As 2012 was coming to a close, American Residential Properties (ARP), a Scottsdale, Ariz.–based REIT, paid $28 million to acquire 196 single-family investment properties in Chicagoland from MACK Companies, a Tinsley Park, Ill.–based company that is Chicago’s largest redeveloper and owner in this asset class.
MACK will continue to manage these properties. It will also supply ARP with between 30 and 50 properties per month over the next two to three years. James McClelland, MACK’s president and CEO, said in a prepared statement that his company’s deal with ARP was the largest transaction of performing (i.e., redeveloped and leased) single-family rentals in the U.S. that year.
McClelland spoke with Builder on Thursday about his 36-year career. He started out as a real estate salesperson and broker, and then got into building planned-unit developments that included $350,000 homes and light-industrial components. About 15 years ago, a local community bank approached McClelland about taking a foreclosed home off of its hands. He renovated that home and sold it within three months, compared to the nine months it took to build and sell a new home. Something clicked in his mind that maybe this was a market segment he could exploit.
The demand for rental properties has been growing ever since, especially during the recent housing and economic recessions, when financing for homeownership became more difficult to obtain and the job market was soft.
In its December 2012 MarketPulse report, CoreLogic reported that rental income from residential properties was up 12% between September 2011 and September 2012 to $470 billion. However, after a five-year period of accelerating growth, the rise in single-family rental income began to moderate last year.
MACK’s business strategy aims at long-term appreciation: buy houses in areas that are likely to produce the best returns, and hold onto those properties until market conditions are right. Chicago is perfect for this strategy because its housing and rents are relatively low-priced compared to other big metros in the U.S.
MACK typically purchases a property for between $50,000 and $60,000, and spends, on average, $40,000 in renovations. The houses are usually around 1,700 square feet with four bedrooms and two bathrooms. McClelland notes that rents in Chicago range from $1,500 to $1,700, so that cash flow “means you really can’t be into a property for more than $100,000” and expect to be profitable.
MACK expects to convert and sell 500 units in 2013 and up to 1,000 in 2014. Before the ARP deal it had about 600 rental units in its portfolio, and McClelland says there’s no chance that his company will run out of inventory any time soon. (He’s buying 50 homes per month, on average.)
However, he’s concerned that institutional investors, which have become enamored of the rental arena lately, could be killing the goose that laid the golden egg.
Blame this investor ardor on Warren Bufffett, who a few years ago said he liked the single-family rental market but couldn’t get his arms around managing the assets. In a widely read report, Morgan Stanley analyst Oliver Chang urged institutions to jump into this fray, and identified MACK as one of the leading suppliers.
Fourteen investment groups approached McClelland. “But they were not realistic; they wanted to grow faster than the asset class would allow.” McClelland is particularly perplexed about the enormous cash outlays that institutional investors such as Blackstone and Colony Capital have been making to purchase foreclosed homes and convert them to rentals. “What they are doing is not sustainable, and they are out of their freakin’ minds. All they want is yield, and isn’t that what got this industry into trouble in the first place?”
Even Chang—who recently started his own company, Sylvan Road Capital, to buy foreclosed homes using $20 million from The Carlyle Group—now sings a different song about the rental market’s potential. “There is currently more hype surrounding this investment than substance,” he wrote recently. “There seems to be more news articles, research reports, conference panels, and press announcements than there are actual investments in actual houses.”
Of all the investor groups he’s spoken with, McClelland says ARP is one of the few that “gets it,” in terms of understanding how an investment strategy for single-family rental needs to be scaled to market demand. Steve Schmitz, ARP’s chief executive, said his company likes the fact that MACK “cherry picks” properties it buys, and expected to see “positive returns on our investment immediately … [and] for the foreseeable future. This is a strategy we expect to repeat with MACK on an ongoing basis.”
McClelland says his company offers renters a lease-to-buy option, but few renters actually make the transition to owner. “You’re talking about millions of people out there who need to rent” because of their employment, financial, or lifestyle circumstances.
That being said, McClelland is optimistic about his company’s new-home construction division, which builds a couple dozen infill single-family homes annually. He tells Builder his company is currently negotiating a deal for a subdivision that could accelerate MACK’s construction this year to 150 units. “I think the housing market in 2013 is ready to go,” he says.
John Caulfield is senior editor for Builder magazine.