Firms bet big on rent houses

Merger aims to use economies of scale to keep prof­its flow­ing

The Dallas Morning News - - BUSINESS - Heather Perl­berg, Bloomberg News

It was a sim­ple phone call be­tween two real es­tate bil­lion­aires that led to the for­ma­tion of a be­he­moth in the house-rental in­dus­try.

Barry Stern­licht, a prop­erty in­vestor, called Jon Gray, head of real es­tate for Black­stone Group LP, in the spring to pro­pose a com­bi­na­tion of Star­wood Way­point Homes, of which Stern­licht is chair­man, and In­vi­ta­tion Homes Inc., ma­jor­ity-owned by Black­stone. The com­pa­nies an­nounced the $4.3 bil­lion merger Thurs­day af­ter months

sort­ing out the de­tails, cre­at­ing a com­pany that will be the largest U.S. sin­gle-fam­ily land­lord, with 82,000 homes across the coun­try.

The move fur­ther con­sol­i­dates the still-young in­dus­try for cor­po­rate own­er­ship of house rentals, leav­ing two large pub­lic com­pa­nies. Pri­vate eq­uity firms and hedge funds, led by Black­stone, spent hun­dreds of mil­lions of dol­lars a month in the af­ter­math of the hous­ing cri­sis to buy homes at dis­tressed prices, build­ing busi­nesses that were even­tu­ally big enough to go pub­lic. Now, with prop­erty val­ues soar­ing and fore­clo­sures slow­ing to a trickle, land­lords are com­bin­ing to gain scale and hone their op­er­a­tions.

“This merger gives the in­dus­try more cred­i­bil­ity now that there’s a more than $10 bil­lion com­pany, big­ger than some apart­ment real es­tate in­vest­ment trusts,” said Jade Rah­mani, an an­a­lyst at Keefe, Bruyette & Woods Inc. “It makes it a more in­vestable sec­tor with con­sis­tent re­turns.”

Shares of Star­wood Way­point rose 24 cents to $35.59 Fri­day, while In­vi­ta­tion Homes rose 19 cents to $21.92. Black­stone’s 70 per­cent stake in In­vi­ta­tion Homes will be re­duced to 41 per­cent of the com­bined com­pany, ac­cord­ing to the firm.

Bets pay­ing off

In form­ing the new real es­tate as­set class, Wall Street was bet­ting on un­prece­dented de­mand for rentals from peo­ple who lost res­i­dences to fore­clo­sure or were un­able to get mort­gages as banks tight­ened lend­ing stan­dards. To­gether, the pri­vate eq­uity firms and hedge funds in­sti­tu­tion­al­ized a busi­ness tra­di­tion­ally run by mom-and-pop in­vestors and gave Amer­ica a new way to think about rental hous­ing, with stan­dard­ized ren­o­va­tions, call cen­ters and tech­nol­ogy that sim­pli­fies pro­cesses for ten­ants.

So far, their bets have paid off. In­vi­ta­tion Homes, al­ready the largest com­pany in the in­dus­try, had a $1.8 bil­lion ini­tial pub­lic of­fer­ing in Jan­uary, and its shares are up more than 8 per­cent since. Amer­i­can Homes 4 Rent, the sec­ond-big­gest house-rental land­lord, has gained al­most 40 per­cent since its 2013 IPO.

Yet the com­pa­nies have had to adapt as the hous­ing mar­ket sta­bi­lizes. In the last cou­ple of years, In­vi­ta­tion Homes has made more tar­geted ac­qui­si­tions and sold prop­er­ties that no longer fit its busi­ness model. Star­wood has grown by merg­ing with Way­point Real Es­tate Group and then Tom Bar­rack’s Colony Amer­i­can Homes. Amer­i­can Homes 4 Rent has turned its eyes to ac­quir­ing land and build­ing new homes strictly to rent.

“The easy money has been made,” said Carl Bell, an early in­vestor in the sin­gle-fam­ily rental in­dus­try and co-head of in­vest­ments at Wash­ing­ton­based In­vic­tus Cap­i­tal Part­ners. “From here it’s about op­er­a­tional and fi­nanc­ing ef­fi­ciency to help drive re­turns. Scale is key.”

In­vi­ta­tion Homes and Star­wood Way­point say their trans­ac­tion is ex­pected to cre­ate an­nual sav­ings of $45 mil­lion to $50 mil­lion. The new com­pany, which will keep the In­vi­ta­tion Homes name and will be based in Dal­las, will have about 5,000 homes in each of its mar­kets and an 83 per­cent over­lap, with a con­cen­tra­tion in places such as South­ern Cal­i­for­nia, Phoenix and South Florida. That’s nec­es­sary when tak­ing into ac­count the costs as­so­ci­ated with man­ag­ing scat­tered site prop­er­ties.

Those added ex­penses have driven some smaller in­vestors, such as Ax­onic Prop­er­ties LLC, out of the busi­ness. That firm is sell­ing its houses, mostly to first-time home­buy­ers, and buy­ing apart­ments in Florida.

“The only way the sin­gle­fam­ily-home busi­ness works long term is if op­er­a­tors have mas­sive ef­fi­cien­cies of scale,” said Jonathan Shecht­man, man­ag­ing prin­ci­pal at Ax­onic. “Oth­er­wise, the costs of things like re­pairs and main­te­nance on houses, which each have a dif­fer­ent floor plan, may have higher ex­penses when com­pared to apart­ments.”

In­ter­est rate threat

The big­gest threat to the sin­gle-fam­ily land­lords is ris­ing in­ter­est rates, said Rah­mani of Keefe Bruyette. If in­ter­est rates surge and rent in­creases fail to keep up, re­turns would com­press, he said.

Home­builders are also in­creas­ingly tar­get­ing en­try-level buy­ers in some of the same mar­kets where these large rental firms op­er­ate. Fort Worth-based D.R. Hor­ton Inc., the largest U.S. home­builder, is see­ing growth in its Ex­press brand, aimed at peo­ple in their 20s and 30s, the big­gest gen­er­a­tion of buy­ers. A ma­jor loos­en­ing of credit could have a larger im­pact on the firms as more renters than ex­pected turn into buy­ers.

That doesn’t seem to be play­ing out yet. Star­wood Way­point’s chief ex­ec­u­tive, Fred Tuomi, who will lead the com­bined com­pany, said on a con­fer­ence call Thurs­day that rental de­mand is even stronger than it was five years ago, when he first got in­volved with the land­lord.

“We have a tremen­dous ad­van­tage of cost of cap­i­tal as well as our scale,” he said. “We’re po­si­tioned to win for the long term.”

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