SFR Strategy utilizing Section 8 Vouchers Exclusively

I've been in talks with a firm (4 years old) that has raised a couple of smaller closed-ended funds ($15MM and $25MM) and deployed into SFR for rent with Section 8 vouchers.  They have invested in only 2 markets thus far (both rust belt major metros) with about 1000 homes under management.  12-13% cash on cash average, with expected 5-7 year IRRs in the high teens/low 20s.  

I guess the SFR with the voucher is a bit of a twist compared to firms strictly doing SFR, I am trying to poke some holes in their business strategy and outside of achieving real scale and dealing with the typical pitfalls of being a section 8 LL, is there anything else I should be cognizant of in terms of what types of cons come with the business strategy?

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Comments (39)

  • Developer in RE - Comm
May 4, 2022 - 4:14pm

Love Section 8. Highest CoC (Cash on Crack)

May 4, 2022 - 4:29pm
devrc, what's your opinion? Comment below:

There can be some major downsides (overall property safety goes down, drugs, lots of property damage) so I tend to stay away. However, I do actually have a few Section 8 tenants mixed in with my market rate tenants. Section 8 tenants usually don't treat their units well but, I have negotiated major rent increases (with the government) without having to renovate the units.

I have also toured a few 100% section 8 deals in a decent area of Phoenix surrounded by renovated market rate units. Many of the tenants were clearly on drugs, there was paraphernalia everywhere, even a bullet hole.

  • Associate 3 in RE - Comm
May 5, 2022 - 10:25am

I have also toured a few 100% section 8 deals in a decent area of Phoenix surrounded by renovated market rate units. Many of the tenants were clearly on drugs, there was paraphernalia everywhere, even a bullet hole.

LMAO. The RE investors putting these units into middle class, owner-occupied neighborhoods are the social equivalent of cancer.

May 4, 2022 - 4:18pm
Ozymandia, what's your opinion? Comment below:
egold70

I've been in talks with a firm (4 years old) that has raised a couple of smaller closed-ended funds ($15MM and $25MM) and deployed into SFR for rent with Section 8 vouchers.  They have invested in only 2 markets thus far (both rust belt major metros) with about 1000 homes under management.  12-13% cash on cash average, with expected 5-7 year IRRs in the high teens/low 20s.  

Just the headache of that number of transactions.  Even tenant vouchers are pretty sticky.

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  • Investment Analyst in PE - Other
May 5, 2022 - 5:04am

Hah, think I spoke with this same firm months ago, were looking for us to give them LP money. Let me check back to my notes see if there were any red flags I noted.

May 7, 2022 - 2:25pm
egold70, what's your opinion? Comment below:

I'm curious though, what's the biggest PRO to this strategy?  Is it the concept that given the demand/waiting list for vouchers, once a well-screened tenant moves in, they are likely sticky and therefore turnover costs/vacancy is much less likely than a typical market rate SFR or apartment unit?  And of course, the portion of rent being paid for by government has essentially a 0% default rate?

I keep hearing that depending on how you negotiate the rent, it can actually be HIGHER than the comparable market rent, therefore you'd be getting an arbitrage relative to market?  I would think that this would be a major selling point?  At least during the hold period, instead of getting let's say a 5% cash on cash average, you could get a higher voucher rent and maybe bump that to 6 or 7%?  

On exit, aren't you essentially just selling these SFRs either to owner-occupied buyers or other investors, hoping that the appreciation/improvement of the neighborhood allows for a residual value that drives the IRR?

May 10, 2022 - 9:20am
Ozymandia, what's your opinion? Comment below:
egold70

I'm curious though, what's the biggest PRO to this strategy?  Is it the concept that given the demand/waiting list for vouchers, once a well-screened tenant moves in, they are likely sticky and therefore turnover costs/vacancy is much less likely than a typical market rate SFR or apartment unit?  And of course, the portion of rent being paid for by government has essentially a 0% default rate?

Pretty much.  No credit risk on the tenant.  Essentially no collection risk.  Sticky tenancies.  Market or above-market rents.  It's like asking why you'd rent your retail space to a CVS instead of some New Age Aromatherapy Apothecary.

