Ten years after the burst of the housing bubble, it might feel to some as if it never happened. Certain real estate assets once again appear fully priced, with average capital values for residential multifamily properties now roughly 73% above 2007 highs in major U.S. cities.
That's not to say, though, that U.S. real estate is merely retreading old ground. As the $11.2 billion merger last August of The Blackstone Group and Starwood Capital Group's residential single-family rental businesses demonstrated, residential real estate investment in the U.S. is undergoing a period of dramatic change. We believe the "institutionalization" of the single-family housing market is a major long-term trend that has only just begun and presents a compelling opportunity for early movers.
Since the financial crisis, the recovery in the single-family residential market (detached, stand-alone houses) has significantly lagged the multifamily apartment sector (Figure 1). This reflects a fundamental difference between the two markets and we believe highlights the current attractive relative value of single-family residential as a sector. This dynamic is similarly expressed in Figure 2, where the widening valuation gap between single-family and multifamily is clear; we believe the former is relatively affordable and presents attractive fundamental value to investors.
The scale of the U.S. single-family market and the composition of the existing investor base are other important factors to consider in framing the potential opportunity. The United States has nearly 16 million single-family homes that are rented rather than owner-occupied. The total capital value of these rental properties is in excess of $2.5 trillion, a number that exceeds the U.S. office market at $1.9 trillion or the U.S. multifamily market at $2.1 trillion. The U.S. housing market also has a high volume of transactions, with more than 5 million existing single-family home sales in 2017. This scale is increasingly drawing the attention of institutional investors seeking to diversify from other real estate sectors.
While office and apartment buildings have long been considered an institutional asset class, less than 2% of the 16 million single-family rental properties in the U.S. are owned by institutional investors. Several decades ago, the multifamily rental market was similarly dominated by private landlords. As this market became more institutionalized, values became increasingly driven by investor capital flows, the search for incremental yield, and a desire to diversify away from publicly traded securities or other real estate sectors. Institutional investment managers entered the multifamily segment, which allowed large-ticket capital allocations and the post-crash recovery to take place more quickly.
Trends in U.S. homeownership: rent vs. buy
When looking at the dynamics of the single-family housing market, we also consider the potentially shifting trends of homeownership in the U.S. since the financial crisis. At about 64%, homeownership in the U.S. is among the highest in the developed world. While owning your own property has historically been associated with economic prosperity and the American dream, renting needn't only be the preserve of those economically locked out of homeownership. Many U.S. millennials (born 1980-96) have a different view of homeownership to their parents' generation. Millennials witnessed the price falls of the financial crisis, and may therefore be more comfortable with the idea of renting and the flexibility it offers. Throughout the financial crisis and the recovery to date, the number of owner-occupied households has remained stable, while rental households have increased by 8 million (Figure 3).
All of this is not to say there isn't still a strong bid for property assets from individuals. Unlike the pre-crisis housing market, the residential market is now on an upward trajectory because of supply and demand dynamics, rather than credit. It's a matter of market fundamentals as opposed to speculation in our view.
In 2016 there were 1.3 million "household formations" in the U.S. — 25% above the long-term average. In a recent research note, Morgan Stanley (MS) said it expects this trend to continue for at least the next five years driven by long-term demographic trends. Household debt-to-GDP has fallen significantly since the financial crisis, with consumers reducing both secured and unsecured debt. U.S. economic indicators are strong, measures of housing affordability are more favorable to consumers than they have been for some time and demand for housing currently outstrips supply, which, as depicted in Figure 4, is at depressed levels.
Following the financial crisis, investors and banks began to sell single-family homes at distressed prices, which led institutional investors to move into the market, recognizing the potential value on offer. While we believe that distressed investment opportunity is largely finished, there remains significant institutional interest in this asset class and we might be on the cusp of a wholesale change in the makeup of the single-family market at a time when properties in many large U.S. cities still look very affordable by the various measures discussed.
Managing thousands of individual homes is more difficult than a single apartment building, which is a fundamental reason the single-family sector did not institutionalize earlier. Technology is now being used to help solve this problem, and institutional investment managers have built required technology that better enable them to manage large portfolios of individual homes.
As the single-family rental sector continues to institutionalize, we believe the drivers that supported richer valuations for multifamily real estate during the recovery will similarly come into effect. Furthermore, we believe that once the market has fully recovered, U.S. single-family properties are likely to trade at significantly lower cap rates (i.e., higher valuation multiple) than multifamily properties.
Institutional investors in real estate have historically allocated to commercial real estate sectors, such as office, industrial, retail and logistics. The underlying fundamental drivers of these sectors are largely linked to the corporate business cycle, whereas the value and rental yield potential of single-family properties are driven by the health of U.S. consumers more broadly.
Within real estate equity investments, single-family homes have exhibited only moderate historical correlation to other real estate sectors (while commercial real estate sectors are more highly correlated to each other). Furthermore, they have shown lower correlation to stocks than other real estate sectors and negative correlation with bonds. When combined with the fact that single-family homes have displayed lower total return volatility (from December 2000 to July 2017) than other real estate sectors, stocks and bonds, despite the U.S. housing market experiencing the deepest nationwide housing crisis in recorded history during this period, we believe it is an opportune time for institutional investors to look again at their real estate allocations, with increased attention to the opportunities in single-family residential.
Mikko Syrjänen is co-head of real assets and Travis Masters is head of U.S. portfolio management for Man GPM, in Zurich and Charlotte, N.C., respectively. This content represents the views of the authors. It was submitted and edited under P&I guidelines, but is not a product of P&I's editorial team.