Research Report Category: Single-Family Rental Investment Trends

Single-Family Rental Investment Trends Report Q3 2024

Single-Family Rental Investment Trends Report Q3 2024

SFR Construction Hits Another All-Time High as Structured
Capital Markets Rebound

Key Findings

  • SFR/BTR construction starts surged to another new record high.
  • SFR CMBS activity in 2024 is on pace to triple last year’s total.
  • Cap rates rose to their highest point in more than six years as rent growth remained healthy.

Table of Contents

State of the Market
Performance Metrics
Supply & Demand Conditions
Outlook

PDF link below

State of the Market

As the single-family rental (SFR) sector expands, its structural strengths continue to counterbalance the challenges of a high-interest rate environment. In construction starts and other fundamental areas, clear signals have emerged that it is well-positioned for another growth spurt.

In recent quarters, institutional investors have focused on ground-up, purpose-built development rather than acquisitions of existing properties, resulting in a build-to-rent (BTR) construction surge.

The SFR sector, including single-family homes for rent, scattered site portfolios, and BTR communities, has a robust set of underlying demand fundamentals right now as access to affordable homeownership remains challenging amid high interest rates, limited available supply, and elevated home prices. According to data from the Federal Reserve Bank of Atlanta, buying a house is about 38% less affordable today than in 2020.

While the challenging conditions associated with high interest rates continue to impact cap rates and debt yields, most other gauges of SFR performance have either stabilized or improved. Structured SFR capital markets saw a burst in activity through 2024’s first half, and distress remained minimal within the sector and throughout the broader housing market. Even as inflation pushes the cost of living higher, occupancy rates are stable, rent growth remains healthy, and construction momentum is gaining steam.

As we move through the second half of the year, SFR’s structural strengths give it a solid foundation to grow as economic conditions continue normalizing.

Performance Metrics

CMBS Issuance

Structured SFR capital markets have seen distinct signs of improvement so far this year, Finsight data shows. SFR CMBS issuance has totaled $4.2 billion through the first half of 2024 — 143% more than the output from the second half of 2023 ($1.7 billion) (Chart 1). If issuance in 2024’s second half matches or exceeds the first six months of the year, total production would at least triple 2023’s mark. While issuance levels have been below the historical highs registered during 2021 and 2022, this year’s pace of activity, if sustained, would be roughly in line with 2020’s tally and more than double 2019’s level, another encouraging sign of a normalization underway.

Originations by Purpose

New acquisition loans have accounted for the lion’s share of SFR originations since 2022 as the interest rate environment has reduced the incentive for refinancings. According to Fannie Mae, new loans intended for purchasing have accounted for 78.2% of SFR lending activity in 2024, the highest share on record going back to 1999 (Chart 2). By contrast, rate-and-term refinancing loans, which accounted for 47.3% of originations just four years ago, accounted for 7.2% of 2024’s lending activity through the first quarter.

The rolling four-quarter dollar volume of rate-and-term refinancings fell by 45.0%, compared to one year ago, an analysis of Fannie Mae data shows (Chart 3). Cash-out refinancings also dropped significantly, declining by 57.7%. However, investor single-family purchases declined less rapidly, sliding by 28.6%. The dip in SFR purchasing activity was in line with the owner-occupant segment of the market, where single-family home purchases by first-time and non-first-time homebuyers retreated at a pace of 24.9% and 23.8%, respectively.

Occupancy

Occupancy rates across all SFR property types averaged 94.6% in the second quarter of 2024, according to U.S. Census Bureau data (Chart 4). The second quarter’s SFR occupancy rate was slightly lower (-10 bps) than the prior quarter’s rate, though it was up 10 bps from the same time last year. DBRS Morningstar, which tracks the performance of 133,664 SFR units within its rated CMBS transactions, reported a similar SFR occupancy rate of 92.4%
through May 2024.

Rent Growth: National

National SFR rent growth continued to increase at a healthy pace. According to Zillow’s Observed Rent Index for single-family rental properties, rents in the sector were up 4.7% from a year earlier through July 2024 (Chart 5). While rent growth retreated from the double-digit growth rates of 2021 and 2022, the current pace of increase remains robust by historical standards. Even though SFR rent growth slid in the past four consecutive months, the current annual growth rate was slightly above the pre-pandemic (2016-2019) average of 4.4%.

