Institutional investors are a professional class of organizations that manage large sums of “institutional capital” (money), such as pension funds, university endowments, insurance companies, sovereign wealth funds, or family offices.
For example, CalSTRS is a pension fund that provides retirement benefits for California’s public school teachers. They are also an institutional investor. As of May 31, 2021, they are responsible for investing $307 Billion of assets under management (AUM) on behalf of their pension.
All pensions, CalSTRS included, do more than just working with their members to provide pension benefits. CalSTRS is also an investment manager of all of the money that they are responsible for, and their investing employees’ primary role is to perform a function called Asset Allocation.
Asset Allocation means to deploy capital using a diversified investment strategy. To do this, they set targets for how much capital is dedicated to each asset class. They base their allocation targets on historical risk and return profiles, as well as high-level macroeconomic trends and forecasts.
CalSTRS target Asset Allocation is reflected below:
Within each asset class, there is further diversification. For instance, within real estate you can diversify across geographies (domestic vs. international), product types (office vs. residential) and strategy (acquisitions vs. development).
Institutional capital is by no means an expert in all of these various domains, so they partner with professional investment managers who specialize in specific sectors and strategies. CalSTRS real estate allocation is managed by over a dozen firms, including Blackstone, Invesco (partnered with Mynd), Divco (partnered with Atlas), Blackrock, Fortress and JP Morgan.
Effects on the Real Estate Market
Institutional capital flows are noteworthy because when investors adjust their target Asset Allocations, it can result in huge sums of money flooding into a sector simultaneously.
For example, CalSTRS decided 14% of their capital should be invested in real estate. As of May 31, 2021, their actual real estate allocation was only ~12%. To bridge the 2% gap, CalSTRS needs to increase its real estate exposure by $6.1B!
This is an example of just one pension fund. There are hundreds of investment managers making allocation decisions, and Institutional investors are known for operating with a “herd mentality” – they tend to copy their peers’ strategies.
Think about this: the 100 largest pension funds collectively manage ~$18T. If they decide to increase their exposure to real estate, or specifically residential housing, by just 1%, they would be mandated to acquire $186B worth of housing units.
Using an average home price of ~$285K, they would need to acquire over 650K homes to hit their allocation targets! These are huge numbers – to put it in perspective, according to the US Census, the City of Austin, TX has ~400K households.
Takeaway
This phenomenon of capital flooding into a sector is especially notable if it is happening for the first time – which is what we are seeing in single family housing, particularly rentals.
To effectively deploy billions of dollars into a sector for the first time, especially one as nuanced and fragmented as housing, new technologies and operating models must be invented and executed with expert precision. These innovations create opportunities for those paying attention.
Tell me more…
- Current State of the Single Family Market
- Pros and Cons of Institutional Investors
- Future of the Market
- How do they Impact Local Investors?
Current State of the Single Family Market
Despite the seemingly abundant headlines about institutions diving head first into the single family housing market, they only control only 2% – 3% of single family rentals. The majority of rentals are owned by small companies and individuals. To contrast, +45% of apartments are owned by institutional capital. That is an indicator for how much room there is for the single family industry to further institutionalize.
There has been institutional presence in the single family housing market since the 2008 housing crash, after which private equity giant Blackstone helped fund Invitation Homes. Invitation Homes (INVH) is now the largest owner of single family rental properties in the country with +80K homes. (Note, Blackstone divested their INVH position in 2019; it is currently an independent publicly-traded REIT.)
However, until recently, examples of institutional investors targeting single family housing have not been all that common. This is primarily because it is notoriously difficult to scale, relative to both capital deployment and ongoing operations.
For example, it is harder to invest $200M into individual single family homes than it is to build a single $200M condo building. From an operating perspective, the condo building only has one roof to maintain while a $200M portfolio of houses could have 700!
That said, the current consumer demand story is too powerful for institutions to ignore. And there is a burgeoning ecosystem of start-ups and other technology companies creating efficiencies that weren’t possible before.
There are a number of long-term demographic trends in place that support a single family housing investment strategy.
- There is a massive undersupply in housing caused by decades of under-building; Freddie Mac estimates the US has a shortage of over 4M housing units.
- Millennials are growing their families which is causing them to seek out more living space, yards, and better school districts – all difficult boxes to check in a multifamily setting.
- Younger generations increasingly value access over ownership. Many of them want the flexibility of renting; they are more mobile than their parents either by choice or necessity, and experience more frequent job changes.
- For those that do want to own, for many reasons it remains difficult to qualify for a traditional mortgage – especially for gig economy workers or those that have heavy student debt burdens.
