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  • Writer's pictureGraceful Finance

Unlocking the Potential: The Safety Framework for Residential Real Estate Investments

We were asked recently how we choose what homes to invest in. The answer was automatic: we look for safety. An important component of safety is scale: focusing on the part of the market where demand is the greatest. 

While commercial real estate has historically been the favored domain for institutional investors due to perceived scalability, the overlooked potential lies within the residential sector. 

Institutional investors have begun recognizing single-family residential properties as a distinct asset class, emphasizing their potential for generating rental income. Unlike commercial buildings, the demand for single-family homes remains robust, driven by factors such as stability, community ties, and familial considerations. This demand extends beyond mere occupancy, encompassing a desire for long-term roots and belonging within a community.

This article delves into the safety framework employed by Graceful Finance, shedding light on the factors that underpin its investment decisions and its implications for the evolving landscape of single-family residential investing.

The case for resi 

Institutions have come to call this asset class Single Family Residential, sometimes called Single Family Rental - because that’s what the investment ultimately is for: to produce rental income. 

The fundamental demand for single family homes has been stronger than commercial buildings: 

  • unlike office buildings, homes are unlikely to be left empty for significant periods of time

  • Unlike retail economic downturns don’t lead to empty homes the way vast swathes of shop can be vacated 

  • And unlike multifamily apartment buildings, there isn’t the concentration risk of there being more supply that becomes available than the natural demand of people looking to rent in that location. 

The need for a home is more than a roof over our heads: it’s a place to put down roots, often near family and friends to be part of a community. 

The three most important factors in real estate: location, location, location 

It’s why place is so dominant in the value of our homes: the same size home in a desirable school district can command multiples of a home elsewhere. 

And while location is the most important factor in determining the value of real estate, the type of property needs to be right for the demand in that area: an oversupply of 1 bedroom apartments in a family focused area would see less upward price pressure, relatively speaking. 

The combination of these factors leads to an analysis of what and where is safe to invest in residential real estate. 

Single Family Rental investors have a ‘persona’ of the families they target: typically millennials who have been priced out of buying a home with a mortgage. A growing yet stable part of the renter population. 

This approach typically leads to a very particular type of property. And limits greatly both geographic diversification and homes at higher price points. 

There’s a similar approach to commercial real estate investing: a focus on what types of companies a building is being purposed for. 

The downside of persona based real estate investing is it leads to concentrated typings and geographic clustering. And that lack of diversification doesn’t weather well in a downturn. 

And that’s the starting point for addressing the question of safety in residential real estate investing. 

Graceful Finance’s safety framework 

Graceful Finance’s risk framework is Place, Property, People, Price. 

We start with locations of fundamental demand: where people live historically and will continue to desire. We explicitly are not looking for gentrifying areas, as that risk taking isn’t where the majority of desirable stock will be in the future. 

Data for migration - who and how many people are moving to and from a location - can easily be misinterpreted. So while useful to identify short term trends, we largely discount the conversations like “everyone is leaving San Francisco”. 

More important are schools. Home prices tend to appreciate proportionately where school districts are better. 

The fundamental demand for an area can be correlated to better schools, as a useful proxy to dig deeper into the data. 

The main two points of other data are yields and the relationship between homes listed for sale vs homes actually sold. 

This last ratio is probably the most important for ‘timing the market’. These ratios moving out of their seasonal norms usually point to a market cooling or heating up. Generally speaking more listings equals more market confidence, which is counterintuitive vs more liquid markers where an oversupply of stock leads to prices falling. 

Homes are individual and have value beyond the financial. So a choice of homes doesn’t usually translate into buyer pricing power when negotiating a purchase. 

Summarised, Place is rightly the most important characteristic in finding safety. And that safety is correlated with good schools and more availability of homes for sale. 

When it comes to property, we again look at desirability: what does the majority of the local demand see as a long term home. Largely these are homes appropriately sized for families to grow in. 

In addition we have a list of reasons for not investing, for example:

  • Poor location: generally where demand has been weaker historically 

  • Yield: below target amounts. While these are likely desirable areas, a minimum yield target ensures there is balance between income and home price appreciation in the portfolio 

  • Position: near busy roads/noise or where zoning permits undesirable commercial activity like mining or refuse sites

  • Layout: odd interior layouts would typically see substantial decrease in the demand for that home, and therefore would be less readily saleable in the future

  • Environment: while extreme weather events are difficult to account for, any location with a certain risk to flooding, fire or other environmental events will be screened out. 

The People part of our framework is very simple: good credit history and good occupation history, i.e. they haven’t trashed their finances or a previous home. 

Stereotypes of older adults lead to judgements along the lines of hoarding and homes being left in a state of disrepair. 

While these stereotypes are less true for people living in more expensive homes, the family situation tends to play a role here. So we ensure family members in line to inherit are party to any agreements, to mitigate future legal and reputation issues. 

And price assesses a number of factors to ensure we do not ever overpay. 

The main pricing metric is relative yield: comparing the yield of price vs the average of homes in that area. 

We also look at price distribution in the area to ensure there is significant demand at those price points. 

Diving deeper into comparable sales and in person inspections helps double check all our automated pricing work pans out as expected. Any learning creates an improvement loop. 

The final missing piece is data: we need enough homes in the pipeline and data on those homes to populate our  Place, Property, People, Price framework.

The next evolution of Single Family Residential investing

Large scale investors in single family homes struggled over the last 18 months. 

Much of this is due to leverage. Rates are higher, loans for these long term investments were secured at short durations and are therefore coming due: estimates are $2 trillion dollars of real estate loans will need repaying or refinancing in the next three years. 

But capital or its availability has never been the limited factor for investors in this asset class: it’s all about sourcing. 

The two main sources historically have been algorithmic analysis of listings in the MLS and acquiring portfolios from banks, regulators or other parties looking for large scale disposals of real estate. 

The amount of real estate that ‘comes to market’ is dwarfed by owner occupied homes. 

But people who own their homes have liquidity needs. Younger folk can access mortgages. Those with impaired credit can access products like HEIs (Home Equity Investments). 

The largest owners of homes are older adults. And their financial needs continue to increase as we all live longer. And unfortunately when looking for finance or liquidity they have limited options: reverse mortgages and HELOCs. 

This presents an unprecedented opportunity to provide liquidity and scale into acquiring homes that are listed for sale. Essentially off-market sourcing at a scale greater than what is available on the MLS. 

According to our estimates older adults with $90bn of home equity are looking for liquidity each year. 

Putting it all together

Safety serves as a guiding principle for informed decision-making. Through a nuanced understanding of market dynamics and a comprehensive risk framework, institutional investors can mitigate potential pitfalls. Graceful Finance's prudent approach offers a roadmap for scale in single-family residential investing.

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