New Home Insights Podcast Episode 10 Transcript | John Burns Real Estate Consulting


Episode 10: Making Sense of the Single-Family Rental Industry

Transcript

Dean Wehrli:

Welcome to latest edition of New Home Insights with John Burns Real Estate Consulting. I’m your host, Dean Wehrli. Today, I have a very, very, special guest. It is Dallas Tanner. He’s the interim president of Invitation Homes and the chief investment officer there since 2012. He’s been in the real estate industry here for over 17 years. Invitation Homes is now one of the biggest single family homes for rent operators in the nation with over 80,000 homes in 17 markets. Dallas, please say hi.

Dallas Tanner:

Hi. Thanks for having me.

Dallas Tanner:

Absolutely. No, I can’t wait. Why don’t we start off with just a brief kind of intro. Give us the story behind Invitation Homes.

Dallas Tanner:

Yeah. We started the business in 2012, a few entrepreneurs and myself with obviously great sponsorship from our capital partner in Blackstone. We quickly built what has become the largest single family rental [inaudible 00:01:23] in the US. We had roughly 50,000 homes through middle part of last year, a little over 50,000 homes. We just completed a merger with Colony Starwood at the end of 2017. This year has been a busy year as we’ve integrated those 32,000 plus homes into our portfolio today. Today, we sit at roughly 80,000 homes across 17 cities, mostly Sun Belt markets, and with predominantly most of our revenue coming out of the West Coast and parts of Florida.

Dean Wehrli:

I mean, you’re still looking.

Dallas Tanner:

Everywhere.

Dean Wehrli:

Let’s start it this way. What are the key factors you are going to look at when you want to enter a market, or increase in that market, or even pull back in a given market? What are the critical factors you’re going to look at?

Dallas Tanner:

Yeah, no, that’s a great question. We spent a lot of time as we built the business thinking through what would be the right portfolio mix long term. There’s a number of different things as we were building the business that we took into consideration. Certainly, you look at household formation statistics, a lot of things that you guys follow at Burns Consulting. We looked at where’s our employment to permit ratio’s going to be the best. When I say permits, meaning new housing stock coming into the market. As we took a step back, it wasn’t rocket science to know that we we’re going to see an outperformance in terms of growth out of Sun Belt markets and parts of the West Coast that were going to lead themselves to larger household formation, population growth, which we believe back in 2012 would mean higher wage earners, more job growth, things that were going to the economy back on track.

Dallas Tanner:

As we look at a lot of that data, and you’ve got to go back to 2012, there were big imbalances between what we could buy properties for relative to replacement costs. I mean, back in 2012 you could buy homes at 50% discounts to replacement cost. You can’t find those kind of discounts today, but you can still find meaningful opportunities to invest at a discount in parts of markets that are higher barrier to entry and more infill.

Dallas Tanner:

I’ll go into a little bit more detail on what that means. If you look at our footprint today, we’re in 17 of the fastest growing cities in the country. We’re in markets like Phoenix, Las Vegas, Southern California, Seattle. And then, in the Southeast we’re in all of the meaningful markets that are showing the most amount of growth, Orlando, South Florida, Charlotte, Nashville, Atlanta. All these markets have lent themselves to greater performance from household formation.

Dallas Tanner:

It’s funny, Invitation Homes’ household formation is 90% greater than the US average, if you look on a go forward basis in terms of expectations. So when you asked me the question, what do we look for in a market? It’s all those things I just described. We’re looking for alpha, or for that growth, that will offer meaningful returns to our investors.

Dean Wehrli:

So, growth is critical. You mentioned discounts, though, and back in the heyday of the single family rentals, where you were scooping up all those discounted homes at those tremendous values. You mentioned, though, you still can find that somewhere? Is that still a key variable or has it matured since then?

Dallas Tanner:

Yeah. It’s a fair question. We look at replacement costs all the time. We’re looking for, where are we seeing rising wage and labor costs? Where are seeing cost of goods sold, meaning construction costs? Where are we seeing some of those being impacted the most? It certainly happened in lumber and steel and some of these things that are going on in the current environment, given tariff regulation and some of the geopolitical stuff going on. Most importantly, 4% unemployment around the US, that just means that generally speaking labor costs are going up. It’s a premium workforce. And so, specifically in markets that are showing an outperformance in terms of household formation, that cost to build a new product or a new home is expensive.