DBRS Morningstar’s latest SFR report shows the resumption of seasonal patterns for rent growth, lease renewals, and tenant turnover. Vacant-to-occupied (V2O) rent growth sat at 3.5% through April 2024 — up from 0.7% six months earlier. Renewal rent growth, which generally accounts for 80-85% of the sector’s units, stood higher at 6.0% over the same period. Notably, renewal rent price momentum has re-accelerated over the past four months of data, with the annual growth rate rising by 1.7 percentage points in that time frame.

Rent Growth: Metros

Among the top 20 SFR hotspot markets (defined here as markets with the highest SFR share of rentals across the top 50 metros by population), Indianapolis has been seeing the most robust levels of SFR annual rent growth, with prices rising 7.7% from a year earlier through July 2024 (Chart 6). Closely behind was Kansas City, KS (+7.0%), and Richmond, VA (+6.7%). At the other end of the spectrum are several Sun Belt markets that accelerated most quickly during the post-pandemic boom and cooled afterward, including Phoenix, AZ (+2.0%), Tampa, FL (+2.9%), and Jacksonville, FL (+3.3%).

Cap Rates

Average cap rates across the SFR sector moved higher again in the second quarter of 2024, rising 26 bps to 6.8%1 (Chart 7). Cap rates rose in seven of the past 10 quarters, increasing by 149 bps, and have hit their highest point since the first quarter of 2018. With interest rates elevated, investors have been broadly revising their yield requirements. The continued upward movement of cap rates comes as transaction-based measures of home prices slid again in the second quarter of 2024 and property-level incomes rose.

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.

The spread between SFR cap rates and 10-year Treasury yields approximates the SFR risk premium. In the second quarter of 2024,10-year Treasury notes carried an average yield of 4.5%, jumping from 4.2% in the first quarter. With average Treasury yields and SFR cap rates rising, the SFR risk premium held relatively flat, falling by a negligible three bps to settle at 231 bps in the second quarter (Chart 8). Meanwhile, the spread between SFR and multifamily properties widened slightly by 12 bps, averaging 117 bps.

Pricing

The average valuation of a single-family rental that received a Fannie Mae mortgage in the first quarter of 2024 was $362,343 — up 0.8% from the 2023 average (Chart 9). During the same time frame, average valuations for owner-occupied units are up by a comparable 1.1%, reaching $420,790.

Historically, the average assessed property values on mortgages originated to single-family owner-occupants and single-family investors have been consistently different. Underwriters consider factors in rental properties (such as vacancies, turnover, and management-related expenses) that are not present in owner-occupied units, contributing to generally lower assessed values for rentals. Average property values are also lower because investors are incentivized to target value-add assets rather than paying higher prices for existing value.

While underwritten valuation gains have been marginal, trends this year have been encouraging. After valuations declined for both renter-occupied and owner-occupied single-family homes in 2022, each segment bounced higher in 2023 and has continued to do so thus far in the 2024 data. Notably, these trends contrast with transaction-based price indices, such as the Federal Reserve Bank of St. Louis’ Median Home Sales Price Index, which continued to decline. This divergence reflects current market conditions in which lower-priced homes have a wider pool of buyers and sellers.

Debt Yields

Debt yields, a key measure of credit risk, jumped again during the second quarter of 2024, rising by 31 bps to finish at 11.1% (Chart 10). The increase marked the eighth time debt yields have risen in the past 10 quarters, indicating 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 $1.00 of property-level net operating income (NOI). Through the second quarter of 2024, SFR debt declined to $9.02 for every $1.00 of NOI, a decrease of $0.26 from the previous quarter and a drop of $0.64 from the same time last year.

Supply & Demand Conditions

Build-to-Rent (BTR)

BTR communities have become a defining feature of the SFR sector. Through the second quarter of 2024, BTR development remained robust, with aggregate production and single-family market share both pushing up against all-time highs. Over the past 12 months, BTR accounted for 8.1% of all single-family construction starts, reclaiming the record high for the product type (Chart 11). For comparison, before the SFR sector institutionalized in the aftermath of the 2007-09 recession, the BTR share of single-family construction never eclipsed 3.1%. By unit count, 83,000 BTR construction starts were recorded in the 12 months that ended in the second quarter of 2024 — another new record high. Notably, the rolling annual sum is up by 20.3% when compared to a year ago, demonstrating the sustained surge in BTR development.

