Single-Family Rental Investment Trends Report Q1 2024

Single-Family Rental Investment Trends Report Q1 2024

SFR Construction Starts Soar to a New High as Cap Rates Jump

Key Findings

  • SFR/BTR construction starts reached a record high of 75,000 in 2023, signaling a surge in development.
  • Renewal rent growth remains strong while new leases revert to seasonal patterns.

  • Cap rates jumped to 6.3% as the benchmark interest rate remained elevated.

State of the Market

While high benchmark interest rates have impacted all commercial property types, the single-family rental (SFR) sector continues to fare better than most, with home prices remaining resilient and delinquency rates holding at rock-bottom levels.

SFR construction has been the sector’s greatest strength as affordable access to homeownership has decreased substantially over the last few years. According to data from the Atlanta Federal Reserve Bank, buying a home is about 37% less affordable today than it was at the onset of the pandemic. As a result, developers are leaning into build-to-rent (BTR) projects, driving the number of SFR/BTR construction starts to an all-time high.

A combination of high barriers to homeownership and the addition of more purpose-built SFR communities has led to an increase in lifestyle renters. Compared to existing SFR households, new renters entering the sector are younger, less likely to have started a family, and earn an average of $11,000 more per year.

Performance Metrics

CMBS Issuance

Following a historic run of investment over the previous two years, SFR issuance in the commercial mortgage-backed security (CMBS) market slowed during 2023. According to Finsight, SFR CMBS issuance totaled $713 million in the fourth quarter of 2023 — sliding back down from the $1.0 billion recorded in the prior quarter (Chart 1).

Issuance totaled $2.8 billion for the entire year — the lowest annual sum on record since 2013. While CMBS activity is unlikely to return to 2021 levels in the near future, forecasts indicate that 2024 will be a more active year. Credit rating agency KBRA projects that market-wide CMBS issuance will improve by 23.6% in the year ahead.

Originations by Purpose

Driven primarily by the interest rate environment and a lack of demand for refinancings, new acquisition loans have emerged as the primary purpose for SFR originations in recent quarters. According to Fannie Mae, new loans intended for purchasing accounted for a majority (59.7%) of SFR lending activity in 2022 for the first time since 2018 (Chart 2). Through the third quarter of 2023, the purchasing share of originations has continued to soar, rising to 77.3% — the highest share on record going back to 1999. Meanwhile, rate-and-term refinancing loans, which accounted for 47.3% of originations as recently as 2020, account for just 6.1% of 2023’s lending activity.

According to an analysis of Fannie Mae data, the dollar volume of rate-and-term refinancings fell by 85.7% during the 12 months ending in September 2023 compared to the prior 12 months (Chart 3). Cash-out refinancings also dropped by 79.5%. Meanwhile, investor single-family purchases fell by 43.6%. The slide in SFR purchasing activity has been proportional to declines observed throughout the rest of the housing market. Single-family home purchases by first-time and non-first-time homebuyers fell by 39.0% and 35.5%, respectively.

Occupancy

Occupancy rates across all SFR property types averaged 94.4% in the fourth quarter of 2023, remaining unchanged from the previous quarter, according to U.S. Census Bureau data (Chart 4). DBRS Morningstar reported a similar SFR vacancy rate of 92.8% in November 2023.

Rent Growth

According to data from DBRS Morningstar, vacant-to-occupied (V2O) annual rent growth resumed a pattern of seasonality that was commonplace before the pandemic. Through October 2023, V2O rents are up just 0.7% from a year earlier (Chart 5). With V2O rent growth having now slid for five consecutive months, its recent performance matches the 2015-2019 trend in which price pressures peak in the early summer and reach a bottom in the early winter.

Meanwhile, annual rent growth of SFR lease renewals has gradually decelerated from record highs. After renewal rent growth peaked at 7.9% in July 2022, the pace of its increase has slowed in 11 of the last 15 months. Through October 2023, renewal rent growth increased 4.9% — a slight elevation from the 2015-19 average of 4.3%. Further, October was the first time in 33 months that SFR renewal rent growth failed to eclipse 5.0%, a departure from a prolonged period of sustained gains.

Cap Rates

SFR cap rates ascended again in the fourth quarter of 2023, jumping 22 bps to settle at 6.3% (Chart 6).1 Cap rates have now risen in four of the past six quarters, increasing by a total of 93 bps in that time. SFR cap rates have now hit their highest point since the second quarter of 2020. With interest rates still elevated, investors have been broadly revising their yield requirements.

The spread between SFR cap rates and 10-year Treasury yields approximates the SFR risk premium. While SFR cap rates rose in the fourth quarter, Treasury yields jumped slightly, causing the SFR risk premium to slide to 180 bps (Chart 7). From the previous quarter, the SFR risk premium shrank by nine bps. Further, the SFR risk premium sits just 12 bps above its all-time low of 169 bps reached one year ago. Meanwhile, the spread between SFR and multifamily properties widened slightly by 10 bps, averaging 88 bps in the fourth quarter of 2023.

Pricing

There are consistent differences between the average assessed property values on mortgages originated to single-family owner-occupants versus single-family investors. Underwriters consider factors such as vacancies, turnover, and management-related expenses that owner-occupied units do not have, contributing to lower assessed values for rental units. Additionally, investors are incentivized to target value-add assets rather than paying top dollar for existing value.

Through the third quarter, the average valuation of a single-family rental that had received a Fannie Mae mortgage in 2023 was $343,498 — down 3.2% from the 2022 average (Chart 8). Average valuations for owner-occupied units increased 3.3% during the same time, reaching $415,281. Subsequently, the average underwritten valuation gap between the two groups of properties has increased to 17.3% through the three-quarters mark of 2023 — its widest point since 2012.

The drop-off in SFR valuations on Fannie Mae mortgages is the likely result of investors becoming more selective. Investors want to have a high degree of confidence that their asset will appreciate over the short term to justify making a purchase. In a housing market with fewer trades, many investors require higher yields and lower prices to execute an acquisition.

Debt Yields

Debt yields, a key measure of credit risk, jumped during the fourth quarter of 2023, rising by 33 bps to land at 10.3% (Chart 9). The increase marked the sixth time debt yields have risen in the past eight quarters, highlighting that lenders have remained cautious in an unsettled investment climate. The rise in debt yields in recent quarters translates to SFR investors securing less debt capital for every dollar of property-level net operating income (NOI). Through the fourth quarter of 2023, SFR debt declined to $9.69 for every dollar of NOI, a decrease of $0.33 from the previous quarter and a drop of $1.29 from the same time last year.

Supply & Demand Conditions

Residential Distress

Even with mortgage rates reducing homebuyer demand, there is an equal (if not greater) impact on housing supply. According to a July 2023 analysis by Apollo, a majority of mortgages outstanding had an annual interest rate below 4.0%. The difference between what homeowners pay on existing mortgages and what they would have to pay on a new mortgage is often significant. As a result, the housing market is locked into a so-called golden handcuffs effect.

Despite fewer buyers in the market, the dearth of available inventory means that sellers are still receiving favorable pricing. Further, the labor market remains robust. Altogether, these factors are leading to a housing market distress environment that is practically nonexistent. According to the Federal Deposit Insurance Corporation (FDIC), mortgage default rates fell to a new post-financial crisis low of 1.2% in the third quarter of 2023, declining four bps from the prior quarter (Chart 10).

Evidence suggests that distress within the SFR sector mirrors the broader single-family ecosystem. According to DBRS Morningstar, within rated SFR CMBS transactions, only 3.2% of loans were delinquent in November 2023 — nearly half the 6.3% rate reported at the end of 2022 (Chart 11).

Build-to-Rent

BTR communities have become a defining feature of the SFR sector. Through the fourth quarter of 2023, BTR production remains robust. Over the past 12 months, BTR accounted for 7.9% of all single-family construction starts, remaining near the record high for the product type (Chart 12). For comparison, before the SFR sector materialized in the aftermath of the 2007-09 recession, the BTR share of single-family construction never eclipsed 3.1%. By unit count, there were 75,000 BTR construction starts in 2023 — another all-time high and an increase of 8.7% from the 2022 total demonstrating a sustained surge in development.

Tracking Demand

Google Trends can identify potential markets for high SFR demand by tracking the popularity of the search term “homes for rent.” In the fourth quarter of 2023, Memphis, TN, ranked highest in search volume for the term (Table 1). All the top 10 metros with the highest number of searches in Google for “homes to rent” are in five southeastern Sun Belt states (Tennessee, Georgia, South Carolina, Alabama, and North Carolina). While SFR communities have succeeded nationwide, the Southeast remains the sector’s epicenter thanks to favorable population growth trends and affordable living costs.