These trends all became more pronounced during the Covid-19 pandemic. Additionally, the newfound ability for many individuals to work from home further increased demand for single family housing as people seek to optimize their living environments.
Combine all that with the fact that during 2020, national single family rents grew by 3.8%, while multifamily saw a 0.8% decline – and the result is that institutional capital has collectively decided that single family is an asset class that deserves a slice of the Asset Allocation pie chart.
Pros and Cons of Institutional Investors
Because of their scale, institutions can invest in tools and strategies that aren’t accessible to individual investors. For example, Pretium and their subsidiary company Progress Homes (2nd largest landlord in the US with approximately 40,000 homes), have a technology layer that monitors the MLS and triggers an immediate alert if a property is listed for sale that meets their acquisition parameters. They make all-cash offers within an hour of the property being listed for sale, which puts them at a material competitive advantage. Progress’ CEO stated on a recent podcast that technology is the driving force behind their ability to acquire over 75 homes per day.
Depending on someone’s perspective or particular situation, the presence of institutions in the market can be either positive or negative.
If you are selling a house that an institutional investor wants to buy, you benefit from relative certainty they will execute on their offer. Progress Residential and others are currently providing an unprecedented amount of liquidity to home sellers today.
Additionally, the renter experience can be improved. Today, there is an undersupply of single family rental product that appeals to modern consumers. Compare renting a single family house versus renting in a large well-managed (likely Institutional-owned) apartment building. The experience of renting in an institutionally-managed apartment is generally far superior than an individually-owned single family home for a variety of reasons. Things that improve the user experience – like a dedicated maintenance staff, online rental portals and other professional service providers – are only realistic to implement through scaled operations.
The flipside is that it can be hard and frustrating for individual consumers or investors to buy a house when competing with institutional capital. According to Redfin, approximately one in seven homes sold during the first quarter of 2021 was purchased by an investor.
Additionally, by definition, the business plans implemented by institutional investors lack authenticity. In general, they like scaled-systems that can be consistently implemented with known profit margins. So, as a renter, you are more likely to end up with the same sink in every house, then you are to have unique and charming property features and characteristics.
Further, most institutional investors don’t intend to sell anytime soon – once a property is owned in a rental portfolio, chances are it will remain a rental for an extended period of time. Rents could increase at an institution’s discretion if they control enough inventory in a neighborhood to move the market. Generally speaking, increasing supply of rental housing should spur healthy competition, with landlords striving to deliver the best service for competitive pricing.
That said, some investors are adopting a “lease-option” model (also known as “rent-to-buy”), in which the tenant pays a downpayment and has the option to purchase the property at a predetermined price in the future. This can be an effective tool for helping someone become a homeowner who wouldn’t have otherwise been able to.
Future of the Market
Institutional capital is in the single family market to stay. In the short term – it can be jarring, especially for consumers trying to buy a home in an overheated market. In the long run, once things stabilize, the market will likely be in a better place with institutional involvement. Competition created by a consistent presence of well-capitalized investors will lead to better choices and lower prices for consumers, as sophisticated companies compete for their business. This should drive positive innovation, and product type segmentation that is not prevalent in today’s housing market, but would be desirable.
The evolution of what the future may hold for single family could take the form of other real estate assets. Hotels are a great example. Hotels, and to an increasing extent apartments, are developed and designed in a segmented way that appeals to specific consumer profiles – they are designed to create a great experience for that unique individual – for instance the business traveler or the vacationer.
Imagine working in another city for a period of time and being able to rent a house with a perfect work from home set-up pre-programed into the house requiring no expensive after-market modifications. Or, for those always on the go – a clean and low-maintenance homestead where the landlord’s concierge service team handled literally everything. The ideas and custom personalizations could be limitless in single family housing given the number of homes and relatively low cost of the assets.
How Do They Impact Local Investors?
As it exists today, most institutional capital is focused on rentals. They value the recurring cash flow streams, and prefer to avoid rehab projects when possible. Most institutional investors categorically avoid homes that require “heavy” rehab.
In commercial real estate, institutions partner with local operators and developers to take on complex construction endeavors. They are unable to do this in the single family sector because it is not worth their time to build and maintain relationships with individuals (today).
However, that’s where Backflip can help. Backflip’s role is to funnel capital into the hands of local entrepreneurs and provide them with similar technology, data, and know-how that was previously only available to the institutions.
Backflip is proud to support individual value-add investors willing to take on inspiring and profitable projects. We believe empowering local entrepreneurs is the key to rejuvenating the housing stock in an authentic way that maintains the urban fabric that makes neighborhoods so unique and amazing.
Put simply, Backflip supports real estate entrepreneurs of all sizes to reinvigorate the housing supply on their terms.