Q2 2020 Single-Family Rental Investment Trends Report
State of the Market
When it comes to residential real estate or the economy more broadly, the slowdown persists with emerging collateral consequences. However, key differences signal that some product types will return to pre-pandemic levels of momentum more quickly than others. Based on pricing in public equity markets, migration patterns, and measures of asset pricing, single-family rentals (SFRs) are attracting attention as a rising subsector of residential real estate. (Chandan Economics defines SFRs as properties containing less than five units for all performance metrics data and as one-unit properties for all SFR construction starts data.)
Multifamily has fared much better than other asset classes, such as the hospitality, retail and office sectors. Yet, COVID-19 and the recession have also affected housing. Based on data compiled by the National Association of Real Estate Investment Trusts (NAREIT), equity apartment REITs declined an average of 23.0% year-to-date, by the end of July. However, when narrowing in on REITs that own and operate single-family rentals over the same period, returns skew far more positively. The two largest REITs in the sector, Invitation Homes and American Homes 4 Rent, are up 1.2% and 12.0%, respectively. These trends suggest an added bonus for the SFR niche, protected from some of the deceleration in the residential sector.
“On the ground” performance metrics across the residential sector are mixed. Rent growth, as measured by both DBRS Morningstar and CoreLogic, is starting to slow. This could signal that while the sector has a favorable balance of prospects, it is not immune from at least some downside pressure. Occupancies, however, have strengthened considerably during the second quarter, according to a Chandan Economics analysis of Census Bureau data.
The growing acceptability and adoption of working from home are framing housing decisions across the board, boosting demand for exurban housing options. However, as many of the accommodative features in the CARES Act expire, the likelihood of increasing tenant issues in the coming months remains high. Yet, all else equal, while the single-family rental sector will also see coronavirus-related challenges, as a residential product type, it is somewhat insulated over the medium term.
Occupancy rates across all single-family rentals, as measured by the Census Bureau, averaged 95.3% in the second quarter of 2020, spiking by 100 bps from the first quarter (Chart 1). The latest estimate is the highest reading for the SFR market since 1994 and is the largest single-quarter jump since the beginning of 2016. From its 2007 low, occupancy rates for all SFR properties are up by 5.6%.
Entering 2020, SFR was riding a wave of momentous growth. As COVID-19’s economic contagion grew to a critical mass, it was unclear whether the sector’s bull run would either strengthen or veer off course. On the one hand, droves of urban households moved to more spacious, suburban housing options, boosting aggregate demand for single-family housing. On the other hand, memories of the not too distant Great Recession still led to some jitters in the housing market. With the virtue of hindsight, it is now apparent that single-family rentals are a rare net-beneficiary of the downturn.
As the country started to reopen during the spring months, sales and leasing activity rose to meet underlying demand, supporting both pricing and limiting vacancies. The continued strength of the U.S. housing market may also be putting downward pressure on vacancies, as SFR property owners might use the opportunity to sell into a hot market, pruning available rental supply.
Cap Rates & Prices
While the emergence of purpose-built communities is starting to help the sector achieve some degree of price independence, SFRs, by and large, still operate within the broader context of the U.S. single-family housing market. According to the Federal Housing Finance Agency (FHFA) All-Transaction Home Price Index, property prices increased by 5.0% in the first quarter of 2020 (Chart 2).
While prices are continuing to rise, they are doing so at a slowing rate. While conventional wisdom is shifting daily, industry expectations are bullish on single-family home prices as post-pandemic preferences take hold. COVID-19 is acting as a catalyst, leading urban households to prefer larger housing options outside of city centers, boosting demand for single-family housing options. SFR’s ability to meet this demand, while accommodating social distancing with a desirable alternative, makes itself a durable market in the years ahead.
Cap rates on SFR properties peaked at 11.0% as home prices bottomed out in 2012 (Chart 3). The formalization of the SFR sector in the intervening few years has meant greater cap rate stability. Generally, national SFR cap rates have hovered between 6.0% and 8.0% for the past six years. SFR cap rates ticked up to 6.7% in the second quarter of 2020, up five bps from the prior quarter, and up 16 bps from a year earlier.
The difference between cap rates on SFR and multifamily properties, as well as Treasury yields, provides a measure of how risky investors view the sector. As a result of COVID-19, global investors are engaging in a “flight to safety,” driving up prices and decreasing yields on low-risk investments. In turn, Treasury yields have cratered, reaching all-time lows. The spread between SFR cap rates and the 10-year Treasury note jumped to 6.0% in the second quarter of 2020 — the widest risk premium since early 2013 (Chart 4). Spreads between SFR and multifamily cap rates remained unchanged at 1.3% in the second quarter, signaling that all residential subsectors are absorbing similar effects.
According to DBRS Morningstar, through April, SFR rents were up 3.6% on lease renewals and 4.0% in properties that have transitioned from vacant to occupied (Chart 5). Price growth in rent renewals, which tends to see far less seasonal variability, has slowed since last May when annual rent growth peaked at 5.0%.