Dallas Tanner:

More importantly, if you look at our footprint as a business, we’re higher barrier to entry, we’re much more infill. We’re not out in the peripheries buying submarkets and communities where you’ve got a lot of green fill around you. We’re buying in parts of markets that are very dense. If you think about a market like Phoenix, Arizona, we’re inside the 202 and the 101 freeways. We’re really focused on areas that are near desirability factors such as schools and transportation corridors.

Dallas Tanner:

You’re not going to find new product nine times out of 10 in these types of environments. What you might find is that, if you use the example of a home maybe getting scraped, or heaven forbid an accident where a home burned down, a finished lot cost in that part of a market is quite expensive. And so, for us, we still buy homes today at meaningful discounts to what it would be to replace in those same markets.

Dean Wehrli:

You’re looking for growth and high barriers to entry simultaneously. Right?

Dallas Tanner:

Yeah. And really, we tell the street this, we’re total return investors. We’re looking for a balance of yield, which would be that revenue stream and where we think we’re going to have the greatest revenue growth, which is also a fundamental of home price appreciation. And then, we’re also looking for that asset appreciation. Beautiful part about single family is that in the single family space, each home is a liquid asset at the end of the day. We can buy and sell on the margin quite efficiently, and continue to refine and optimize our portfolio.

Dean Wehrli:

So, you’re constantly juggling how big we should be. Should we sell some here? Should we buy some there? Is that just a constant ongoing strategy?

Dallas Tanner:

Yeah. In order to be a good capital allocator, we sit back and look at our portfolio on a day to day, week by week, month by month basis. We look for areas where perhaps we’re seeing underperformance. That could be from an operational issue, or maybe there’s a municipal issue that’s causing us challenges, fixed costs being too expensive, maybe an HOA, maybe we’re seeing a property tax increase that is just happening faster than the norm. We’ll also look at asset appreciation. If you look at a lot of our West Coast assets, for example, we may see that, in California, we might find a home that we bought for $500,000 five years ago that’s worth $1 million today, and it just doesn’t pencil as a rental product anymore. We should sell that home back into the end user market. It’s a very efficient way for us to continually refine and optimize our business.

Dean Wehrli:

Yeah, that’s a good point. You’re looking at just a ton of variables. How about demographics? Do you look at the demographics, the demographic makeup of a market, when you again decide to go in, not go in, expand, retract?

Dallas Tanner:

Absolutely. You’re right, I mean, we’re data junkies. We’ve got a whole team that focuses on optimizing data and thinking through where is the greatest predictability for us in terms of that revenue stream and that revenue growth. Where are we going to see the biggest demand for our product? That certainly brings those demographic factors into consideration. A couple things, as we take a step back, in our business our average customer today is about 39 years of old, excuse me, 39 years old. They’ve got about a combined household income of somewhere right around a $100,000. And so, that millennial cohort, we get a lot of questions around that.

Dallas Tanner:

There 65 million people between the ages of 20 and 35 that are coming our way in terms of our current customer base. And so, we are looking at things like job growth and what types of markets are acquiring that level of talent, that age cohort. Are we seeing MSAs that are outperforming?

Dallas Tanner:

Dallas would be a great example of that. The Dallas market is a great job market for people coming out of business school that are looking to make that first move, or that second move, into a more professional environment. You see it in the fundamentals of the greater DFW area. You see it in the household formation statistics. You see it in the net migration statistics of what’s happening in North Dallas and the Fort Worth area. You also see it in some of the subjective information out there in terms of new businesses putting national and global headquarters in and around Dallas. Those are all things we look at that are driving additional talent to the area. We think it’s meaningful.

Dean Wehrli:

How many U-Haul trips are going in and out of that metro area. Yeah.

Dallas Tanner:

Transportation times are a big one, in terms of what it takes for somebody to get to the major transportation quarters. So you start to look at… Seattle just overwhelmingly passed a bond that’s going to create above rail. It’s going to take a long time for it to build, but they passed billions and billions of dollars, their state did, in terms of voting for it. We looked at that as a positive. It’s just going to spur a tremendous amount of additional growth to areas like that when you make it easier for people to get downtown.

Dean Wehrli:

Hopefully, it’ll be a lot faster than here in California getting our speed rail across the state, which is yet to happen. I want to just highlight that one stat you said, because I think every time… I know that stat now, I’ve heard it multiple times, but that $100,000 is the average income for one of your customers. I think that that’s shocks a lot of folks. Tell us about your customers. I mean, what is the makeup of your folks who are renting your homes?