Residential Distress

Even with elevated mortgage interest rates, there has been little to no distress across the U.S. housing market. The Federal Reserve Bank of New York’s Q2 2024 Quarterly Report on Household Debt and Credit indicated that only 0.6% of household mortgages were more than 90 days delinquent through the second quarter of 2024, which is half of a percentage point below where default rates were at the start of the pandemic (Chart 12).

 

Within the SFR sector, evidence suggests that distress patterns mirror the broader single-family ecosystem, with delinquency rates dropping considerably. According to DBRS Morningstar, within rated SFR CMBS transactions, 2.4% of loans were delinquent in May 2024 — nearly half the 4.2% rate reported one year earlier (Chart 13).

Outlook

Investors broadly expect that the Federal Reserve will loosen monetary policy this year, adding momentum to an ongoing normalization of real estate capital markets. Regardless, the SFR sector has not waited to hear the Fed’s starting bell.

With structural tailwinds overmatching cyclical headwinds, BTR construction’s gains this quarter were clear evidence of a sector on the rise. SFR’s short- and long-term prospects continue to be bright due to its long-term demand profile and a strong pipeline, which will limit the need for conversions.

As the math behind rent-versus-buy calculations changes, single-family homes for rent continue to be an attractive option for many would-be buyers priced out of the housing market. On balance, while risks and challenges remain, investments in purpose-built communities and scattered site portfolios are solidly positioned to grow and even outpace its current gains in future quarters.



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Disclaimer
This report is intended for general guidance and information purposes only. This report is under no circumstances intended to be used or considered as financial or investment advice, a recommendation or an offer to sell, or a solicitation of any offer to buy any securities or other form of financial asset. Please note that this is not an offer document. The report is not to be considered as investment research or an objective or independent explanation of the matters contained herein and is not prepared in accordance with the regulation regarding investment analysis. The material in the report is obtained from various sources per dating of the report. We have taken reasonable care to ensure that, and to the best of our knowledge, material information contained herein is in accordance with the facts and contains no omission likely to affect its understanding. That said, 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 or warranties, express or implied, as to 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. There may have been changes in matters which affect the content contained herein and/or the Companies subsequent to the date of this report. Neither the issue nor delivery of this report shall under any circumstance create any implication that the information contained herein is correct as of any time subsequent to the date hereof or that the affairs of the Companies have not since changed. The Companies do not intend, and do not assume any obligation to update or correct the information included in this report. The contents of this report are not to be construed as legal, business, investment or tax advice. Each recipient should consult with its legal, business, investment and tax advisors as to legal, business, investment and tax advice. The information contained herein may be subject to changes without prior notice. This report is only intended for the recipients, and should not be copied or otherwise distributed, in whole or in part, to any other person.

Single-Family Rental Investment Trends Report Q2 2024

Single-Family Rental Investment Trends Report Q2 2024

SFR Construction Soars as Rent Growth Remains Robust

Key Findings

  • SFR/BTR construction starts surged to another new record high.
  • CMBS activity jumped, signaling improvements in structured capital markets.
  • Cap rates climbed to 6.6% amid high interest rates and robust rent growth.

Table of Contents

State of the Market
Performance Metrics
Supply & Demand Conditions
Outlook

PDF link below

State of the Market

Despite ongoing challenges in the capital markets environment, the strength of the single-family rental (SFR) sector has become fully apparent. As it reaches new highs quarter after quarter and build-to-rent (BTR) construction surges, optimism is building in SFR’s long-term prospects.

 

SFR construction has shown considerable gains since homeownership became substantially less affordable after interest rates started rising in March 2022. According to data from the Atlanta Federal Reserve Bank, buying a home is about 29% less affordable today than at the onset of the pandemic. As a result, BTR communities have attracted the attention of tenants and investors, driving the number of SFR/BTR construction starts to an all-time high.

 

While the interest rates have presented real challenges, the SFR sector’s favorable balance of tailwinds is unmistakable. Occupancy rates are stable, rent growth remains robust, and construction momentum has never been stronger. As 2024’s midpoint approaches, SFR’s structural strengths continue to outweigh cyclical headwinds.

Performance Metrics

CMBS Issuance

Structured SFR capital markets registered high levels of activity to start the year. According to Finsight, SFR CMBS issuance totaled $1.9 billion in the first quarter of 2024 — more than doubling the output of $713 million in the fourth quarter of 2023 (Chart 1). Additionally, issuance in the first quarter reached its highest quarterly total since the middle of 2022. If SFR CMBS issuance were to sustain its first-quarter pace through the balance of the year, the annual total would reach $7.7 billion, a 45% increase from its 2015-2019 average of $5.3 billion.

