At the start of 2021, we have had the better part of a year to assess the effects of the COVID-19 pandemic. Although the impact on the U.S. real estate market has varied, the strength of single-family housing appears to be one of the few areas of consistency.
For commercial mortgage brokers looking to expand their client base in 2021 and beyond, single-family rental investor loans are an attractive option. With abundant capital available from lenders, brokers who work within this space are likely to draw new clients. Investors are looking to capitalize on a growing demand for single-family rentals, a trend that will surely outlast the current crisis.
Federal, state and local responses to the ongoing pandemic yielded a wide range of outcomes across real estate markets, asset classes and market participants. Yet there has been one consistent trend during the pandemic: Single-family homes are more valuable now than ever.
Since 2006, single-family rentals have been the fastest-growing segment of the housing market, according to the National Rental Home Council. Single-family homes comprised about one-third of the nation’s 47.2 million rental units in 2018, according to the Joint Center for Housing Studies of Harvard University (JCHS). Although the pandemic continues to cause pain across retail, office and other commercial asset classes, single-family rentals have become increasingly attractive.
Demographic trends that were already favorable for single-family rental homes have been accelerated by the shift to remote work and the preferences of renters to flee dense urban cores in favor of more space. At the same time, recent developments in single-family rental lending practices have opened the asset class to a deeper pool of potential borrowers.
Demographic trends that were already favorable for single-family rental homes have been accelerated by the shift to remote work.
Growing demand
Even before the pandemic, macroeconomic conditions — especially the chronic shortage of affordable housing in the U.S. — created a strong demand for single-family rental homes. Over the past decade, median home prices have continued to increase while housing starts have failed to keep pace with demand.
Realtor.com estimated in January 2020 that the U.S. has a shortage of 3.8 million homes following several years of underbuilding after the Great Recession, and now needs to produce at least 1.2 million new single-family homes per year to meet the demand. Single-family housing starts through the first 11 months of last year lagged slightly below that pace, according to the U.S. Census Bureau. Although starts had picked up substantially this past fall, many expect that long-term supply constraints will send median home prices to all-time highs over the next few years.
Long-term rental trends reflect this dynamic. From 2005 to 2015, the number of rental households increased among all income brackets and age groups, pushing rental-occupancy rates to 30-year highs, Harvard’s JCHS reported.
Rents generally held firm even during the Great Recession. And while homeownership rates began to show signs of growth in 2020, affordability remains a serious barrier for first-time homebuyers. When combined with a more transient workforce and a millennial cohort that is reaching peak housing-formation age, these trends bode well for the future values and demand for single-family rentals.
The economic effects and uncertainty created by the pandemic also have increased demand for single-family rentals. As we have witnessed, remote work and extended time spent at home have motivated many to upgrade their homes. There has been a flight from urban apartment buildings to suburban single-family housing. This flight has already started to hurt urban occupancy rates and pricing, especially in high-demand areas such as Manhattan. Rents there fell 7.8% year over year in third-quarter 2020 and rental inventory increased by 70%, according to a recent StreetEasy report.
At the same time, affordable housing in all areas — already scarce before the pandemic — is now more difficult to find than ever, driving prices up and making entry-level housing harder to obtain. In the end, higher home prices and a shortage of affordable housing make single-family rentals the most viable way for households to transition out of urban multifamily living and into future homeownership.
Financing rentals
This demand dynamic spells increased opportunity for commercial mortgage lenders and brokers hoping to recoup lost sales volume in 2021 and beyond. With a growing array of financing options available for single-family rental investors, the pool of borrowers eligible for these loans is expanding.
The single-family rental class remains a favorite of commercial lenders. Traditionally, the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac have been the dominant financiers of single-family rental properties, but increasingly more private lenders have entered this space. In doing so, the underwriting standards have subtly changed. The GSEs still treat single-family investor loans similar to traditional home-purchase loans.
For Fannie and Freddie, the personal debt-to-income ratio is the primary metric used to evaluate borrower credit. Private lenders, however, tend to view these loans as true commercial real estate transactions and use a loan qualification system based largely on the debt-service-coverage ratio (DSCR). Given that these are business-purpose loans, DSCR is a better predictor of loan performance for a single-family rental property.
The strength of the DSCR-based approach is that it primarily focuses on the income of the property rather than the borrower’s ability to repay the loan, which is the standard for owner-occupied single-family home purchases. The credit decisions are primarily based on the sufficiency of the rent collected.
For example, a borrower with monthly rental income of $2,000 and mortgage debt obligations of $1,000 has a debt-service-coverage ratio of 2.0, more than enough of a buffer to put a lender at ease. Conversely, $1,000 in rental income and a debt obligation of $2,000 clearly signals that the rental income doesn’t justify the loan without other mitigating factors.
Many experienced investors own more than one property, so providing financing under a single loan, but securing and cross-collateralizing multiple properties, provides for greater flexibility and cost efficiencies for these investors. This often reduces the overall risk to the lender.
Expanding credit
DSCR-based loan qualifications expand the pool of potential borrowers, as qualification depends more on the borrower’s ability to find viable renters than the current earnings of the borrower. Real estate investors can now access 30-year term loans for amounts up to 75% of the loan-to-value ratio, based on future rents from the mortgaged property.
This capital can be used to finance tenant- occupied properties, making them ideal for investors looking for longer-term financing options, particularly after refinancing out of a short-term bridge or rehabilitation loan. These loans also can be used by real estate investors who have reached the GSE leverage limits that apply when financing up to 10 rental properties with Fannie or Freddie.
Private lenders also find these loans attractive for their advantageous servicing and recovery practices. They are treated as business-purpose loans, which creates significant advantages over consumer-purpose residential loans.
For example, investment-property loans have shorter foreclosure timelines and typically allow for personal recourse, which enables the lender to sue a delinquent borrower and seize the collateral to recoup the full value of the loan. Some loans in this category also benefit from additional risk-mitigation practices, such as rent collection, tenant direction letters and property-management replacement. All of these practices serve to improve recoveries and mitigate loss severity.
Yet these new products and practices are not the only reasons that investment-property loans have become more attractive to lenders. Increasingly, institutional investors have entered the space, which has made capital more abundant, added greater uniformity of credit standards and underwriting, and reduced pricing. Given the strong fundamentals supporting the single-family rental market, it seems that capital markets will make financing for this asset class even more accessible than ever. ●
