Research Report Category: Single-Family Rental Investment Trends

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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.

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

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%.

Table of Contents

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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

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).

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.

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

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.

Table of Contents

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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.

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

Single-Family Rental Investment Trends Report Q2 2022

Rent Growth and New Construction Trend Higher as Cap Rates Edge Lower

Key Findings

Vacant-to-occupied rent growth surges again, reaching 14.8% year-over-year.
Cap rates slide back to 5.3%, just above all-time lows.
Build-to-rent construction starts totaled 57,000 over the past year, a new record high.

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State of the Market

At a time when economic growth is slowing, the single-family rental (SFR) market is flourishing.

The cost of homeownership rose again in the second quarter, with 30-year fixed mortgage rates averaging 5.3% — their highest quarterly average since 2008. Even as there are reports of new homebuyer momentum cooling, prices remain near record highs. The combination of record prices and high borrowing costs is now leading would-be homeowners to seek alternatives, supporting the demand for SFR.

In the CMBS market, SFR issuance reached a record $16.6 billion in 2021 — nearly doubling 2020’s total of $8.9 billion, according to Finsight. Through the second quarter of 2022, issuance soared 34% above the mark set at 2021’s midpoint (Chart 1) to reach $8.5 billion. Further, SFR’s market cap reached $4.4 trillion.

The growing success of the SFR sector has not gone unnoticed, including on Capitol Hill. In late June, the U.S. House Committee on Financial Services convened a hearing to explore the role single-family investors have played in declining affordability. According to the testimony of Brookings Metro Senior Fellow Jenny Schuetz, the growth of the institutional SFR sector has been a symptom, not a cause, of tight housing markets. Her testimony is in line with recent research from Freddie Mac that identifies record-low mortgage rates and limited new homebuilding as the primary culprits for declining home affordability. Further, according to a recent Arbor-Chandan analysis, the overall share of rentals in the housing market has remained balanced in recent years, even with the growing wave of institutional participation.

On balance, the specter of potential market-limiting legislation cannot be ignored. At the same time, the sector is well-positioned to see continued growth in the second half of 2022. SFRs are uniquely capable of offsetting the effects of inflation through annual rent renewals, and the sector remains insulated from a potential impending recession as would-be homebuyers are re-engaging with the rental market in larger numbers.

Performance Metrics

Originations

According to a Chandan Economics analysis of Fannie Mae data, a lending source for mostly non-institutional borrowers, refinancing, instead of acquiring, has accounted for the majority of recent originations to single-family investors. However, as the Federal Reserve has kicked off its monetary tightening cycle and market interest rates have risen in 2022, the splits between acquisitions and refinancings have started to look more balanced. In 2020, refinancing activity accounted for 71.0% of tracked originations (Chart 2). In 2021, the refinancing share remained elevated at 68.8%. Through the first quarter of 2022, the refinancing share dropped all the way down to 58.5% of originations. The decline was driven by a significant decrease in term/rate refinancings. Term/rate refinancings accounted for 47.3% and 41.3% of SFR originations in 2020 and 2021, respectively. So far in 2022, they have only accounted for 19.5% of originations.

Occupancy

As measured by the U.S. Census Bureau, occupancy rates across all SFRs averaged 94.9% in the second quarter of 2022, holding steady from the first quarter of the year (Chart 3). The second-quarter reading keeps the SFR occupancy rate within 40 basis points (bps) of its generational high — indicating that the sector is operating at or near full potential occupancy.

Rent Growth

According to DBRS Morningstar, vacant-to-occupied (V2O) annual rent growth accelerated to an unprecedented high of 16.7% in July 2021 (Chart 4). Thereafter, rent growth on new leases slowed, lessening in four of the next six months. V2O rent growth totaled 11.4% year-over-year in January 2022, and while it remained high by historical standards, the pattern was clearly that of falling momentum. Then, surprisingly, V2O re-inflected in February and posted higher totals in three consecutive months through May. By the end of May 2022, rents on new leases were up 14.8% from a year earlier.

The ‘twin peaks’ of extraordinarily robust SFR rent growth over the last two years can be attributed to two independent forces. A wave of new single-family housing demand during the COVID-19 pandemic and an increase in hybrid work adoption led to what can be best described as a recalibration of market pricing. The more recent surge in rent growth is attributable to high levels of inflation, which operators consider when resetting rents.

For lease renewals, annual rent growth slid to 7.2% in April, the most recent reading. This was down from the all-time high of 7.9% in February, although remained well above baseline levels of growth. Between 2015 and 2019, SFR renewal rent growth consistently ranged between 3.3% and 5.0%.

Analyzing rent growth at the market level, unsurprisingly, the Sun Belt has maintained its dominance. According to CoreLogic’s Single-Family Rent Index, annual rent growth across the top 20 U.S. metros through May was highest in Miami (39.5%), Orlando, (24.8%), and Las Vegas (16.7%). All of the tracked Sun Belt metros saw rent growth totals above 9.7% in the year ending May 2022.

Cap Rates

Property-level yields for SFR assets ticked down in the second quarter of 2022, falling by 29 bps to settle at 5.6% (Chart 5).¹ The second-quarter observation brings SFR cap rates within 5 bps over their all-time low in the fourth quarter of 2021. According to the S&P/Case-Shiller National Home Price Index, U.S. home prices were up 19.8% from a year ago through May 2022. With single-family annual home price growth reaching record highs over the past year, it has created downward pressure on SFR cap rates. However, home price growth is losing momentum throughout the country. If home price appreciation recedes from its record high levels and SFR rent growth maintains its pace, SFR cap rates are likely to see some upward influence through the second half of 2022. Historically,

rent inflation trends lag behind the overall inflation rate, making the above scenario more likely.