Outlook

Even as the Federal Reserve considers its time frame for lowering interest rates, the pace of any cuts is unlikely to match the speed at which the central bank raised rates in 2022 and 2023. As a result, interest rates that are higher for longer could serve as both a tailwind and a headwind through different channels.

On the one hand, malaise in SFR CMBS markets should be expected, and cap rates may have more room to grow. On the other hand, mortgage rates may not return to pre-2023 levels in the near term. According to Fannie Mae, 30-year mortgage rates are forecast to average 6.1% and 5.6% in 2024 and 2025, respectively. With homeownership remaining prohibitively expensive for many would-be buyers, SFR is positioned to absorb a sizeable portion of housing demand. On balance, the SFR sector continues to demonstrate strength amid economic turmoil, attracting increased attention from the broader multifamily investment community.

1 Unless otherwise noted, the Chandan Economics data covering single-family rental cap rates and debt yields are based on model estimates and a sample pool of loans. Data are meant to represent conditions at the point of origination.

For more single-family rental research and insights, visit arbor.com/research

Disclaimer All content is provided herein “as is” and neither Arbor Realty Trust, Inc. or Chandan Economics, LLC (“the Companies”) nor their affiliated or related entities, nor any person involved in the creation, production and distribution of the content make any warranties, express or implied. The Companies do not make any representations regarding the reliability, usefulness, completeness, accuracy, currency nor represent that use of any information provided herein would not infringe on other third party rights. The Companies shall not be liable for any direct, indirect or consequential damages to the reader or a third party arising from the use of the information contained herein.

Single-Family Rental Investment Trends Report Q4 2023

Single-Family Rental Investment Trends Report Q4 2023

SFR Construction Starts Reach New Peak as Cap Rates Slide

Key Findings

  • SFR/BTR construction starts reached a new record high in the second quarter of 2023, accounting for 7.7% of all single-family starts.

  • Rent growth for lease renewals continued to outpace historical averages.

  • Cap rates slid to 6.1% in the third quarter amid rising home prices.

State of the Market

While elevated interest rates have impeded commercial real estate growth, the single-family rental (SFR) sector has exhibited strength and resiliency due to its favorable balance of structural tailwinds.

New construction has continued to be one of SFR’s brightest spots. With mortgage rates at a multi-decade high, many priced-out homebuyers have been choosing to live in build-to-rent (BTR) communities. As demand for SFR units grows nationally, the market share of new BTR construction has set new milestones in 2023.

However, the interest rate environment in the fourth quarter of 2023 still presents challenges in capital markets. CMBS activity, which attracted large amounts of capital into the SFR sector in recent years, has been quiet. At the same time, SFR’s fundamental strengths are undeniable. On-time rent payments remained robust as cap rates slid in the third quarter of 2023, demonstrating the health of this sector amid ongoing economic dislocation.

Performance Metrics

CMBS Issuance

In the CMBS market, SFR issuance has shown signs of modest improvement. According to Finsight, SFR CMBS issuance totaled $1.0 billion in the third quarter of 2023 — more than doubling the $416 million from the prior quarter and nearly matching the $1.1 billion issuance total from all of the first half of 2023 (Chart 1).

Nevertheless, even as SFR CMBS has started to show signs of new life, this year is likely to go on record as the most subdued for issuance in recent memory. SFR CMBS issuance is on pace to clear just over $2.8 billion this year, which, if this pattern holds, would be the lowest total since 2013. For comparison, $11.7 billion was closed in 2022.

Originations by Purpose

New acquisition loans have recently emerged as the predominant purpose type for SFR originations, driven primarily by the interest rate environment. According to Fannie Mae, in 2022, new SFR loans intended for purchasing accounted for 59.7% of originations to single-family investors, constituting a majority for the first time since 2018 (Chart 2). This trend has continued into 2023. With mortgage interest rates continuing to climb, existing asset owners have yet to see much incentive to strategically refinance. Through the first six months of 2023, loans for acquisitions accounted for 75.9% of single-family investor originations — a record high by 12.7 percentage points. Meanwhile, rate-and-term refinancing loans, which accounted for 47.3% of originations as recently as 2020, have accounted for just 6.6% of lending activity this year.

An analysis of Fannie Mae data shows that the dollar volume of rate-and-term refinancings fell by 87.9% during the 12 months ending in June 2023 compared to the prior 12 months.1 Cash-out refinancings also dropped off by 76.4% (Chart 3). While both of these declines are dramatic, the slight difference in severity between rate-and-term and cash-out refinances likely reflects the fact that many smaller-scale investors use accrued equity as capital to make a down payment on a new acquisition.

Single-family purchases by investors, while still down, fell at a milder pace of 34.1%. Meanwhile, single-family home purchases by first-time and non-first-time homebuyers fell by 41.1% and 36.0%, respectively. These trends underscore the strength of investor confidence in the single-family rental sector. While SFR purchasing activity has felt the impact of higher interest rates and turbulence in the capital markets, its pullback has proven to be less pronounced than that of other categories of single-family lending.

Occupancy

Occupancy rates across all SFR property types averaged 94.4% in the third quarter of 2023, decreasing by 10 bps from the previous quarter, according to U.S. Census Bureau data (Chart 4). DBRS Morningstar, which actively tracks the performance of about 130,000 SFR properties, also reported a similar vacancy rate of 93.5% in the sector in August 2023.

Rent Growth

According to DBRS Morningstar, vacant-to-occupied (V2O) annual rent growth has continued to be very volatile. Through July 2023, V2O rents are up 4.5% from a year earlier, which is the slowest annual growth rate since April 2020 (Chart 5). However, while this monthly measurement was subdued compared to the double-digit growth rates seen in recent years, the recent pace remains a full percentage point above the 2015-19 average of 3.5%. It appears V2O rent growth may be resuming seasonal patterns that were commonplace before the pandemic when price pressures peaked in the early summer and reached a bottom in the early winter.

The annual rent growth of SFR lease renewals has retreated gradually from its record highs. Renewal rent growth hit a record high of 7.9% in July 2022. Since then, the pace of increase has slowed in eight of the last 12 months, although it remained elevated through July 2023, landing at 6.4%. However, despite the recent slowdown, the current pace of growth is closer to the record high than the 2015-19 average of 4.3%. Prior to 2020, the SFR renewal rent growth rate had never eclipsed 5.0%. Through July 2023, it has been higher than 5.0% for 30 straight months, marking an unrivaled period of sustained gains.

Rent Collections

On-time rent payments in SFR properties remained at healthy levels as the sector entered the final stages of 2023. In October, an estimated 82.1% of units paid their full rent on time, according to the Independent Landlord Rental Performance Report (Chart 6). SFR’s forecasted full-payment rate, which includes on-time payments, late payments, and expected late payments based on historical trends, was 92.6% during the same period.


SFR full-payment rates have sat in a tight range between 92.6% and 93.0% for each of the past six months, marking a favorable string of consistent high performance. The overarching trend of improving collection rates in recent months can be attributed to two primary factors. The first is the labor market, which has been robust, outperforming even the most optimistic forecasts from earlier this year. The second is that high mortgage rates have caused many households with strong balance sheets to delay homeownership.

Cap Rates

Previously rising SFR cap rates hit the pause button in the third quarter of 2023, dropping only slightly to 6.1% (Chart 7).2 The third-quarter movement is a departure from the recent trend line, which saw SFR cap rates rise or hold flat in four consecutive quarters through mid-2023. The third-quarter cap rate compression is unique among commercial property types — including other forms of rental housing.

With interest rates high, investors are broadly adjusting their yield requirements higher. However, the SFR sector’s third quarter statistical outlier is that valuations in the housing market have already started to pick back up, with recent gains seen in both the S&P Case-Shiller Home Price Index and HUD’s tracking of the median sales price of houses sold.

The spread between SFR cap rates and 10-year Treasury yields approximates the SFR risk premium. With SFR declining in the third quarter as Treasury yields jumped, the SFR risk premium slid to 193 bps — a decrease of 61 bps from the previous period (Chart 8). At the same time, the spread between SFR and multifamily properties also narrowed (-26 bps), averaging 85 bps in the third quarter of 2023.