Dallas Tanner:

Yeah, and we don’t know everything about our customers, right. We only, we only know bits and pieces from our screening and our underwriting and some of the surveys we do. As we’ve surveyed and we’ve talked to customers, we know that typically it’s a joint household formation, one to two kids, generally they have pets, and they’re really truly looking for the leasing lifestyle. Today, our current customer is staying with us almost three years in our business, and that continues to grow quarter over quarter. And so, we know we have a sticky profile there in terms of people that are choosing our type of living. What we’ve found is that they also want a suite of services. They want to find things. They want to optimize their home. They like the idea, upon moving in, of maybe having some optionality in terms of upgrades to flooring, kitchen upgrades, or even paint. These are services that we’re starting to provide.

Dallas Tanner:

It’s interesting, if you think about it. 20 years ago, people thought about leasing a car and it was like a bad word, right? Everybody wanted to own a car. Today, nobody cares. People love to lease vehicles, and they love to switch it up every three to four years, or whatever it is they choose. But, they love the fact that, in their lease, they can optimize. It’s no different in housing. In our business, the way we approach it is that it should be no different. Someone should have a sense of ownership, whether they’re leasing or whether they’re owning a home. As we refine that process for people moving in and we offer those services, we’re finding that people are not only opting in, but they’re choosing to do more to our homes. We love that because these are assets longterm that way at less cost us as a business.

Dean Wehrli:

That’s interesting. There’s always the skin in the game thing for ownership and why there’s that pride of ownership. In your case, the skin in the game is the fact that they’ve spent some money options and upgrading and that they’re going to be there for a fair amount of time.

Dallas Tanner:

Yeah, and people don’t really appreciate when you buy a home. We’ve all been through this. For those of us that have owned, there’s more that goes on to maintenance in a home than you ever anticipate the first time you buy. What’s nice is we take all the headache out of that. From a management standpoint, we cover all the ends. We just expect a good customer that is a good citizen, a good neighbor, and on top of that, that we offer a service that they want to renew. We’re finding the 70% of the time they renew their lease.

Dean Wehrli:

That’s awesome. Let’s talk about the industry for a minute. The single family space has been dominated by these mom and pops, the small, the very small operators for the most part. Do you see that gradually changing? Do you think we have some consolidation in the SFR space coming forward?

Dallas Tanner:

Well, there certainly has been some today. I mean, we’ve had a number of consolidation moments. We just went through a merger with Colony Starwood, for example. Earlier last year Tricon bought Silver Bay. Starwood and Colony had done a merger before that. Those were all big names in the space and in a relatively new timeframe. I mean, the industry is only been around [inaudible 00:13:30] years from an institutional standpoint. It’s been around forever, in terms of people leasing homes for hundreds of years.

Dallas Tanner:

I think there’s going to be more consolidation for a couple of reasons. One, there are certainly good operators out there that are building up portfolios of substance. At a certain point, every capital stack out there has to make a decision about whether they want to stay private, go public. Or, are we better off selling or merging our portfolio into a bigger company? And so, those create moments of opportunity.

Dallas Tanner:

The other second point is we’re seeing a lot of new capital come into the space. We hear almost weekly or monthly at a minimum, but typically weekly, we’re hearing about a new investor, a foreign sovereign, or a pension fund that seems to be coming in and starting to build a portfolio in a couple of key markets. I think people have found, and rightfully so, that this business of 16 million people that have rented homes for a long time should be… Parts of it should be institutional. Today, maybe 250,000 homes are institutionally held out of 16 million. That’s a really small percentage. Plus, [crosstalk 00:00:14:33]. Why wouldn’t this be an industry someday that a million or two million of the 16 million rentals are institutionally and professionally managed? Because, people want that. They want all the bells and whistles that come with professional management.

Dean Wehrli:

Yeah, that’s another amazing step by the way. The portion of the single family rental market, when we understand how big it is and how it has been around for decades and decades in the US, the institutional share of that is absolutely tiny. So, it does make sense.

Dallas Tanner:

So, so tiny. You’re absolutely right, so tiny.

Dean Wehrli:

And so, one of the big hurdles historically anyway, at least, one of the concerns of folks is that the operating expenses for single family rental at least compared to traditional apartment world, it’s a higher operating expense percentage wise. How do you deal with that? How do you get around that or handle that?