Originations by Purpose

With elevated interest rates reducing the incentive for refinancing, new acquisition loans have accounted for the lion’s share of SFR originations over the past two years. According to Fannie Mae, new loans intended for purchasing accounted for 78.0% of SFR lending activity in 2023 — the highest share on record going back to 1999 (Chart 2). Simultaneously, rate-and-term refinancing loans, which accounted for nearly 50% of originations as recently as 2020, were 5.8% of 2023’s lending activity.

In 2023, the dollar volume of rate-and-term refinancings fell by 74.5% from the previous year, according to an analysis of Fannie Mae data (Chart 3). Cash-out refinancings dropped similarly, decreasing 74.2%. However, investor pullback in single-family purchases was only 38.6%, about half as severe as the decline was for refinancings. The recent slide in SFR purchasing activity has been comparable to trends in other commercial real estate sectors. For example, single-family home purchases by first-time and non-first-time homebuyers fell by 30.0% and 27.0%, respectively.

Occupancy

SFR occupancy rates remained strong through the first three months of the year and continued to support the sector’s structural health. Occupancy rates across all SFR property types averaged 94.7% in the first quarter of 2024, according to U.S. Census Bureau data (Chart 4). The first quarter average SFR occupancy rate was an improvement of 30 bps over the prior quarter and an increase of 30 bps over the same time last year. DBRS Morningstar, which tracks the performance of 128,350 SFR units within its rated CMBS transactions, reported a similarly healthy SFR occupancy rate of 92.9% through February 2024, another sign that renter interest in SFR continues to be high.

Rent Growth: National

National SFR rent growth climbed at a healthy pace through 2024’s first quarter mark. According to Zillow’s Observed Rent Index (ZORI) for single-family rental properties, rents in the sector were up 5.0% from a year earlier through March 2024 (Chart 5). While rent growth slowed from the lofty, unsustainable double-digit growth rates seen in 2021 and 2022, the pace of increase remained robust by historical standards. The first quarter’s growth rate sits well above the pre-pandemic (2016-2019) average of 4.4% for the sector.

Data from DBRS Morningstar helps to shed light on the difference in rent growth trends between renewing leases and properties that have turned over with a new set of tenants. According to the company’s latest report, vacant-to-occupied (V2O) rent growth resumed seasonal patterns, where rent growth peaks in the spring and bottoms out in the fall, with current V2O growth sitting at 2.0% through January 2024. Rent growth for renewals, which generally accounts for more than 80% of the sector’s leased units, stood higher at 4.7%.

Rent Growth: Metros

Of the top 20 SFR hotspot markets — those with the highest SFR share of rentals among the 50 most populous metros — Richmond, VA, had the most robust levels of SFR rent growth through March 2024, with prices rising 8.1% from a year earlier (Chart 6). Following closely behind was St. Louis, MO, with an increase of 7.7% and Birmingham, AL, which saw 7.5% growth. At the other end of the spectrum are a few markets where rent growth accelerated most quickly during the post-pandemic boom and has since cooled, including Phoenix, AZ (+2.5%), Las Vegas, NV (+3.4%), and Memphis, TN (+3.4%).

Cap Rates

SFR cap rates ascended again in the first quarter of 2024, climbing 11 bps to 6.6% (Chart 7).1 Cap rates have now risen in six of the past nine quarters, increasing by a total of 132 bps to hit their highest point since the second quarter of 2018. In today’s elevated interest rate environment, investors have broadly revised their yield requirements. The ongoing upward movement of cap rates comes as home prices slid slightly nationally in the first quarter of 2024 and resilient rent growth continues to support rising property-level incomes.

Another key measure of the health of the SFR market is the spread between SFR cap rates and 10-year Treasury yields that approximates the SFR risk premium. In the first quarter, 10-year Treasury notes carried an average yield of 4.2%, falling from 4.5% during the fourth quarter of 2023. As average Treasury yields fell and SFR cap rates rose, the SFR risk premium climbed 243 bps in the first quarter (Chart 8). At the same time, the spread between SFR and multifamily properties widened slightly by 5 bps, averaging 116 bps.

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, not present in owner-occupied units, that contribute to generally lower assessed values for rental units. Additionally, SFR investors often target value-added assets instead of paying premium prices for properties with higher existing value.