Pricing

There are consistent differences between the average assessed property values on mortgages originated to single-family owner-occupants when compared to those originated to single-family investors. Underwriters consider factors such as vacancies, turnover, and management-related expenses that owner-occupied units do not have, contributing to lower assessed values for rental units. Additionally, investors are incentivized to target value-add assets rather than paying top dollar for existing value.

Through the second quarter of 2023, the average valuation of a single-family rental that received a Fannie Mae mortgage this year was $330,972 — down 6.7% from the 2022 average (Chart 9). Meanwhile, for owner-occupied units, the average valuations were up by a marginal 1.2% through the second quarter of 2023, rising to $407,046. Subsequently, the average underwritten valuation gap between the two groups of properties has increased to 18.7% through the first half of 2023 — its widest point since 2012.

The sizeable drop-off in SFR valuations on Fannie Mae mortgages is the likely result of investors becoming more selective. Investors want to have a high degree of confidence that their asset will appreciate over the short term to justify making a purchase. In a housing market with fewer transactions, many investors require higher yields and lower prices to execute an acquisition.

Debt Yields

Debt yields, a key measure of credit risk, remained virtually unchanged during the third quarter of 2023, rising by 3 bps and remaining at 10.0% (Chart 10). While the increase was minuscule, it still marked the sixth increase in the past seven quarters, highlighting that lenders have remained cautious. The rise in debt yields in recent quarters translates to SFR investors securing less debt capital for every dollar of property-level net operating income (NOI). Through the third quarter of 2023, SFR debt declined to $9.98 for every dollar of NOI, a decrease of $0.03 from the previous quarter and a drop of $1.00 from the same time last year.

Supply & Demand Conditions

Residential Default Rates

After a record runup in prices through 2021 and the first half of 2022, many investors believed that a housing market correction was inevitable, which would create a unique buying opportunity. To date, existing home sales have cratered, though valuations have not. The combination of a strong labor market and many homeowners having low-interest rate mortgages has resulted in an exceedingly low rate of mortgage defaults. According to the Federal Deposit Insurance Corporation (FDIC), mortgage default rates improved to a new post-financial crisis low of 1.3% in the second quarter of 2023, down from 1.9% one year ago (Chart 11).

Build-to-Rent

Purpose-built SFR properties, known as BTR communities, have become a defining feature of the SFR sector, especially among institutional investors. Through the second quarter of 2023, BTR production remained elevated despite slowing construction throughout the single-family rental sector. Over the past year, BTR accounted for 7.7% of all single-family construction starts — marking a record high for the product type (Chart 12).

For comparison, before the SFR sector’s emergence in the aftermath of the 2007-2009 recession, the BTR share of single-family construction did not eclipse 3.1%. By unit count, there were 68,000 BTR construction starts in the year ending in the second quarter of 2023. Notably, the rolling annual sum for BTR construction starts has held between 68,000 and 69,000 for each of the past five quarters, underscoring an impressive consistency.

Tracking Demand

Google Trends can help to identify potential markets for high SFR demand by tracking the popularity of the search term “homes for rent.” In the third quarter of 2023, Memphis, TN, was the area where the term “homes for rent” was searched the most (Table 1). All the top 10 metros where this term received the highest number of searches in Google are in six southeastern Sun Belt states (Tennessee, Georgia, South Carolina, Alabama, North Carolina, and Florida). While SFR communities have found success nationwide, the Southeast remains SFR’s strongest region due to favorable population growth trends and relatively affordable costs of living.

Outlook

Even as the investment community is betting that the Federal Reserve has likely reached the end of its monetary policy tightening cycle, more restrictive conditions remain a possibility via a yield curve normalization that could send long-term Treasury rates and market interest rates higher. For the SFR sector, continued pressure on long-term interest rates serves both as a tailwind and a headwind through different channels. On the one hand, rising mortgage rates could translate into downward pressure on home prices across the board, which would cause cap rates to climb. At the same time, would-be homeowners are bolstering demand for single-family rentals, sustaining rent pressures, and firming collection performance trends. On balance, the SFR sector is well-positioned to limit distress through the challenges of the current moment while advancing its standing within the single-family housing market for the long term.

1 Findings are based on Fannie Mae’s historical loan credit performance data accessible through its Data Dynamics portal.

2 Unless otherwise noted, the Chandan Economics data covering single-family rental cap rates and debt yields are based on model estimates and a sample pool of loans. Data are meant to represent conditions at the point of origination.

For more single-family rental research and insights, visit arbor.com/research

Disclaimer All content is provided herein “as is” and neither Arbor Realty Trust, Inc. or Chandan Economics, LLC (“the Companies”) nor their affiliated or related entities, nor any person involved in the creation, production and distribution of the content make any warranties, express or implied. The Companies do not make any representations regarding the reliability, usefulness, completeness, accuracy, currency nor represent that use of any information provided herein would not infringe on other third party rights. The Companies shall not be liable for any direct, indirect or consequential damages to the reader or a third party arising from the use of the information contained herein.

Single-Family Rental Investment Trends Report Q3 2023

Single-Family Rental Investment Trends Report Q3 2023

SFR Construction Starts Hit Another High as Cap Rates Continue Rising

Key Findings

  • SFR/BTR construction starts reached a new record high in the first quarter of 2023, accounting for 7.3% of all single-family starts.
  • Rent growth increased slightly, resuming pre-pandemic seasonal patterns.
  • Cap rates reached 6.2% in the second quarter, an increase of 16 bps over the previous quarter.

State of the Market

Amid a challenging interest rate climate, the single-family rental (SFR) sector has been garnering the attention of the multifamily investment community, with a strong set of tailwinds and wide availability of attractive opportunities.

While SFR acquisitions decreased in the first half of 2023, buying activity in this sector has been less negatively impacted than owner-occupant purchases. The current slowdown, which has extended to institutional investors, reflects a need for increased property yields among buyers and a lack of distress in the market to motivate sellers. SFR construction continues to be a bright spot. With mortgage costs soaring and underwriting standards for first-time home buyers near their tightest levels since the 2008 financial crisis, priced-out would-be homeowners are now choosing to live in build-to-rent (BTR) communities. As demand for SFR units has grown, the market share of new BTR construction reached record highs last year and could continue setting new milestones throughout 2023.

Performance Metrics

CMBS Issuance

In the CMBS market, SFR issuance activity continued to slow. According to Finsight, SFR CMBS issuance totaled $416 million in the first quarter of 2023 — the lowest quarterly amount since 2017 (Chart 1). SFR CMBS issuance has now declined in each of the past four quarters. This pullback is consistent with what has been occurring throughout commercial real estate. Overall, total CMBS deal volume finished the second quarter of 2023, down 55% from one year ago.

Originations by Purpose

New acquisition loans have become a predominant purpose type for SFR originations. Loans intended for purchasing, not refinancing, accounted for the majority (59.0%) of originations to single-family investors in 2022 for the first time since 2018, according to Fannie Mae (Chart 2). Moreover, purchases accounted for the largest share of investor originations since 2000. Through the first quarter of 2023, the shift toward purchases has accelerated, with acquisitions accounting for 75.3% of tracked originations — the highest share on record dating back to 1999.

The financial markets shifted in 2022 after the Federal Reserve began its monetary tightening cycle. In the 17 months ending in July 2023, the central bank raised interest rates 11 times, bringing its federal funds target rate from 0.25% to 5.50%. As a result, voluntary refinancings of existing mortgages became much less attractive.

According to a Chandan Economics analysis of Fannie Mae data, the dollar volume of rate-and-term refinancings fell by 89.1% during the 12 months ending in March 2023 compared to the prior 12 months. Cash-out refinancings also dropped off by 66.0% (Chart 3). The difference in the size of the decline between rate-and-term and cash-out refis likely reflects the fact that many smaller-scale investors use accrued equity as capital to make a down payment on a new acquisition.

Most strikingly, single-family purchases by investors, while still down, fell at a milder pace of 14.7% in the 12 months ending in March 2023. Meanwhile, single-family home purchases by first-time and non-first-time homebuyers fell by 35.5% and 30.9%, respectively. This stark difference demonstrates just how much investors believe in the single-family rental sector. While SFR purchasing activity has felt the impact of higher interest rates and turbulence in the capital markets, its pullback has proven to be less pronounced than other categories of single-family lending.

Occupancy

Occupancy rates across all SFR property types averaged 94.5% in the first quarter of 2023, increasing by 10 bps from the previous quarter, according to U.S. Census Bureau data (Chart 4). DBRS Morningstar, which actively tracks the performance of 128,379 SFR properties, also reported a similar SFR vacancy rate in May 2023.

