. On the private-equity side, Strata is an acquisition service providing them with deal flow. Their unique value proposition allows them to connect with owners who are not actively selling by presenting them with multiple offers from private capital, unlike wholesalers who are lowballing their lowest bid. On the sell side, they are looking to maximize portfolio value. Stern keeps his fees relatively low and compensates with volume. He says his fees are low because he feels responsible for helping the owner; most have spent their entire life building the portfolio.

Stern lays out this example: a seller owns 30 rental properties and decides to sell each one individually on the MLS. However, during this process, they will incur "disposition costs." These include vacancies, rehab, taxes, closing costs, and the major headache of each sale. According to Stern, these costs will account for 8-10% of the portfolio's value. On the other hand, if you sell to an institution, they'd offer around 85% of the portfolio value, only 5% less than the retail value. There are no canceled contracts or pesky contingencies, and the seller can utilize a 1031 exchange on the portfolio. It seems like a no-brainer!

Is the market slowing down?

Stern responds, "It's funny when people say slowing down. We don't see it as slowing; it is a change in what buyers are willing to pay for real estate now. A year ago, interest rates were at 3.5%. The prime rate was half what it is today, and pricing went up month over month. So sellers were getting excellent pricing (above asking) from investors. Today, interest rates are double what they were a year ago, and properties must be bought at lower prices (below asking) to hit the desired cap rate. The firms haven't slowed down; they're still buying. However, the amount they are buying is less now because they're not able to offer as good of pricing. They cannot get as many deals done, and this will continue until sellers realize it's not going to get as good as it was anytime soon."

Depending on the market, demographics, and median home price, SFR portfolio cap rates were sub-5% a year ago. Today, new construction properties in a good market are trading at 5-5.5% cap rates. Since the news has not extensively covered the changing housing market pricing, most sellers have yet to realize the market has tightened up. As more data and mainstream coverage emerge, sellers will eventually return to market levels.

Re:Cap key takeaway

The “smart money” has recognized that the country is evolving into a renter society. In Q3 of 2022, 1 out of 15 homes sold was purchased by institutions. With the help of technology and economies of scale, it will reduce operating costs over time, leading to additional investment. Strata is at the forefront of this emerging industry and will continue to bridge the gap between residential portfolio owners and institutional capital.

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