The return of the prodigal single-family rentals

It’s no secret that inadequate inventories have been stunting the housing recovery. Through November, total housing inventory has fallen year-over-year for 18 straight months and supplies are now 11.4 percent lower than they were two years ago.

As inventories decline, rising income, improved employment and historically low mortgage rates have given demand a shot in the arm.

Sales in November reached 15.4 percent higher than a year ago — nothing to sneeze at — but the sad truth is that sales could have been 6.5 percent higher if more houses were available to buy.

Don’t blame the builders

Pressure is on America’s homebuilders, an industry that was virtually devastated by the housing crash and has yet to recover fully.

In November, housing starts were only 0.5 percent higher than they were a year ago, and new home construction is still only about half the 1.5 million starts annually the production necessary to meet the needs of America’s expanding population.

With new homes selling like hotcakes, builders can’t do much better due to ever-increasing local land use and environmental restrictions and skilled labor shortages.

So don’t count on new construction to bridge the gap. Along with rising mortgage rates, that’s why Freddie Mac and Fannie Mae forecast sales growth to slow to about 4.7 percent or 4.8 percent next year — close to historic norms, but probably much less than house-hungry millennials could buy if they could find affordable properties.

It’s time for the prodigals to return home

Inventories — especially supplies of the smaller, more affordable homes most in demand by young buyers — are low-profit and, therefore a low priority for many builders trying to get into the black.

However, perhaps the time has come to seek salvation from an entirely different direction.

Five years after the end of the foreclosure era, next year we will see many of these long-lost properties return home to the owner-occupant marketplace in earnest.

Most are affordable and right-sized for today’s young buyers. Typical single-family rentals are older, smaller and have fewer bedrooms than the average home. They are located largely in suburbs and might be affordable for many buyers who are being priced out of homeownership today.

Over a relatively brief period, the population of single-family rentals soared. Between of 2004 and 2013, the number of single-family detached rentals rose by 35 percent, from 9 million to more than 12 million. That increase is roughly equal to half the number of all homes sold in America in 2016.

With the end of the foreclosure flood, investing in single-family homes has declined dramatically and now has returned to levels closer to 12 years ago. These days, small investors who buy and hold homes to rent them out account for only 3 percent to 4 percent of purchases, a share about double the 2 percent of sales by investors in residential properties in 2004, per the National Association of Realtors’ 2004 Profile of Home Buyers and Sellers.

“There will be a handful of entities that will stay in the single-family rental business for the long-term,” said Daren Blomquist, vice president for data firm RealtyTrac. “They will look to buy portfolios from tired investors.”

As for the vast majority of landlords who own a handful or fewer rentals, changing conditions could motivate so many to sell that they could change the direction of the nation’s housing economy.

Six reasons to sell

Here are six reasons single-family rentals are on the decline and tired investors are ready to sell — and why most of their properties will return to ownership status.

1. Prices are too high to buy but perfect to sell. Prices for single-family rentals have been rising more quickly than the rents, driving down the yields investors receive from their assets.

2. Soaring home prices are motivating smaller investors to sell out and cash out now, while price increases are at their peaks.

A recent survey of 111 experts and housing economists found that more 90 percent expect home value growth to be slower next year, and more than 85 percent of them foresee home value appreciation rates flat or lower compared to 2016 in every year through 2021.

Source: November Realtors’ Confidence Index. National Association of Realtors.

3. Competition for tenants is getting tougher. Projections of household growth suggest that the demographics that fit the profile of single-family renters are not expected to grow faster than all household types over the next twenty years.

Moreover, high levels of multifamily construction are absorbing much of the demand from groups that have traditionally been renters.

4. Upkeep grows more expensive with time. Homeowners are advised to set aside 1 percent to 3 percent of their home’s purchase price each year for home maintenance and repairs.

Though many single-family rentals were remodeled to make them “rent ready,” the passage of time increases the chances owners will get socked with the serious expense of replacing or repairing major systems, like air conditioning, furnace, water heater, main electric box, roof, windows, basement leakage or appliances.

For foreclosures converted into rentals during the peak of the foreclosure floods — 2009 to 2012 — the clock is ticking.

5. Landlording gets old. Professional property management companies cost 10 percent off the top of your rental income and may not always be reliable. Choices are few in many markets.

Doing it yourself gets old when you have to answer calls at midnight or holidays, forgo vacations, fight with irresponsible tenants or watch your annual rental profits evaporate when your property goes vacant for a month or more.

Just the “friction cost” of fixing up the house after a tenant departs and then leasing the house again after a sale can equal 8.0 percent to 12.0 percent of the cost of the properties.

6. Securities are beating real estate these days. When Great Recession torched 401(k)s, the double income from single-family rentals — rents and appreciation — looked like a no-lose strategy for a secure retirement.

Nowadays, the securities markets are doing just fine. Moreover, securities are so much more liquid than real estate that investors can adjust their portfolios with a couple of clicks of a mouse.

Residential real estate investing has always had fans and always will. Many investors feel more secure in real estate because they understand their local real estate values and can anticipate changes due to local economic conditions.

Landlording appeals to many folks who are handy and live near their properties. Those owners can manage their rentals profitably if they have the time.

A year ago I argued that single-family rentals would hold their own for the near future.

So far, I have been right — but I am changing my mind because both rents and purchase prices are flattening.

The greatest apartment construction boom in decades is weakening rents, especially for single family rentals in vulnerable markets. At the same time, home price appreciation, bolstered by short supplies, is also forecast to slow down next year.

Should landlords read the same tea leaves that I do and sell, prices will soften even more, and sales will benefit — especially sales to first-time buyers and those in moderate price tiers.

Steve Cook is editor and co-publisher of Real Estate Economy Watch. Visit him on LinkedIn and Facebook.

Email Steve Cook.

Editor’s note: This story has been updated.