Newly signed leases in SFR properties that were previously vacant tend to outperform renewals during the summer months when housing demand is highest and underperform during the winter months. These data, of course, do not yet reflect the full extent of the pandemic. Markets dependent on tourism will continue to feel more of a downside housing shock than others, leading to local rent growth softness. At the same time, inventory constrained exurbs adjacent to major metros are likely to benefit from proximity and supply and demand imbalances, supporting pricing pressures.
Loan-to-value ratios (LTVs) on SFR mortgages rose 190 bps in the second quarter of 2020, settling at 66.1% (Chart 6). The increase is the biggest quarter-over-quarter jump since late 2014. Still, the reading is below cyclical highs observed in late 2017. Generally, recessions tend to have oppositional effects in credit markets, where increasingly attractive debt terms coexist with tightening lending standards.
Rising LTVs would seem to counter this intuition, though there are likely a few factors influencing the data. The first is that pricing expectations remain upbeat for single-family assets. Lenders do not need to work with greater equity cushions if the underlying asset value is unlikely to come under downside pressures. The other factor that may be influencing the data is the prevalence of refinancing activity.
Interest rates have fallen appreciably in recent months, creating a strong incentive for existing property owners to restructure their capital stacks and lower their debt servicing costs. Assets obtaining this type of financing are typically already stabilized and well performing. An abundance of these refinancing transactions may be skewing observed LTVs higher.
Debt yields fell 17 bps between the first and second quarters, averaging at 10.6%. The reading falls closely in line with the average set across 2019 of 10.5% (Chart 7). The inverse of debt yields, debt encumbrance per dollar of NOI, rose by 15 cents in the second quarter to $9.40 (Chart 8). These trends suggest that appetites for credit risk have largely gone unaffected in the SFR market due to the pandemic.
During the housing crisis, investors with available financing took advantage of the opportunity to acquire large portfolios of single-family assets at steep discounts. Mortgage default rates soared to 8.1%, and an abundance of buyers began seeding the SFR sector as we know it today (Chart 9).
In the first quarter of 2020, default rates remained unchanged at 1.8%. There remains some concern that mortgage defaults still may rise appreciably due to COVID-19, though such developments have not yet materialized. Under the CARES Act, Congress extended relief by introducing mortgage forbearance and a moratorium on evictions for single-family homeowners with federally backed mortgages. Consequently, a wave of defaults was kept at bay, and price declines were moderate. Further, the presence of and competition among SFR investors is a demand backstop that should also support valuations and limit the number of foreclosures. Certainly, there will be an increase in distressed sales due to the pandemic’s continued economic disruption. But forced sellers will at least be able to sell into a fully priced market, preserving accrued equity and household wealth.
Build-to-rent strategies continue to become a defining feature of the SFR sector. In addition to better aligning supply with the demand, builders and operators realize the advantages of purpose-built, single-family communities. These developments are often able to replicate amenity packages that one might find in a Class A multifamily property, all from the spacious seclusion of the suburbs.
As the maturation of millennial cohorts continues to support household formations, access to quality public schools will become a higher priority in the housing choice equation. Furthermore, pandemic induced shifts in consumer priorities and daily work commuting patterns should also act as an independent wind in the product type’s sails.
Based on an analysis of Census Bureau data, between 1975 and the start of the 2007 recession, SFRs accounted for a little less than 1.6% of all single-family construction (Chart 10). SFR’s share of single-family starts has since soared. In 2013, SFR’s construction share approached 5.0%, and today it remains elevated at 3.6%. SFR construction starts totaled 40,000 units through the 12 months ending in first-quarter 2020, down 5,000 from the post-recession high set in the third quarter of 2018 (Chart 11).
Tracking Future Demand
Utilizing Google Trends, we used the search engine as a proxy to measure existing and future hotspots of SFR demand. Using the search term “homes for rent” as an input, metropolitan areas in the Southeast dominate the list. The search term was most popular in Albany, Georgia, making it the second quarter in a row where a Georgia suburb stood at the top of the list (Table 1).
Metro areas in Florida, both of the Carolinas and Tennessee also appeared in the top 10, making the region the country’s unquestioned SFR epicenter. Two California metropolitan statistical areas (MSAs), Sacramento and Fresno, were also high on the list. Given the Golden State’s density of urban areas, it stands to reason that adjacent exurbs would absorb a large share of the rental demand fleeing cities due to COVID-19.
To track which parts of the country might expect to see new demand form in the coming months, we measured the popularity of the search term, over the first and second quarters of 2020, noting where the biggest jumps occur. Dayton, Ohio, led the way, jumping 71 spots to land at number 30 on the list. Boise, Idaho, Honolulu, Hawaii, and Spokane, Washington, were other metro areas seeing relatively large jumps in the search term’s popularity (Table 2).