Single Family Rental Homes: Asset Class with 8.5% Historical Returns

How about this housing market? A few weeks ago, the CEO of Redfin shared a viral Twitter thread about what he was seeing. Here’s just a snippet:

It has been hard to convey, through anecdotes or data, how bizarre the U.S. housing market has become. For example, a Bethesda, Maryland homebuyer working with @Redfin included in her written offer a pledge to name her first-born child after the seller. She lost.

Inventory is down 37% year over year to a record low. The typical home sells in 17 days, a record low. Home prices are up a record amount, 24% year over year, to a record high. And still homes sell on average for 1.7% higher than the asking price, another record.

What about single-family homes as an investment asset class? Larry Swedroe points to a recent academic study about the historical total returns of single family rentals. Here are some highlights from the paper:

The study covers the nearly 30-year period from 1986 to 2014, including zip codes across the largest 15 US metro areas.
Total return is broken down into two components: rental income (net of expenses) and house price appreciation, similar to stocks and indexes like the S&P 500.
Across all cities, the total returns were approximately the same: 8.5% total annualized return. On average, this broke down to 4.2% rental income + 4.3% price appreciation.
In higher-priced cities, the total returns were composed of lower rental yields but higher price appreciation.
In lower-priced cities, the total returns were composed of higher rental yields but lower price appreciation.
On average, they found that net rental income is about 60% of gross rental income. In other words, for every $1,000 of gross rent, $400 was eaten up by operating expenses like maintenance, repairs, property taxes, etc.
Single family rentals represent 35% of all rented housing units in the US, and have a market value of approximately $2.3 trillion.

According to Swedroe, during the same period the S&P 500 returned 10.7% annualized but with more volatility.

I definitely acknowledge rental properties are the way that many people have built wealth. As individuals can combine cheap leverage from government-subsidized mortgages along with that 8.5% annualized return, that definitely helps make it an even more an attractive option.

I’ve thought about purchasing a rental property (or four) as well, but I’ve always ended up using my time and life energy in other ways. In the end, I look at managing rental properties as more similar to running your own business than passive income. If you have the right personality and skillset, then managing rental properties is a great business and a great way to build wealth in terms of return on invested time. But for me, I’d much rather work on online businesses, what I call “digital real estate”. With excess cash from work, I would rather invest in completely passive shares of businesses (stocks) and REITs which require zero ongoing work. When I am fully retired, the dividend checks will simply show up in my brokerage account. I don’t need to screen tenants, hassle them about late rent, argue about security deposits, or worry about evicting a family on hard times.

What about simply buying an REIT that owns single-family rentals? It appears the two biggest are Invitation Homes (INVH) with 80,000 single-family homes and American Homes 4 Rent (AMH) with 50,000 single-family homes. As you might expect, their recent returns have also been quite hot. The 5-year average return for AMH is 17.45%, per Morningstar, but it’s too young to have a 10-year return history. However, the current forward dividend yield of is 1.80% for INVH and 1.02% for AMH, which isn’t terribly exciting.

Here’s a 5-year historical performance chart of American Homes 4 Rent alongside some other residential REITs and the S&P 500, from YCharts. Buying a specific REIT can result in a bumpy ride.

Single Family Rental Homes: Asset Class with 8.5% Historical Returns

Now, if you own the Vanguard Real Estate ETF (VNQ), you’ll find that 14% of its portfolio is invested in residential REITs. This includes apartments, student housing, manufactured homes, and single-family homes. INVH is about 1.2% and AMH is about 0.65% portfolio weight in VNQ. The mutual fund version of VNQ is VGSLX, and has a 10.5% annualized average return since inception in 2001. That’s not too bad, either, and I’ve been pretty satisfied with my VNQ holding.

But again, single-family real estate is one of the original “side hustles” that helped folks build their own wealth over time. Sometimes, I wonder if I should work on building the required skills and knowledge base, just to keep my future options open and have something to teach my children.

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Single Family Rental Homes: Asset Class with 8.5% Historical Returns from My Money Blog.