More than 1 trillion dollars in U.S. real estate equity is going to be consolidated over the next decade. The single-family rental (SFR) industry, which emerged as an institutional asset 10 years ago, is being reborn as a commercial real estate food group now. The apartment industry is adopting single family rentals, and things are about to get really interesting.
Can’t see it? Let’s take a look at the path SFR’s more mature cousin, the multifamily rental sector, took more than 25 years ago…
1979: Federal Reserve raises the discount rate
1981: Congress deregulates banks
1989: Savings & Loan Crisis: More than 1,000 savings & loan institutions went under thanks to risky lending
1989-1995: The Resolution Trust Corporation (RTC) liquidates $400 billion in distressed assets from those bank losses.
What does the “discount rate” mean? The discount rate is the interest charge to commercial banks and other depository institutions on loans they receive from the regional Federal Reserve Bank’s lending facility. Banks borrow money from the Fed to resolve short-term liquidity needs and create flexibility for annual funding needs, such as seasonal lending pressure that might occur in an agricultural or resort community. When the discount rate rises, the “price” (interest) that banks must pay on these loans rises as well, making it harder for banks to meet financial pressures usually met using Fed loans.
Back in 1979, the Federal Reserve raised the discount rate it charged banks to a level that left many of them insolvent. Just two years later, in 1981, Congress deregulated those same banks, enabling them to offer a wider spectrum of financial products, including variable rate commercial mortgages.
The combined impact of these two government actions was to
- render the business model of savings and loans unworkable, and
- give them a license to “gamble” to make up the shortfall. Many gambled by making risky loans to commercial real estate developers despite having little or no experience in that arena.
By the end of the decade, the country faced a savings and loan crisis thanks to that gambling. The music stopped; more than 1,000 savings and loans went under, and $400 billion in distressed assets needed to be packaged and sold. The Resolution Trust Corporation (RTC) was formed to resolve the crisis, and a fire sale soon followed as commercial real estate operators and financial institutions stepped in to capitalize on the opportunity. The modern era of institutional real estate investment was ushered in. To further fuel the buying frenzy, the RTC offered very attractive seller-financing to enable buyers to leverage their capital 3:1.
The past decade in the housing market is disturbingly similar in trajectory to the events I just described:
Clumsy government action set up the unintended consequence of risky real estate lending, just like in the 1980s. A wave of distressed real estate hit the market, threatened the overall economy and spawned a government-sponsored bailout. Smelling blood in the water, deep pockets converged for the historic opportunity. Early players were first attracted by the short-term appeal of the discounts and fire sales, but many stayed and built long-term businesses.
In the 1990s, buyers saw fantastic financing options emerge, including seller-financing from the RTC. This time around, we’ve already seen some of the lowest-cost financing ever offered to SFR owners.
In the 20 years following the savings and loan crisis, over $1.8 trillion in multifamily asset value was consolidated by institutional investors. If the pattern holds, capital will flow into SFR over the next decade on a similar scale. Existing players will expand, and new players will enter. The face of the sector is going to change, particularly given that many of the “new players” in SFR are experienced players in the multifamily sector. Take a look at any “sponsor board” for a major SFR industry event in 2019. The commercial real estate industry is showing up for SFR in force. They bring the type of funding that will revolutionize and permanently change the face of this sector. Wise investors will learn to work with them and welcome them with open arms.
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