Buying single-family homes to rent them out is an investment strategy that people have been using since the middle ages (harkening back to the era of serfs and feudal lords). In recent times, more and more people have been building personal portfolios of single-family homes to create passive income. In the past few years, this strategy has become so popular that even big institutions with billions to invest have adopted it as a way to diversify their portfolios, generate income and gain exposure to the red-hot American housing market.
The industry, which has been branded “SFR” (short for single-family rentals), has grown tremendously over the past five years, and retail investors now have many ways to access this trend, ranging from private SFR funds, online brokerage platforms that sell single-family homes with tenants in place (like Roofstock), and publicly listed SFR real estate investment trusts (like Invitation Homes and American Homes 4 Rent). Bringing institutional-quality rigor and property management to what had previously been a cottage industry is a positive development for retail investors. However, nearly all of these existing solutions focus almost exclusively on freestanding single-family homes in suburban locations and secondary and tertiary markets.
There’s another targeted investment strategy that I believe could be integrated into real estate portfolio construction — one that is related to traditional SFR but has different attributes. That’s a strategy I call “urban SFR.”
Why Urban SFR Is Worth Understanding
Americans are moving to cities at unprecedented rates, and the fastest-growing American cities are experiencing population and job growth that is rapidly driving up home prices within those city limits. Couple this with a growing demographic that avoids long commutes and prefers the urban lifestyle, and it’s no wonder that urban residential real estate price growth has outpaced suburban and rural home price appreciation. That’s why integrating an urban SFR strategy into your personal portfolio is a smart, relatively low-risk strategy that will give you portfolio diversification and exposure to this historically strong-performing asset class.
One of the easiest ways to invest in urban SFR is to invest in condos in major cities. This is what my company specializes in, and through this experience, I've seen firsthand that there are five good reasons to consider condominiums in fast-growing cities if you're looking for a new investment.
1. Favorable Supply And Demand Inefficiencies
Demand for condos is not only governed by economics, but also by people’s circumstantial housing needs and behaviors. Remember, the condo market consists primarily of end-user home buyers, and not profit-driven investors whose decisions are dictated by simple math. End-user homeowners have a myriad of reasons to buy and sell apart from producing outsized returns (reasons such as wanting a newer kitchen or needing more closet space.) These dynamics create arbitrage opportunities to take advantage of both oversupply on the buy side and undersupply on the sell side.
2. Macro Urbanization Trends
People are moving to cities at a record pace, and it's predicted that by 2050, 68% of all people will live in cities, compared to 55% in 2018. This increasing trend toward urbanization will have an impact on people’s housing preferences, and I believe this could lead to city price appreciation outpacing suburban and rural home price appreciation.
3. Market Liquidity
It’s no surprise that it is far easier to sell an individual condo unit than an entire building. If you need to sell a condominium, there’s typically a plethora of buyers (at the right price), and such transactions can close in a much faster time frame. This reduced liquidity risk offers investors looking to enter the real estate market more protection on their investment.
4. Hassle-Free Management (Relatively Speaking)
Full-service condominiums have staff to support tenants, which is covered by the monthly maintenance expense embedded in homeowner’s dues or condo fees. For a landlord/owner, this on-site team is like having a property maintenance staff without the expense of employing an entire team. Therefore, condo owners do not always have to deal with the massive headaches that come with repairs and maintenance in the building or the physical plant issues that come from single-family homes (e.g., leaky basements, roofs, etc.).
5. Differentiated Return Streams And Upside Potential
While many types of real estate are valued based on income multiples (cap rates) or dividend yields, condominiums are valued based almost entirely on supply and demand and metrics such as price per square foot. This creates an opportunity for enhanced price appreciation. Income and appreciation are inversely related, so condos can offer diversified exposure and complement your existing income-oriented investments. Think about growth stocks like Netflix or Amazon: They don’t pay dividends. Nobody invests in these companies for income; they invest for appreciation. Condos behave similarly: You invest to capture future appreciation, not to clip coupons.
Although condos are a relatively low-hassle way to invest in a city's future growth, it's important to note that it can be difficult to lock up deals when you aren't physically based in that city. Meeting brokers, attending open houses and bidding in competitive bidding processes are all a necessary part of the process, and can seem insurmountable if you are investing from afar.
That being said, condo investment is a strategy that has long been used by wealthy individuals looking for a secure place to park wealth and as a hedge against inflation. And now, retail investors can access this asset class and capitalize on the trend of urbanization while capturing the growth of major cities through urban SFR.