Rent Growth

According to DBRS Morningstar, vacant-to-occupied (V2O) annual rent growth tumbled in late 2022, falling from a high of 15.7% in June 2022 to reach a low of 4.5% in December (Chart 5). While this V2O rent growth was dramatic, it was also short-lived.

In January 2023, V2O rent growth retreated significantly to 7.0%, and it has continued to recover in two of the past three months, reaching a high of 8.5% through April. The resurgence of V2O rent growth is likely a signal of the resumption of seasonal patterns that were commonplace before the pandemic when price pressures peaked in the early summer and reached a bottom in the early winter.

The annual rent growth of SFR lease renewals decreased in six of the last eight months through March 2023, falling from a high of 7.9% to a low of 6.5%. But, just one month later in April, it saw its largest month-over-month increase on record — a jump of 91 bps to 7.5%.

It’s important to note that current levels of renewal rent growth remain exceptionally high by recent historical standards. Between 2015 and 2020, SFR renewal rent growth did not eclipse 5.0%. Through April 2023, SFR renewal rent growth has been higher than 5.0% for 27 straight months, marking an unrivaled period of sustained gains.

Rent Collections

On-time rent payments in SFR properties remained at healthy levels through the halfway mark of 2023. In June, an estimated 82.1% of units paid their full rent on time, according to the Independent Landlord Rental Performance Report (Chart 6). SFR on-time payment rates had fallen as low as 70.6% during 2020 due to pandemic-related financial distress. However, in the years since rent collection performance has gradually improved. Between the start of the pandemic and September 2022, monthly SFR on-time payment rates eclipsed 81% only five times. Since then, on-time payment rates have held above 81% for nine consecutive months — a testament to the strength of SFR cash flows and the household balance sheets of SFR tenants in a resilient labor market.

Cap Rates

SFR cap rates continued to tick up in the second quarter, rising 18 bps to reach 6.2% (Chart 7).1 Cap rates during the pandemic and its aftermath had compressed as single-family home prices appreciated at a record-setting pace.

Now, as interest rates are higher, investors have started adjusting-up their yield requirements, causing cap rates to rise. Cap rates have either increased or held flat in the past four consecutive quarters, placing SFR cap rates above 6.0% for the first time since mid-2020. The spread between SFR cap rates and 10-year Treasury yields approximates the SFR risk premium. As SFR cap rates ascended and Treasury yields fell slightly in the second quarter of 2023, the SFR risk premium grew to 256 bps — an increase of 23 bps from the previous period, creating the widest spread since the first quarter of 2022 (Chart 8)

At the same time, the spread between SFR and multifamily properties also slightly increased (+11 bps), averaging 108 bps in the second quarter of 2023. After the cap rate spread between SFR and multifamily compressed to an all-time low of 47 bps in the third quarter of 2021, the risk premium has now risen in four of the last seven quarters, more than doubling in that time.

Pricing

There are consistent differences between the average assessed property values on mortgages originated to single-family owner-occupants versus single-family investors. Underwriters consider factors such as vacancies, turnover, and management-related expenses that owner-occupied units do not have, contributing to lower assessed values for rental units. Additionally, investors are incentivized to target value-add assets rather than paying top dollar for existing value.

In the first quarter of 2023, the average valuation of a single-family rental that received a Fannie Mae mortgage was $316,638 — down 10.8% from the 2022 average (Chart 9). Meanwhile, for owner-occupied units, the average valuation is down by just 0.6% in the first quarter of 2023, falling to $399,437. Subsequently, the average underwritten valuation gap between the two groups of properties has increased to 20.7% through the first quarter of 2023 — its widest point since 2012. The sizeable drop-off in SFR valuations on Fannie Mae mortgages is the likely result of investors becoming more selective. Investors want to have a high degree of confidence that their asset will appreciate over the short term to justify making a purchase. In a housing market with fewer trades, many investors require higher yields and lower prices to execute an acquisition.

Debt Yields

Debt yields, a key measure of credit risk, rose by 18 bps during the second quarter of 2023, jumping to 10.0% (Chart 10). The rise marked the fifth increase in the past six quarters, signaling that lenders are continuing to exercise caution in an unsettled housing market. The rise in debt yields in recent quarters translates to SFR investors securing less debt capital for every dollar of property-level net operating income (NOI). Through the second quarter of 2023, SFR debt declined to $10.05 for every dollar of NOI, a decrease of $0.19 from the previous quarter and a drop of $1.21 from the same time last year.

Supply & Demand Conditions

Residential Default Rates

After a record runup in prices through 2021 and the first half of 2022, many investors believed that a housing market correction was inevitable, which would create a unique buying opportunity. To date, existing home sales have cratered, though valuations have not. The combination of a strong labor market and many homeowners having low-interest rate mortgages has resulted in an exceedingly low rate of mortgage defaults. According to the Federal Deposit Insurance Corporation (FDIC), mortgage default rates fell to a new post-financial crisis low of 1.4% in the first quarter of 2023, declining 4 bps from the end of 2022 (Chart 11).

Build-to-Rent

Purpose-built SFR properties, known as BTR communities, have become a defining feature of the SFR sector, especially within the institutional investor segment of the market. Through the first quarter of 2023, despite a construction slowdown throughout the rest of the single-family rental sector, BTR production remained elevated. Over the past year, BTR accounted for 7.3% of all single-family construction starts — another new record for this product type (Chart 12). For comparison, between 1975 and the start of the prior recession in 2007, BTRs accounted for a little less than 2.0% of all single-family construction starts, according to an analysis of Census Bureau data.

By unit count, there were 68,000 BTR construction starts in the year ending first-quarter 2023 — a 15.3% growth rate from a year earlier.

Tracking Demand

Google Trends can help to identify potential markets for high SFR demand by tracking the popularity of the search term “homes for rent.” In the second quarter of 2023, Memphis, TN, was the area where “homes for rent” was searched most (Table 1). All the top 10 metros where this term received the highest number of searches in Google are in six southeastern Sun Belt states (Tennessee, Alabama, Georgia, South Carolina, Florida, and North Carolina). Demand-side factors and lower average land prices in the Southeast have made this region more attractive to large-scale SFR strategies.

Outlook

The investment community is betting that the Federal Reserve has reached the peak of its historically aggressive monetary tightening cycle. If interest rates normalize in the coming months, SFR would likely benefit as access to active capital markets would fuel the sector’s sustained expansion.

Notwithstanding institutional capital markets, underlying performance data supports a picture of SFR’s resiliency. Despite overall economic volatility, housing market stress remains exceedingly limited. The cash flows of SFR properties appear sound as rental occupancy rates have steadied, and tenants are increasingly paying their rent on time. While financial market conditions will present ongoing challenges, SFR is uniquely positioned to benefit from a likely increase in demand for high-quality rental housing from those priced-out of homeownership. Over the long term, demographic and structural market trends will likely strengthen SFR’s tailwinds, advancing its standing within the housing market.

1 Unless otherwise noted, the Chandan Economics data covering single-family rental cap rates and debt yields are based on model estimates and a sample pool of loans. Data are meant to represent conditions at the point of origination.

For more single-family rental research and insights, visit arbor.com/articles

Disclaimer All content is provided herein “as is” and neither Arbor Realty Trust, Inc. or Chandan Economics, LLC (“the Companies”) nor their affiliated or related entities, nor any person involved in the creation, production and distribution of the content make any warranties, express or implied. The Companies do not make any representations regarding the reliability, usefulness, completeness, accuracy, currency nor represent that use of any information provided herein would not infringe on other third party rights. The Companies shall not be liable for any direct, indirect or consequential damages to the reader or a third party arising from the use of the information contained herein.

Single-Family Rental Investment Trends Report Q1 2023

Single-Family Rental Investment Trends Report Q1 2023

Investor Purchases, New Starts, and Tenant Performance Show Strength as Cap Rates Rise

Key Findings

  • SFR/BTR accounted for 6.9% of new single-family construction starts in the past year, a new record high.
  • Cap rates jumped to 5.9%.
  • Investor purchasing activity increased in 2022 despite macroeconomic headwinds.

State of the Market

For the first time since the institutional emergence of the single-family rental (SFR) sector, investors must navigate through an economic environment absent of overwhelming macroeconomic tailwinds. Still, SFR’s significant structural support has enabled it to take noticeable steps forward, while other commercial property types have been merely treading water.