Dallas Tanner:

Well, there’s a couple of things that go into that. I mean, one of the things you got to appreciate about single family rental, it’s about half of our expenses are due to property taxes. That’s a different percentage than the multifamily business. In markets that are growing, we’re always going to have a bit of property tax growth. There’s nothing you can do about that. We’re the largest payer of property taxes and school taxes in the country, as a business. Something we quite frankly take some pride in, the cost of ownership, and I think it’s because it’s early and I think you’re referencing cost to maintain, now we get pretty [inaudible 00:16:01] around in the high two thousands in terms of what it costs us to maintain a home year over year. But, it is certainly early, and vintage, and age, and quite frankly geography come into play there.

Dallas Tanner:

Warm weather markets it’s a lot cheaper to maintain homes, generally speaking. As you get into some of the wetter markets, you deal with things like roofs and vegetation, but it’s all part of your original underwriting. I think, for the most part, those that are in the public spectrum, like ourselves and some of our other peers, done a nice job of laying out what those costs are, and we’ve been pretty consistent year over year. I think, it’s just that the industry is so new, people still have questions. There’s less predictability. [inaudible 00:16:41] family has been around for 30+ years.

Dean Wehrli:

Yeah. Yeah. And that’s fair. That’s fair. Essentially, that cost, that maintenance cost, whatever it is, has been factored in now, and we have years of experience to see that you’re still making money despite that. Is that fair to say, to characterize?

Dallas Tanner:

Absolutely. The other thing to keep in mind is that, for professional managers like ourselves, we can maintain a home at a much cheaper cost than a traditional homeowner can due to our procurement capabilities. I mean, if you think about it, we buy materials by the truckload and the train load, and here’s efficiency. And then, our cost of labor can be optimized over a long period of time. We really do offer a much affordable approach to maintaining a home than what it would cost anyone that owns a home today.

Dean Wehrli:

Okay. That’s a fair point. How about going forward? Now, let’s do a couple of go forwards thereto end our podcast here. The first one is just what do you see as the biggest hurdle in general to the single family rental world going forward? What’s your biggest when you wake up in the morning?

Dallas Tanner:

You know, I think we have a committed focus to making sure that we get the service side of the business really right. I believe that we are early stages in terms of what we can offer customers. There’s so much low hanging fruit in front of us as a business, in terms of what we can and can’t do, in terms of what we offer the customer. I hate to use the word hurdle because it’s more of an opportunity, but you can only do so many things so quickly as you’re stabilizing these businesses and getting them running the way they are. Again, we’re like in the first couple innings of this from an institutional standpoint. I think, regulation’s one that we’re always sensitive to, making sure that we’re working with states and municipalities, that the proper narrative is out there and the correct narrative.

Dallas Tanner:

To your point earlier, we are such a small part of the housing continuum today. I mean, to be only 250,000 units institutionally managed and we get a lot of headlines for right or wrong that that can sway public opinion on things. And so, we really want to be careful and make sure that our service and our product is consistent, and also that we work with municipalities to be affordable housing option for people. That’s really important to us.

Dean Wehrli:

Do you get the, for lack of a better term, I know it’s a loaded term, but the NIMBY kind of reactions specific to you, specific like they’re afraid, oh, you’re putting the mom and pops out of business, or you’re taking out of the home ownership stock available to them? Do you get those kinds of reactions and given markets or neighborhoods?

Dallas Tanner:

Well, you get headlines once in a while. You also get really positive headlines, in fairness. I mean, we get a lot of reporters and news outlets that write really good reviews when they take the time to understand how the business works. But yeah, those are challenges. I think the other challenges for our space is, because it’s so early stage, the tools are rapidly evolving. Multifamily, for example, has had 30, 40, years of revenue management systems, and property management tools, and asset management softwares that have continued to be developed. It’s still the first inning in terms of single family systems, and accounting softwares, and leasing tools, and smart home technologies, and things that we can add into our property. Those are definite opportunities, but they’re also hurdles early stage, because there aren’t a million customers out there that have institutional accounting platforms needed for single family rental. Now, we’ve done a nice job and we have great partners that have helped us build these out. But, you’d love to see that part of the industry continue to develop a bit more.

Dean Wehrli:

Yeah, for sure. You mentioned affordable, you offer an affordable option. Do you see that becoming maybe even, you know all these cities have affordable goals they have to meet. Do you see SFR becoming a part of that solution potentially?