Compressing SFR yields in the second quarter of 2022 matched with growing Treasury yields causing the risk spread to narrow by a weighty 127 bps. In total, the risk premium sits at just 239 bps — its lowest rate on record by a sizeable 87 bps (Chart 6).

The cap rate spread between SFR assets and multifamily properties also narrowed, albeit by a more marginal 10 bps, settling at 76 bps. Over the past decade, SFR-multifamily cap rate spreads have narrowed from a high of 496 bps in 2012 to the sub-100 bps levels observed today. 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

According to a Chandan Economics analysis of Fannie Mae securitized mortgages, there are material differences between the average assessed property values on mortgages originated to single-family owner-occupants versus single-family investors. The average underwritten value of a single-family investment property in 2022 has averaged $365,313 compared to $413,988 for owner-occupied units (Chart 7).

Through the first quarter of 2022, there is an average valuation gap of 11.8% on units purchased for investment vs. for an owner-occupant — an increase of 258 bps from the 2021 average. Several factors are likely to contribute to this valuation gap, one being that many investors are targeting value-add assets rather than paying top dollar for value that already exists. Additionally, investor-owned SFR properties have vacancy, turnover, and management-related expenses that owner-occupied units do not have to account for, contributing to lower values for these types of rental units. Nevertheless, the gap has narrowed dramatically over the past decade.

Between 2004 and 2011, the valuation gap sat in a consistent range of 27.2% to 32.5% (Chart 8). As more investors and capital entered the SFR space, discounted investment units became harder to find and competition for inventory ramped up, sending the valuation gap to an all-time low of 5.4% in 2017. With demand for single-family housing reaching a fever pitch leading up to and through the pandemic, the valuation gap has rebounded in recent years.

Debt Yields

Debt yields, a key measure of credit risk, rose by 15 bps during the second quarter of 2022, settling at 8.9% (Chart 9). The increase marked the second consecutive quarterly increase after nearly two years of uninterrupted declines.

The slight debt yield increases over the past two quarters translate to SFR investors securing marginally less debt capital for every dollar of property-level net operating income (NOI). Through the second quarter of 2022, SFR debt declined to $11.26 for every dollar of NOI, a $0.19 decrease from the prior quarter, yet still up by $0.43 from this time last year.

Supply & Demand Conditions

Residential Default Rates

default rates peaked at 8.1% in 2012, leading to an abundance of distressed sales and accelerated institutional growth in the SFR sector (Chart 10).

The pandemic had a much different impact on the housing market than the Great Recession. Between growing asset prices and federally directed forbearance, homeowner defaults remained uncommon during the pandemic. Default rates hit a pandemic high of 2.5% in the fourth quarter of 2020 — just 74 bps above its all-time low. As of the first quarter of 2022, single-family default rates declined for five consecutive quarters, settling at 1.8%.

Build-to-Rent

Purpose-built SFR properties, known as build-to-rent (BTR) communities, continue to become a defining feature of the SFR sector, especially within the institutional slice of the market.

Based on an analysis of Census Bureau data, 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 (Chart 11). In 2013, BTR’s percentage share of construction starts reached an all-time high of 5.8%, and through the first quarter of 2022, the share remained elevated at 5.0%. Moreover, the BTR share of single-family home construction has increased for three consecutive quarters.

Measuring by unit count, there were 57,000 BTR construction starts in the year ending in the first quarter of 2022 — a 33% increase from a year earlier and a new all-time high. While these construction totals represent significant market expansion, they are also like to be understated. The single-family construction starts data does not include units that have been started and sold to SFR operators (build-for-rent or BFR). In a recent Arbor-Chandan analysis, Chandan Economics estimates that the total number of SFR construction starts in 2021 may have been as high as 90,000.

Tracking Demand

Utilizing Google Trends, the popularity of the search term “homes for rent” can shed light on the hotspots of SFR demand in different markets across the country. Memphis, TN, was the area where this term was searched most during the second quarter of 2022, dethroning Savannah, GA, which had seen the highest search frequency in the previous quarter (Table 1).

The Sun Belt continues to be the region driving the most SFR demand, with the southeast corner of the country being its tightly packed epicenter. All of the metros in the top 10 are located in just five states: Georgia, Tennessee, South Carolina, Alabama, and North Carolina. Affordability, lower taxes, and warmer weather are among the leading reasons why these states top the list.

Outlook

The SFR sector had a marquee year in 2021, and through 2022’s halfway point, it performed in a similar fashion. Cyclical forces are aiding the sector even as macroeconomic momentum slows. A recent Gallup poll indicates that a record low share (30%) of Americans think that right now is a good time to buy a home. Combining this with the fact that Americans are increasingly favoring suburban housing options, the SFR sector’s favorable outlook is clear. The potential for new housing legislation targeted toward rentals is a potential uncertainty that should remain on the sector’s radar. However, all told, the immediate outlook for the sector remains firmly positive, as a bedrock of demand, a countercyclical business model, and the ability to absorb inflation are uniting to propel the SFR market upward in an otherwise challenged macroeconomic period.

¹ Unless otherwise noted, the Chandan Economics data covering single-family rental cap rates, loan-to-value ratios, 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

Single-Family Rental Investment Trends Report Q1 2022

Cap rates hold steady as valuations accelerate into Spring 2022

Key Findings

Annual rent growth for lease renewals reaches 7.8% — a new all-time high.
Cap rates rise to 5.6% as cashflows strengthen.
First-quarter SFR securitizations are up more than double from last year.

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