 

The SFR sector has been contending with two major forces in recent months — both of which were initiated by rising interest rates. First, home prices have fallen from their record highs, impacting SFR asset valuations. Secondly, and most recently, banking sector turmoil has taken its toll. The CMBS market, which institutional investors access to find liquidity for large-scale deals, has seen a dramatic contraction of new activity.

 

Nevertheless, investors purchased more SFR units in 2022 than in 2021 — a trend that starkly contrasts the owner-occupied single-family housing markets. Moreover, construction continues to ramp up in the sector, with SFR starts reaching all-time highs by unit count and market share. Even in this high-interest rate environment, the long-term ascent of the sector remains undeterred.

Performance Metrics

CMBS Issuance

In the CMBS market, SFR issuance continued to slow. According to Finsight, SFR CMBS issuance totaled just $650 million in the first quarter of 2023 — the lowest quarterly amount since 2019 (Chart 1). SFR CMBS issuance has now declined in each of the past three quarters. However, the drop-off in activity is not unique to SFR — rather, it is a symptom of a broader pullback from CMBS. According to Trepp, overall CMBS deal volume finished down 79% in the first quarter of 2023 compared to a year ago.

Originations by Purpose

Loans for purchasing, not refinancing, accounted for the majority (59.0%) of originations to single-family investors in 2022 for the first time since 2018, according to Fannie Mae (Chart 2). Moreover, purchases accounted for the largest share of investor originations since 2000.

The market shifted in 2022 after the Federal Reserve began its monetary tightening cycle. In the 15 months ending in May 2023, the Fed hiked interest rates 10 times, bringing its federal funds target rate from 0.25% to 5.25%. As a result, voluntary refinancings of existing mortgages became less advantageous.

 

According to Chandan Economics’ analysis of Fannie Mae data, the dollar volume of term/rate refinancings fell by 84.9% in 2022 compared to the year prior. Cash-out refinancings also dropped off but by a milder 38.4% (Chart 3). The relative discrepancy between rate/term and cash-out refis likely reflects the fact that accrued equity, especially for smaller-scale investors, represents the capital needed for a down payment on new acquisitions. Most strikingly, single-family purchases by investors bucked the overarching trend of declines, posting a 6.9% year-over-year increase in 2022 — even as purchases by owner-occupants fell 25.5%.

Occupancy

Occupancy rates across all SFRs averaged 94.4% in the first quarter of 2023, declining by 40 bps from the previous quarter, according to U.S. Census Bureau data (Chart 4). The data aligns well with similar data from private sources. DBRS Morningstar, which actively tracks the performance of 123,929 SFR properties, reported a 94.1% SFR occupancy rate in February 2023.

Rent Growth

DBRS Morningstar also reported that vacant-to-occupied (V2O) annual rent growth tumbled in late 2022, falling from a high of 15.7% in June 2022 to reach a low of 4.5% in December (Chart 5). However, V2O rent growth jumped again in January 2023, rising to 7.0%. Since the onset of the pandemic, V2O rent growth has been volatile. As a new stable equilibrium takes hold in the coming years, a return to seasonal V2O rent growth patterns can be expected, where price pressures peak in the early summer and reach a bottom in the early winter.

For lease renewals, annual rent has also slowed from its peaks, albeit far more gently. After hitting an all-time high of 7.9% in July 2022, lease renewal rent growth has slid in four-of-six months, landing at 7.0% through January 2023. Further, despite the recent declines, current levels of renewal rent growth remain exceptionally high by recent historical standards. Between 2015 and 2020, SFR renewal rent growth never eclipsed 5.0%. As of January 2023, SFR renewal rent growth has sat above 7.0% for 15 straight months, marking an unrivaled period of sustained gains.

Rent Collections

On-time rent payments in SFR properties remain at healthy levels. In March 2023, an estimated 84.7% of units paid their full rent on time, according to the Independent Landlord Rental Performance Report (Chart 6). These on-time payment rates fell as low as 70.6% during 2020 as pandemic-related financial distress was widespread. However, rent collection performance gradually improved and is now consistently reaching new highs. These trends signal that the household balance sheets of SFR renters remain healthy, especially as the labor market shows signs of resiliency. As a result, SFR properties continue to have strong cash flows even amid growing economic headwinds.

Cap Rates

SFR cap rates continued to tick up in the first quarter, moving 40 bps higher to land at a rounded 5.9% (Chart 7).1 Cap rates during the pandemic and its aftermath compressed as single-family home prices appreciated at record-setting rates. Now, as home prices have fallen from their record highs, cap rates have started moving in reverse. However, according to the S&P Case-Shiller Home Price Index, valuations have stabilized and even started rising again in February. If home prices start another ascent, SFR cap rates would likely see less upward pressure.

The spread between SFR cap rates and 10-year Treasury yields approximates the SFR risk premium. With SFR cap rates jumping in the first quarter of 2023 and Treasury yields falling slightly, the SFR risk premium saw its largest quarterly increase since 2020. The SFR risk premium averaged 227 bps in the first quarter — rising 58 bps from the previous period (Chart 8).

Meanwhile, the spread between SFR and multifamily properties has stabilized. In each of the past five quarters, SFR cap rates have stood between 75 and 90 bps higher than multifamily cap rates. In the first quarter of 2023, this SFR/multifamily yield spread averaged 84 bps, increasing 9 bps from the previous quarter.

Pricing

There have been consistent differences between the average assessed property values on mortgages originated to single-family owner-occupants versus single-family investors since 2006. Now, investors are incentivized to target value-add assets rather than paying top dollar for value that already exists. Additionally, investor-owned SFR properties have vacancies, turnover, and management-related expenses that owner-occupied units do not have, contributing to lower values for the rental units. Before the Financial Crisis, the valuation gap between owner-occupied single-family units and SFRs routinely sat at about 30%. However, this gap has contracted over the past decade to the 10% range where it remains today.

 

In 2022, the average valuation of an SFR receiving a Fannie Mae mortgage was $354,236 — down 4.5% from a year earlier (Chart 9). Meanwhile, for owner-occupied units, valuations sank by just 1.4% to $401,935. Subsequently, the average valuation gap between the two groups of properties increased slightly in 2022 from 9.0% to 11.9%. The widening can likely be explained by the fact that investors and owner-occupants have different purchasing considerations. Investors need a reasonable degree of certainty that their asset will appreciate over the short term to justify the purchase. As a result, especially in a housing market where home prices are falling, investors require higher yields and lower prices before they are willing to execute an acquisition.

A slight annual increase in the valuation gap has emerged as valuations across all single-family properties have declined this year. The average underwritten value of a single-family investment property through the third quarter of 2022 was $358,019, a drop-off of 3.5% from the 2021 average. Owner-occupied units hold an average underwritten valuation of $403,511 in 2022, down 1.0% from the year prior (Chart 10).

Debt Yields

Debt yields, a key measure of credit risk, rose by 55 bps during the first quarter of 2023, jumping to 9.9% (Chart 10). The quarter-over-quarter increase was the largest on record since 2012. Moreover, the rise marked the fourth increase in the past five quarters, signaling that lenders have continued to exercise caution in an unsettled housing market.

The rise in debt yields in recent quarters translates to SFR investors securing less debt capital for every dollar of property-level net operating income (NOI). Through the first quarter of 2023, SFR debt declined to $10.12 for every dollar of NOI, a decrease of $0.60 from the previous quarter and $1.33 from the same time last year.

Supply & Demand Conditions

Residential Default Rates

After a record runup in prices through 2021 and the first half of 2022, many investors believed that a housing market correction was inevitable, which would create a unique buying opportunity. To date, national home prices have not dropped substantially. While new home sales have cratered, average home valuations are down by less than 3.0% compared to their recent peaks. The combination of a strong labor market and most homeowners being locked into low-interest rates has resulted in an exceedingly low rate of mortgage defaults. According to the Federal Deposit Insurance Corporation (FDIC), mortgage default rates fell to a new post-Financial Crisis low of 1.4% in the fourth quarter of 2022, declining 4 bps from the third quarter (Chart 11).

Build-to-Rent

Purpose-built SFR properties, known as build-to-rent (BTR) communities, have become a defining feature of the SFR sector, especially within the institutional slice of the market. Through the end of 2022, despite a construction slowdown throughout the rest of the single-family sector, BTR production held at elevated levels. During 2022, BTR accounted for 6.9% of all single-family construction starts — another new record for this product type (Chart 12). For comparison, between 1975 and the start of the prior recession in 2007, BTRs accounted for a little less than 2.0% of all single-family construction starts, according to an analysis of Census Bureau data.

