Do Not Be Afraid of the Big Bad REIT

Written by Victor Jernigan

Do not be afraid of the “big money” getting into the single family rental market. Instead, every real estate investor can benefit by understanding the buying parameters used by the Real Estate Investment Trusts (REITs) and Hedge Funds now buying single family homes across America. These giant funds, once they commit to a market area, must meet their publicly stated objectives for total number of homes purchased and average rates of return. For the individual investor, regardless of experience, this is like a game of cards where the other player shows you his hand.

Each REIT and Hedge Fund has strict buying standards that severely limit the type and price of house it can purchase. Fortunately, the agents, representing these “big money” buyers, will provide you with the exact criteria they are using for your market. You can find one of the buying agents by just calling random agents and property management companies if they know anyone buying for a large investment group. This information spreads quickly among agents. With this information, it is easy to establish a price range these big money buyers will pay for a specific property. Therefore, every investor that wants to assign, wholesale or flip a single family house should look to these buying standards as an investor’s guide to making money.

These funds are buying homes for long term rental, generally 5 years. Typically, they want to buy newer homes, usually less than 20 years old that will only need limited repairs. They are not going to manage total remodels. They want a home that is ready to rent. What is critical is that the monthly rental number will establish the de facto minimum market value for whatever type of home meets their buying standard. The concept of After Repaired Value means nothing to these “big money” buyers. They may use comps and Zillow but their entire focus is the rental income and anticipation of the future value.

Criteria commonly used by these funds are for the annual purchase of at least 300 – 600 houses within a specific trade area and each house having a minimum of 3 BR, 2 BA, and 1 car garage. Each house purchased will need a monthly rental income to provide a minimum annual return of 6% (about 4% over 10 year T Bills) after anticipated expenses. These funds plan for a small repair reserve and anticipate a vacancy rate under 5%. The only real variable is the anticipated monthly rental income. Because these funds use all cash and the value is determined by the anticipated rental income stream (the current market value is only a consideration), they can and often do close without appraisals.

As a simple example, if a house is listed at $135,000 and you are confident the market rent is $1,000 per month; the funds will most likely calculate the monthly net rental to be $680. This is based on a monthly management fee of 7% ($70), maintenance reserve 0.5% ($50), taxes and insurance (combined) at 10% ($100), landscaping 0.5% ($50) and annual vacancy of 5% ($50). In broad numbers if the annual income (NOI) is $8,160 and the desired return (Cap Rate) is 6% the fund will pay as much as $136,000 in a competitive situation. Even if you cannot get a copy of the funds’ specific proforma, it is easy to estimate their expenses. You should know the market rents for your area and you can easily calculate the exact tax and insurance rate. You can confirm your own estimates by searching public records for properties they have already purchased.

Although finding properties for and selling to these “big money” buyers will be a business model for at least the next 24 months, the best opportunities may be just outside of their buying standards

About the author

Victor Jernigan