 

The average valuation of a single-family rental property that received a Fannie Mae mortgage in 2023 was $344,761 — down 2.8% from the 2022 average (Chart 9). During the same time period, average valuations for owner-occupied units increased 3.3%, reaching $415,575. Subsequently, the average underwritten valuation gap between the two groups of properties increased to 17.0% — its widest point since 2012.

The drop-off in SFR valuations on properties with Fannie Mae mortgages in 2023 reflects heightened caution among buyers. Investors want to have a high degree of confidence that their assets will appreciate over the short term to justify making a purchase. In a housing market with recent price instability and a dearth of transaction activity, many investors require higher yields and lower prices to execute an acquisition.

Debt Yields

Debt yields, a key measure of credit risk, jumped again during the first quarter of 2024, rising by 23 bps to land at 10.9% (Chart 10). The increase marked the seventh time debt yields have risen in the past nine quarters, highlighting that lenders have remained diligent in an unsettled investment climate. The rise in debt yields in recent quarters translated to SFR investors securing less debt capital for every dollar of property-level net operating income (NOI). Through the first quarter of 2024, SFR debt declined to $9.16 for every dollar of NOI, a decrease of $0.20 from the previous quarter and a drop of $0.78 from the same time last year.

Supply & Demand Conditions

Residential Distress

Even with mortgage rates remaining above 7%, there has been little to no distress across the U.S. housing market. Most homeowners have locked-in rates that are well below prevailing market norms, resulting in a shrinking of available housing inventory, and home valuations pressing all-time highs. Meanwhile, underwriting standards have tightened for borrowers who are applying for mortgages. According to the Federal Reserve Bank of New York’s Q1 2024 Quarterly Report on Household Debt and Credit, the share of new borrowers with a credit score above 760 has risen in four consecutive quarters and currently sits at 70.5%.

 

The New York Fed’s report indicated that only 0.9% of household mortgages are more than 90 days delinquent, slightly below where default rates were at the start of the pandemic (Chart 11). Mortgage performance trends differ from other types of household debt that are more sensitive to variable interest rates, such as credit cards. In the past year, the share of mortgages that are more than 90 days delinquent rose by 16 bps. Meanwhile, the share of credit card debt that is seriously delinquent rose 245 bps. These two disparate trends underscore that although some of the conditions necessary for distress are present, the unique contours of the mortgage market have thus far insulated the housing sector from interest-rate-driven defaults.

Within the SFR sector, newly released data suggests that distress patterns mirror the broader single-family ecosystem. According to DBRS Morningstar, within rated SFR CMBS transactions, only 2.9% of loans were delinquent in February 2024 — nearly half the 5.4% rate reported one year earlier (Chart 12).

Build-to-Rent

BTR communities have become a defining feature of the SFR sector. Through the first quarter of 2024, BTR production was robust. Over the past 12 months, BTR accounted for 8.0% of all single-family construction starts, remaining near its record high (Chart 13). For comparison, before the 2007-2009 recession ended, the BTR share of single-family construction never eclipsed 3.1%. By unit count, there were 80,000 BTR construction starts in the 12 months ending in the first quarter of 2024 — also a new record high. Compared to a year ago, the rolling annual sum is up by 15.9%, demonstrating a sustained surge in development.

Outlook

Even as the impact of persistently high interest rates is readily apparent, the structural strengths of the SFR sector are impossible to ignore. The continued surge in BTR construction shows undeterred optimism in SFR’s long-term prospects. Its strengthening pipeline continues to reduce the need for converting existing single-family homes into rental units. Property-level yields remain heavily influenced by movements in the broader interest rate environment. With barriers to ownership increasing for would-be homebuyers, single-family rental homes continue to absorb an increasing share of housing demand generated by Generation Z, lifestyle renters, and even downsizing Baby Boomers. Strengthened by sound fundamentals, SFR is surging and has room to grow within the multifamily real estate sector.

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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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 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.

Table of Contents

State of the Market
Performance Metrics
Supply & Demand Conditions
Outlook

PDF link below

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.

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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.

Table of Contents

State of the Market
Performance Metrics
Supply & Demand Conditions
Outlook

PDF link below

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.

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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.

Table of Contents

State of the Market
Performance Metrics
Supply & Demand Conditions
Outlook

PDF link below

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.

Whitepaper-2023-Q3-Chandan-Single-Family-Report-table1

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.

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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.

Table of Contents

State of the Market

Performance Metrics

Supply & Demand Conditions

Outlook

PDF link below

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.

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