 

By unit count, there were 69,000 BTR construction starts in 2022, growing at a rate of 32.7% when compared to the year before.

Tracking Demand

Google Trends can be used to track the popularity of the search term “homes for rent,” and help identify potential hotspots for SFR demand. Dothan, AL, was the area for which “homes for rent” was searched most during the first quarter of 2023, dethroning Augusta, GA, from the fourth quarter of 2022 (Table 1). All the metros within the top 10 most searched locations are found in five southeastern Sun Belt states (Georgia, Tennessee, Alabama, North Carolina, and South Carolina). In addition to demand-side factors, lower average land prices in the Southeast have made the region more attractive for large-scale SFR strategies. According to an analysis of Census Bureau data, more than half (52.1%) of all SFR/BTR housing starts in 2022 were in the South.

Outlook

The Federal Reserve’s public comments hint that the May 2023 interest rate increase could be the conclusion of its historically aggressive tightening cycle. If interest rates normalize in the coming months, SFR could be one of the many beneficiaries. For the sector to continue expanding, access to active capital markets is necessary to power its momentum.

 

However, just because a car needs gas, it does not mean the engine is broken. Underlying performance data, from lease renewal rent growth, rent collections, and investor acquisitions, all point to a sector that remains on solid footing despite macroeconomic headwinds.

 

Moreover, demographic and generational trends have made it more difficult for younger households to find affordable entry points into homeownership — a factor that should continue to influence SFR demand. While economic conditions continue challenging investors, SFR’s short- and long-term tailwinds are two big reasons to be optimistic for brighter days ahead.

1 Unless otherwise noted, the Chandan Economics data covering single-family rental cap rates and debt yields are based on model estimates and a sample pool of loans. Data are meant to represent conditions at the point of origination.

For more single-family rental research and insights, visit arbor.com/articles

Disclaimer All content is provided herein “as is” and neither Arbor Realty Trust, Inc. or Chandan Economics, LLC (“the Companies”) nor their affiliated or related entities, nor any person involved in the creation, production and distribution of the content make any warranties, express or implied. The Companies do not make any representations regarding the reliability, usefulness, completeness, accuracy, currency nor represent that use of any information provided herein would not infringe on other third party rights. The Companies shall not be liable for any direct, indirect or consequential damages to the reader or a third party arising from the use of the information contained herein.

Single-Family Rental Investment Trends Report Q4 2022

Single-Family Rental Investment Trends Report Q4 2022

SFR Construction Captures Record Market Share as Cap Rates Rise

Key Findings

  • Build-to-Rent (BTR) accounts for 6.3% of new single-family construction starts in the past year, a new record high.
  • Single-Family Rental (SFR) rent growth on new leases slows sharply as renewal rent pressures maintain their strength.
  • Cap rates have started to rise, jumping to 5.6%.

State of the Market

The SFR sector sits at a crossroads between secular growth and a housing market correction, placing it in uncharted territory.

 

Across the country, single-family home prices continue to fall. According to the S&P/Case-Shiller U.S. National Home Price Index, prices have fallen an average of 3.6% between June and November 2022. While SFR assets are not immune from downside housing market pressures, there are countercyclical features of the sector that are helping it to withstand the current climate — namely, an influx of rental demand from otherwise would-be buyers. High mortgage interest rates have made buying a home in today’s market more expensive. As a result, Realtor.com reports that renting a home is currently more affordable than buying one in 45 of the 50 largest U.S. markets.

 

How debt and equity investors are pricing risk in the current interest rate environment continues to shift, with debt yields and cap rates both rising for SFRs. A slowdown in rent gains is well underway, with a reversion to historical patterns of growth appearing likely — especially as occupancy rates continue to hold at healthy levels. If all else remains equal, SFR will maintain exposure to the cyclical disruption brought on by the housing market’s softness and rising interest rates, even though its structural growth outlook remains positive and unchanged.

Performance Metrics

CMBS Issuance

In the CMBS market, the single-family rental issuance has slowed substantially. According to Finsight, single-family rental CMBS issuance totaled just $939 million in the fourth quarter of 2022 — the lowest quarterly amount since 2019 (Chart 1).  While SFR CMBS deal activity finished the year totaling $11.2 billion, the second-highest annual volume on record, more than three-quarters of issuances came in the first half of 2022.

 

Originations by Purpose

Loans for purchasing, not refinancing, account for the majority (56.0%) of originations to single-family investors in 2022 for the first time since 2018, according to Fannie Mae (Chart 2).

The market shifted through 2022, driven by the Federal Reserve’s monetary tightening cycle. As of the beginning of February 2023, the Fed has moved up its benchmark Federal Funds rate eight times in the past year, rising 450 bps. The impact of the Fed’s tightening cycle on interest rates has been dramatic, including on mortgage interest rates, which have held above 6% since September 2022.

 

The rise in borrowing costs has meant that fewer existing SFR owners would benefit from refinancing their existing mortgages. Term/rate refinancings, which accounted for 47.3% and 41.2% of originations in 2020 and 2021, respectively, have fallen to 11.9% in 2022. Meanwhile, cash-out refinancings have continued to hold up this year, despite the impact of higher borrowing costs. Through the third quarter of 2022, cash-outs have accounted for 32.1% of SFR lending activity. Often, for smaller investors, accrued equity in existing properties represents the capital needed for a down payment on another.

Occupancy

As measured by the U.S. Census Bureau, occupancy rates across all SFRs averaged 94.6% in the fourth quarter of 2022, improving by 40 bps from the previous quarter (Chart 3). The Census Bureau data aligns well with similar data from private sources. DBRS Morningstar reported the SFR vacancy rate as 94.1% in November 2022.

Rent Growth

Vacant-to-occupied (V2O) annual rent growth has cratered in recent months, according to DBRS Morningstar. Between March 2021 and August 2022, V2O annual rent growth stood above 10% for 18 consecutive months (Chart 4). Fast forward to October 2022, annual V2O rent growth has decelerated to just 5.3% — its lowest level since May 2020. After an unprecedented run of historically robust V2O rent growth, recent data indicate that the slowdown is well underway.

Rent growth for lease renewals has started to slow, albeit far more gently. After hitting an all-time high of 7.9% in July 2022, lease renewal rent growth has slid for three consecutive months through October, landing at 7.2%. While it is coming down, the pace remains well above normal. Between 2015 and 2019, SFR renewal rent growth consistently ranged between 3.3% and 5.0%. Since February 2021, the rate has topped 5.0% in 21 consecutive months, marking an unrivaled period of sustained gains. Even as the growth rate is poised to slow, it will likely remain at higher-than-normal levels for several months as the resetting of market rents experienced by new lease signers in the past year will influence the prices paid by renewing tenants.

 

Looking at annual rent growth at the market level, metros in the Sun Belt are seeing some of the sharpest slowdowns in the country. According to CoreLogic’s Single-Family Rent Index (SFRI), Miami and Orlando, two Florida hotspots that continued to see some of the highest annual growth totals in the country through November (12.7% and 13.4%, respectively), are now also seeing a rapid reversion. Compared to three months earlier, Miami’s annual SFR rent growth rate has slowed by 12.3 percentage points. Meanwhile, Orlando has seen its growth rate slow by 7.4 percentage points (Chart 5). Of the 20 markets tracked by CoreLogic, only two (Boston and St. Louis) posted higher annual growth totals in November than three months earlier.

Rent Collections

On-time rent payments in SFR properties remain at healthy levels, according to the Independent Landlord Rental Performance Report. In January 2023, an estimated 81.8% of units paid their full rent on time (Chart 6). These on-time payment rates fell as low as 70.6% during 2020 as pandemic-related financial distress was widespread. However, rent collection performance has gradually recovered. For the first time since the onset of the pandemic, on-time payment rates have now held above 81% for four consecutive months, a sign of SFR households’ financial wellness.

Cap Rates

SFR cap rates continued to tick up in the fourth quarter, moving up by another 8 bps, and landing at a rounded 5.6% (Chart 7).1 This was following a 24 bps increase during the previous quarter. Cap rates compressed during the pandemic and its aftermath as single-family home prices appreciated at record-setting rates. As home prices inflected, the impact on cap rates is starting to move in reverse.

The spread between SFR cap rates and 10-year Treasury yields approximates the SFR risk premium. Despite SFR cap rates rising in the third and fourth quarters of 2022, Treasury yields have jumped more quickly. As a result, the risk premium has continued to narrow, falling to a new all-time low of 181 bps in the fourth quarter of 2022 (Chart 8). Compared to one year ago, this risk premium has more than halved, shaving off 193 bps in that time.