I keep hearing that depending on how you negotiate the rent, it can actually be HIGHER than the comparable market rent, therefore you'd be getting an arbitrage relative to market?  I would think that this would be a major selling point?  At least during the hold period, instead of getting let's say a 5% cash on cash average, you could get a higher voucher rent and maybe bump that to 6 or 7%?  

It is slightly more complicated than that, but yes.  I'm more familiar with Project-Based contracts, so I'll let someone who knows more about the tenant based side of things chime in.

The flip side is that you actually have to put work into units to achieve those rents; "post-rehab" rents require some proof that the "rehab" portion was actually done.  Slapping a coat of paint on it won't cut it.

On exit, aren't you essentially just selling these SFRs either to owner-occupied buyers or other investors, hoping that the appreciation/improvement of the neighborhood allows for a residual value that drives the IRR?

I mean.... how is this different from any other real estate investment?  It's highly unlikely a tenant will buy - if they have the money for a home, they probably won't qualify for their voucher anymore.  On the other hand, they can leave or not have a lease renewed and you can sell to a "normal" home buyer.  As far as an exit goes it is no different from any other single family home, because the Section 8 voucher isn't actually associated with the underlying home but with the tenants who live there.  Once they go, it's just another piece of property.

May 10, 2022 - 9:20am
T30Alumnus, what's your opinion? Comment below:

In this thread Ozymandia tells us that section 8 residents are actually safer than normal, hard working taxpayers, that they treat the units the same, and that it's good to tell towns to go eff themselves when the feds want to put their "clients" in nice areas. I hope your daughter Susie goes to school with these human orcs. 

May 10, 2022 - 9:22am
Ozymandia, what's your opinion? Comment below:
T30Alumnus

In this thread Ozymandia tells us that section 8 residents are actually safer than normal, hard working taxpayers, that they treat the units the same, and that it's good to tell towns to go eff themselves when the feds want to put their "clients" in nice areas. I hope your daughter Susie goes to school with these human orcs. 

Bigots aren't known for their reading comprehension, so I'm not surprised this was your, ah, "interpretation".  Or perhaps fantasy is a better word.

Takes a real shit head to hear someone say "people are people, some suck and some don't" and think "that is a really objectionable opinion"

May 10, 2022 - 9:23am
T30Alumnus, what's your opinion? Comment below:

"People are people. Microwaves are microwaves, even when one is a defective line with a 1/100 chance of exploding during use and deadly injury has been caused."  Fuck your tenants. You're nothing better than a carnival barker and a pimp, putting gross people no one wants in the 'burbs after these innocent people escaped ghetto trash the first time around from the 50s-80s. You're a monster 

Most Helpful
May 11, 2022 - 1:45pm
Terran, what's your opinion? Comment below:

A couple risks that I can think of:

1). Housing choice vouchers aren't tied to the property, so there's a chance tenants leave and take the voucher with them. It's less likely with SFRs because of the high demand, but it's still possible.

2). Maintenance and utilities can be an issue since you don't have the same economies of scale as you do with multifamily properties. A single building housing 30 units can better absorb the cost of a roof replacement.

3). Rental payment risk isn't completely zero. Typically tenants pay up to 30% of their income and the voucher pays the rest. Mismanagement can lead to a buildup of accounts receivables that end up being written off. You can have delays in receiving voucher payments if you fail inspections or for some other reason while debt service is due on time every month.

4). Exit options aren't as flexible. As others have pointed out, you have a smaller market of potential buyers.

5). Lenders likely won't underwrite the excess income generated by vouchers, so debt proceeds will be constrained by DSCR.

May 11, 2022 - 4:00pm
Ozymandia, what's your opinion? Comment below:
Terran

A couple risks that I can think of:

1). Housing choice vouchers aren't tied to the property, so there's a chance tenants leave and take the voucher with them. It's less likely with SFRs because of the high demand, but it's still possible.

They're actually really sticky.  Well, voucher tenants in MF properties are.  I would imagine it's the same trend in SFR.

4). Exit options aren't as flexible. As others have pointed out, you have a smaller market of potential buyers.

Why?

People keep asserting this like gospel without defending the position (also much like the Gospel!).  Why should the exit be any more constrained than any other single family property?  As you point out, the voucher isn't attached to the home, so there is no actual reason that you don't have the same universe of buyers as your neighbor who rents their unit on the market.

May 11, 2022 - 7:03pm
Terran, what's your opinion? Comment below:

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