Dallas Tanner:

Well it already is. You have a number of Section 8 customers across all the different portfolios out there to date. And so, you definitely have some government subsidy in people’s portfolios that you see out there. I would think that we can be a real big help on the community side longterm. There’s a lot of ways to be involved, and to help, and to create awareness around some of the affordable options that are available to people. The nice thing about it is people can choose to be down payment light.

Dallas Tanner:

If part of affordability is that we’re looking for ways to get families into desirable neighborhoods that can otherwise not have to put down a huge down payment, that’s a big deal. Because, at a minimum people are putting down a 3%. most people are putting down somewhere between 5% and 15%. On a $300,000 home, that’s a lot of money. It’s anywhere from $15,000 to $45,000. With companies like us, if people don’t have that down payment, but they’ve got fairly decent credit, they can move into a neighborhood and experience all those same things a homeowner can, and can quite frankly stay as long as they like. And so, we know there’s an affordability factor here because of the amount of renewals we get in a year over year basis that people love the product, they like the neighborhoods. So, I think awareness of that is a good thing.

Dean Wehrli:

That’s a great point. That down payment is such a hurdle, especially in those upper end price markets that that could be a big part of it right there. Let me ask you, Dallas, one last question. Just a little more general with a little specific Q at the beginning is just, longterm, what’s your strategy going forward, as much as you can divulge with us? And, especially interested in do you see more partnerships with single family home builders in your future?

Dallas Tanner:

Yeah. It’s a great question. It’s one we get all the time and the investor community. I would say, and I always say this to people, because we’re going to continue to grow. We’re a business that’s focused on finding growth both in our own portfolio today. From an organic standpoint, we see a lot of optimizing and a lot of low hanging fruit that we can continue to evolve over the next couple of years with. And then, outside of that, we’ll externally grow, when the opportunities are there and when things make sense.

Dallas Tanner:

The specific question around will we buy new homes, the short answer is yes. We are channel agnostic, meaning we will look at every channel, and we do this today, in terms of where we can buy new product and add it to our existing footprints, but we are absolutely location specific. Meaning, we care about being in the right parts of the MSA, the right parts of the neighborhood where we think desirability is the greatest. What we found is that will probably be a small part of our strategy going forward, but you’re just not going to get a lot of new builder product in the most infill interior areas. That’s been a focus for us is we like higher barrier to entry, a little bit higher price point, where you’ve got little bit of a more sophisticated, not sophisticated, but a little bit of a higher price point where where the desirability and probably the predictability of our customer is going to stay a bit longer. And so-

Dean Wehrli:

That makes-

Dallas Tanner:

For us, we’ll then fill opportunities like that from time to time. We’d done a little bit of it. I don’t think it’s like we’re a home builder or we’re going to start a home builder company. We’d probably be more likely to partner with home builders and find opportunities to buy from them over the long haul.

Dean Wehrli:

Yeah, yeah. We’re hearing about that, where it makes sense when you have a mix of renters and homeowners in a given new development. When folks hear that your typical renter has that $100K income, I think that eases a lot of those concerns.

Dallas Tanner:

Exactly. We want to find that balance and we want somebody who will stay with us for a long time, but also is willing to pay for the right type of product, because it’s a longterm decision for them. And so, for us, if we’re out in the Greenfield areas where there’s a lot of developments still to come and things like that, that’s going to take five or 10 years for those types of areas to mature. We want to be in mature neighborhoods where the desirability is already quite high.

Dean Wehrli:

Awesome. Anything else? Anything else you want to add or have a look forward kind of strategy?

Dallas Tanner:

No, I mean, I think if anything, we really appreciate people like Burns, John Burns and the consulting team that you guys have put together. There’s so much interesting data out there. The more we can learn about what the customer’s actually looking for, the better we can be at providing those opportunities. We appreciate the opportunity to get our message out there and we really appreciate the support from you guys and your team long term.

Dean Wehrli:

Well, we appreciate you coming on the podcast and sharing your thoughts with us. Dallas, thank you very, very, much.

Dallas Tanner:

Happy to do it [inaudible 00:25:07]. Thank you.

Dean Wehrli:

Absolutely. Well, thanks so much. And that’s it for us here. Please give us a listen. In a couple of weeks and we’ll have another episode for you. Until then, see you later.

 

 

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