Meanwhile, the spread between SFR and multifamily properties has seen far less volatility in recent quarters. The SFR/multifamily spread declined by 5 bps in the fourth quarter, landing at 87 bps. In the aftermath of the 2019 housing crisis, SFR/multifamily spreads stood as high as 496 bps. However, over the past decade, the risk profiles of the two product types have come closer to parity. Since the end of 2020, the spread has bounced between 50 bps and 100 bps — a stable range where it remains today.

Pricing

There have been consistent differences between the average assessed property values on mortgages originated to single-family owner-occupants versus single-family investors since 2006. This disparity incentivizes investors to target value-add assets rather than paying top dollar for value that already exists. Additionally, investor-owned SFR properties have vacancies, turnover, and management-related expenses that owner-occupied units do not have, contributing to lower values for the rental units.

 

Nevertheless, the gap has narrowed dramatically over the past decade, coming down from above 30% in the aftermath of the 2008 financial crisis to the 10% range where it sits today, according to an analysis of Fannie Mae securitized mortgages. The valuation gap averaged 11.3% in 2022, rising 229 bps from its 2021 average (Chart 9).

A slight annual increase in the valuation gap has emerged as valuations across all single-family properties have declined this year. The average underwritten value of a single-family investment property through the third quarter of 2022 was $358,019, a drop-off of 3.5% from the 2021 average. Owner-occupied units hold an average underwritten valuation of $403,511 in 2022, down 1.0% from the year prior (Chart 10).

Debt Yields

Debt yields, a key measure of credit risk, rose by 11 bps during the fourth quarter of 2022, climbing to 9.5% (Chart 11). This fourth consecutive quarterly increase signals that lenders have continued to exercise caution as the housing market works through a pricing correction.

The rise in debt yields over the past four quarters translates to SFR investors securing less debt capital for every dollar of property-level net operating income (NOI). Through the fourth quarter of 2022, SFR debt declined to $10.58 for every dollar of NOI, a decrease of $0.12 from the third quarter and a decrease of $1.32 from the same time last year.

Supply & Demand Conditions

Residential Default Rates

In the aftermath of the Great Recession, investors took advantage of the market dislocation, acquiring large portfolios of single-family assets at steep discounts. For a similar scenario to happen again in this current market remains unlikely. According to the Federal Deposit Insurance Corporation (FDIC), mortgage default rates fell to a new post-2008 low of 1.4% in the third quarter of 2022. The presence of historically low interest rates in the years leading up to 2022 and the continued strength of the labor market means that homeowners have maintained the ability to pay their mortgages. As a result, borrower distress remains limited despite the housing market’s pricing slowdown (Chart 12).

Build-to-Rent

Purpose-built SFR properties, known as build-to-rent (BTR) communities, have become a defining feature of the SFR sector. In the year ending in the third quarter of 2022, BTR accounted for 6.3% of all single-family construction starts, another new record (Chart 13).

Between 1975 and the start of the prior recession in 2007, BTRs accounted for a little less than 2.0% of all single-family construction starts, according to an analysis of Census Bureau data.

 

By unit count, there were 68,000 BTR construction starts in the year ending in the third quarter of 2022 — a 42% growth rate from a year earlier. As explored by Ivan Kaufman and Sam Chandan in their Spring 2023 Special Report, increased consumer attention for SFR has allowed the sector to ramp up new construction, even as non-SFR single-family construction starts have slowed.

Tracking Demand

Using Google Trends to track the popularity of the search term “homes for rent” can help identify potential hotspots for SFR demand. Augusta, GA, was the area where “homes for rent” was searched most during the fourth quarter of 2022, dethroning its Georgia neighbor, Macon (Table 1). All the metros within the top 10 most searched locations are found in six southeastern Sun Belt states (Georgia, Tennessee, Alabama, North Carolina, South Carolina and Florida). In addition to demand-side factors, lower average land prices in the Southeast have made the region more attractive to large-scale SFR strategies.

Outlook

Evidenced by its most recent 25 bps rate hike, the Federal Reserve has been seeing progress in its fight against inflation and is starting to slow the pace of its monetary tightening policy. The eventual normalization of interest rates will be a boon for both the housing market and SFR, as the headwinds of uncertainty will weaken. In the year ahead, the SFR sector will see both challenges and opportunities. Homebuilders have been experiencing high cancellation rates and have had trouble offloading inventory. In some cases, homebuilders are even offering substantial mortgage rate buydowns to save deals. As a result, SFR operators are positioned as an alternative type of buyer for homebuilders with oversupplied pipelines. The sustainability of work-from-home and hybrid work will continue to support high levels of rental housing demand outside metro urban cores. While SFR will face cyclical headwinds at the beginning of this year, the long-term outlook remains firmly positive as this product type positions itself as the new American starter home.

1 Unless otherwise noted, the Chandan Economics data covering single-family rental cap rates and debt yields are based on model estimates and a sample pool of loans. Data are meant to represent conditions at the point of origination.

For more single-family rental research and insights, visit arbor.com/articles

Disclaimer All content is provided herein “as is” and neither Arbor Realty Trust, Inc. or Chandan Economics, LLC (“the Companies”) nor their affiliated or related entities, nor any person involved in the creation, production and distribution of the content make any warranties, express or implied. The Companies do not make any representations regarding the reliability, usefulness, completeness, accuracy, currency nor represent that use of any information provided herein would not infringe on other third party rights. The Companies shall not be liable for any direct, indirect or consequential damages to the reader or a third party arising from the use of the information contained herein.

Single-Family Rental Investment Trends Report Q3 2022

Single-Family Rental Investment Trends Report Q3 2022

New Construction Soars as Rent Growth Retreats from its Peak

Key Findings

  • SFR rent growth slows, although it remains elevated, as renewal rent growth gains steam.
  • Cap rates remain unchanged at 5.3% despite rising interest rates.
  • Build-to-Rent (BTR) construction starts totaled 69,000 over the past year, another new record high.

State of the Market

If there is any corner of the U.S. housing market that is still maintaining the momentum of the past few years, it’s the single-family rental (SFR) sector.

 

Broadly, the single-family housing market has reached an inflection. The 30-year fixed rate mortgage averaged 5.6% in the third quarter of 2022 and then accelerated to eclipse 7.0% in October for the first time since 2002. Rising capital costs for potential homeowners have curtailed buying activity and diminished market pricing. In their October 2022 forecast, Fannie Mae predicted that home prices will fall 1.5%
next year.   

 

Within the SFR sector, the overall slowdown likely means a mixed bag of outcomes. On the one hand, SFR asset prices operate within the entire single-family housing ecosystem, meaning any deterioration in the overall housing market will negatively impact SFR valuations. On the other hand, SFR will likely benefit from being well-positioned as a primary alternative for would-be homeowners who have been priced out in the current high-interest-rate housing market.

In the CMBS market, SFR issuance remains active, though the pace of new issuance has slowed since 2021. According to Finsight, SFR CMBS issuance has totaled $10.2 billion through the third quarter of 2022 (Chart 1). At its current pace, SFR CMBS deal activity would finish the year 17.7% below 2021’s record $16.6 billion.

While the housing market sits on shaky ground, the SFR sector has a secure foundation. Several indicators continue to point in a positive direction for SFR. The sector’s share of total construction activity has reached new heights and renewal rent growth is still picking up. At the same time, lenders have started to adjust risk pricing through higher debt yields, while equity investors have yet to meaningfully change their cap rate targets — a possible sign that an adjustment period is on the horizon. All else remaining equal, SFR will have some exposure to changing housing market conditions, though the sector is countercyclically balanced as financial obstacles to homeownership often transfer housing demand to rental units.

Performance Metrics

Originations

Loans for purchasing, not refinancing, accounted for a majority (50.7%) of originations to single-family investors in 2022 for the first time since 2018, according to Fannie Mae (Chart 2). 

The immediate cause of the market shift is the Federal Reserve’s monetary tightening cycle. On November 2, the Fed moved up its benchmark Federal Funds rate by 75 bps for the fourth consecutive meeting in a row. The impact of the Fed’s tightening cycle on interest rates has been dramatic. Mortgage interest rates, which started 2022 just above 3%, have now climbed above 7%.

 

The significant rise in mortgage borrowing costs has meant that fewer existing SFR owners would benefit from refinancing their existing mortgages. Term/rate refinancings, which accounted for 47.3% and 41.2% of originations in 2020 and 2021, respectively, have fallen to 14.2% in 2022. Meanwhile, cash-out refinancings have continued to hold up this year, despite the impact of higher borrowing costs. Through the second quarter of 2022, cash-outs have accounted for 35.1% of SFR lending activity. Often, for smaller investors, accrued equity in existing properties represents the capital needed for a down payment on another. 

Occupancy

As measured by the U.S. Census Bureau, occupancy rates across all SFRs averaged 94.2% in the third quarter of 2022, dropping by 70 bps from the previous quarter (Chart 3). The third-quarter decline was the largest on record since 2013. These data may reflect a slight change in market dynamics, especially as there are increasing reports of rents dropping on a month-over-month basis. As rents fluctuate, tenants opting for new rental units over existing leases could slightly increase the share of vacant units and lower the occupancy rate. Still, the current SFR occupancy rate remains 141 bps above the 2010-2019 average.

Rent Growth

According to DBRS Morningstar, vacant-to-occupied (V2O) annual rent growth has sharply decelerated in recent months, although it remains elevated. In the year ending July 2022, V2O rents are up 12.2% (Chart 4). By comparison, annual V2O rent growth did not eclipse 8.0% from 2015 to 2021. Still, the most recent data represents a clear market inflection. The pace of annual V2O growth fell by 355 bps from a month earlier — the largest single-period decline on record.

For lease renewals, annual rent growth hit a new all-time high in July 2022, reaching 7.9%. Between 2015 and 2019, SFR renewal rent growth consistently ranged between 3.3% and 5.0%. Since February 2021, SFR renewal rent growth has topped 5.0% in 18 consecutive months, marking an unrivaled period of sustained gains.

 

Even if V2O rent growth continues to slow, renewal rent growth is likely to have a longer stretch of above-average increases. From 2015 through the end of 2020, renewal rent growth, on average, outpaced V2O by 0.5% per year. Since 2020, the trend has flipped, with V2O rent growth outpacing renewals by an average of 4.8% per year. As a result, renewal rent growth is likely to close that gap over the next several months.

 

Looking at annual rent growth at the market level, the Sun Belt continues to be a national leader even as growth rates have reached an inflection. According to CoreLogic’s Single-Family Rent Index (SFRI), Miami, Orlando, and Atlanta had the highest annual rent growth across the top 20 U.S. metros through August, climbing by 25.0%, 20.8%, and 11.7%, respectively. However, compared to three months ago, annual growth rates have slowed sharply. Miami has seen the most dramatic slowing, with its annual growth rate dropping by 14.5 percentage points (Chart 5). Of the 20 markets tracked by CoreLogic, only two (New York and Philadelphia) posted higher annual growth totals in August than in May.

Cap Rates

Property-level yields for SFR assets remained flat in the third quarter of 2022, holding at 5.3% (Chart 6).1 The most recent observation keeps SFR cap rates anchored at their all-time low. While cap rates have been compressing, single-family homes have been consistently appreciating. However, the ground has started to shift in recent months. According to the S&P/Case-Shiller Home Price Index, average U.S. home prices fell in both July and August.

The spread between SFR cap rates and 10-year Treasury yields approximates the SFR risk premium. Unwavering SFR cap rates in the third quarter of 2022, matched with growing Treasury yields, narrowed the risk spread by 17 bps — its fourth consecutive quarterly decrease. In total, the risk premium sits at just 223 bps, which is another record low (Chart 7). Compared to one year ago, this risk premium is down by 194 bps.

The cap rate spread between SFR assets and multifamily properties marginally narrowed, by 9 bps, settling at 68 bps. Over the past decade, SFR-multifamily cap rate spreads have fallen from a high of 496 bps in 2012. Increased liquidity and tech adoption have allowed the SFR sector to operate more efficiently over the past decade, generating a bid-down of its risk premium. Over the long term, some positive yield differential between SFR and multifamily assets remains likely — accounting for the co-location efficiencies and shared physical inputs.

 

Pricing

There are consistent differences between the average assessed property values on mortgages originated to single-family owner-occupants versus single-family investors since 2006. Investors are incentivized to target value-add assets rather than paying top dollar for value that already exists. Additionally, investor-owned SFR properties have vacancies, turnover, and management-related expenses that owner-occupied units do not have, contributing to lower values for the rental units.

 

Nevertheless, the gap has narrowed dramatically over the past decade, coming down from above 30% in the aftermath of the Financial Crisis to the 10% range where it sits today, according to an analysis of Fannie Mae securitized mortgages. The valuation gap has averaged 10.9% in 2022, rising 189 bps from its average last year (Chart 8).

A slight annual increase in the valuation gap has emerged as valuations across all single-family properties have declined this year. The average underwritten value of a single-family investment property through the first half of 2022 was $362,302, a drop-off of 2.3% from the 2021 average. Owner-occupied units held an average underwritten valuation of $406,541 in 2021, down 0.3% from last year (Chart 9).

Debt Yields

Debt yields, a key measure of credit risk, rose by 46 bps during the third quarter of 2022, jumping to 9.3% (Chart 10). The rise marked the third consecutive quarterly increase, signaling that lenders are exercising caution as economic headwinds mount and the housing market slows.

The rise in debt yields over the past three quarters translates to SFR investors securing marginally less debt capital for every dollar of property-level net operating income (NOI). Through the third quarter of 2022, SFR debt declined to $10.70 for every dollar of NOI, a decrease of $0.55 from the second quarter and $0.69 from the same time last year. 

Supply & Demand Conditions

Residential Default Rates

According to the Federal Deposit Insurance Corporation (FDIC), mortgage default rates fell to a new post-Financial Crisis low of 1.6% in the second quarter of 2022 — a positive sign that, despite the housing market’s pricing slowdown, borrower distress remains exceptionally limited (Chart 11). 

In the aftermath of the 2008 housing crisis, investors with available financing took advantage of the market dislocation, acquiring large portfolios of single-family assets at steep discounts. A similar scenario happening again in this current market is extremely unlikely. Central to the 2008 housing market crash were several factors, such as a deteriorating labor market, relatively high average debt burdens for households, and overexposure of the U.S. banking system to mortgages, which are not present today.   

Build-to-Rent

Purpose-built SFR properties, known as BTR communities, are becoming a defining feature of the SFR sector, especially within the institutional slice of the market. In the past year, BTR has accounted for 6.1% of all single-family construction starts, a new record for the product type.  

Between 1975 and the start of the prior recession in 2007, BTRs accounted for a little less than 2.0% of all single-family construction starts, according to an analysis of Census Bureau data. 

Over the past decade, BTR construction activity has risen appreciably. By unit count, there were 69,000 BTR construction starts in the year ending in the second quarter of 2022 — a 60% growth rate from a year earlier and a new all-time high (Chart 12). The second-quarter total is a 17% jump from its previous all-time high, which was reached just in the prior quarter.

While recent construction totals represent significant market expansion, they are also likely to be understated. The BTR estimate does not include units that have been started and sold to SFR operators (build-for-rent or BFR), as covered in a recent Arbor-Chandan article.

Tracking Demand

Using Google Trends to track the popularity of the search term “homes for rent” can help identify potential hotspots for SFR demand. Macon, GA, was the area where “homes for rent” was searched most during the third quarter of 2022, dethroning Memphis, TN (Table 1)All the metros within the top 10 most searched locations are found in the Sun Belt — further evidence of the region’s epicenter status for the SFR industry. In addition to demand-side factors, lower average land prices in the Southeast have made the region more attractive to large-scale SFR strategies.

Outlook

Following 2022’s marquee year, SFR’s outlook remains highly favorable. In the newly released ULI-PwC 2023 Emerging Trends in Real Estate, rental housing investors remain firmly upbeat about the sector, giving it the second-highest “buy” rating of the six polled residential sub-types. A plurality (42.3%) of investors rate SFR as a buy, compared to just 17.0% giving the sector a “sell” rating. On the horizon, there are some warning signs to watch. Namely, the sustainability of record-low capitalization rates should be in question as home prices decline and lenders raise their required debt yields. However, the immediate outlook for the SFR sector remains positive. All else being equal, its position as the homeownership alternative should be seen as a sign of countercyclical stability in the current market environment while the long-term tailwinds of institutionalization and professionalization will remain at the sector’s back.

1 Unless otherwise noted, the Chandan Economics data covering single-family rental cap rates and debt yields are based on model estimates and a sample pool of loans. Data are meant to represent conditions at the point of origination.

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