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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   August 2018

Plant More Possibilities

The single-family rental-home market is an emerging mortgage-finance opportunity

Plant More Possibilities

With the Great Recession in the distant past, the economics  of residential real estate have regained a measure of value and stability. Although risk remains, single-family rental (SFR) homes are emerging as an independent and increasingly competitive asset class, albeit with more conservative leverage and less complexity than was the case when the speculative bubble exploded 10 years ago.

Commercial mortgage brokers can be involved in this space by working with middle-market investors who assemble larger SFR portfolios. These asset pools, like other classic investment vehicles, offer opportunities to manage short-term risk and maximize long-term gains.

In the years since the end of the Great Recession, economic growth and other fundamental factors have broadened the flow of capital from a diversified class of professional investors. Across the spectrum, from large institutions to small businesses, investors have applied active management strategies to residential real estate through SFR-portfolio purchases.

Investors have played a major role in shifting the supply of single-family homes from the purchase market to the rental market. From 2007 to 2016, the number of SFRs nationwide grew by 31 percent, according to U.S. Census Bureau estimates. In the wake of the Great Recession, large private investment funds stepped in to absorb millions of foreclosed properties.

Their value plays gave birth to huge portfolios of rental homes. As a result, single-family homes and townhomes now comprise 35 percent of all U.S. rental properties.

Market trends

Demographic and economic realities are driving a nationwide shift from homebuying to renting and — more specifically — a shift to single-family rentals. An increasing share of consumers who once purchased homes as they entered the workforce and raised families are being priced out of the conventional residential home-purchase market.

With high levels of student debt, fewer millennials qualify for home mortgages in today’s lending environment. And, simultaneously, the parents of the millennial generation are moving into rentals at higher rates as they plan for retirement. From 2009 to 2015, for example, the number of renters ages 55 and older grew by  nearly 30 percent, censusdata shows.

The capital constraints of owner-occupied home purchases strengthen the case for SFR investments.

The capital   constraints of owner-occupied home purchases strengthen the case for for SFR investments. Renters generally have greater liquidity than homeowners. Millennials who sign leases are spending a higher portion of income on rent than their older siblings.This liquidity has helped support a steady succession of rent increases for single-family homes. This past February, for example, single-family rents rose year over year by 2.1 percent and had experienced monthly increases of 2 percent or more since August 2017, according to real estate services company Zillow.

Of course, rental income plays a major role in an investor’s total return, and the long-term trends have been favorable. With a steady source of income, investors can take full advantage of market fluctuations, selling at premium prices and buying discounted properties for greater future growth.

Investor strategies

Although Wall Street started the trend toward institutionalization, value-creation opportunities remain robust for smaller players in the SFR market, which has always been fragmented.

Some mortgage lenders will finance portfolios of as few as five homes with investors and operators who are looking to grow. Other lenders concentrate on the small- and middle-market institutional operators of 10 to 100 homes. Despite the increased flow of new institutional capital, publicly traded institutional portfolios represent just 1 percent of the nation’s rental housing stock, according to Green Street Advisors. That leaves plenty of room for medium-sized investors.

Most middle-market SFR investors adhere to two basic strategies: buy and hold or fix and flip. In either case, the range of investment outcomes can vary substantially, depending on costs and execution, as well as the accessibility and flexibility of financing.

Unfortunately, flexible sources of SFR funding are not widely available to middle-market borrowers. Traditional commercial lenders are squeezed by post-financial-crisis regulations and capital requirements. Lending limits and the volatility of securitization markets have constrained funding, especially for smaller portfolios of properties. Moreover, traditional lenders have been slow to adapt
standards and practices that adequately support medium-sized SFR investors.

Many lenders fail to fully underwrite and price their loans for long-term growth opportunities, even for borrowers with proven track records in operations and management. As a result, SFR portfolios are often built with a jerry-rigged collection of overlapping recourse credit lines from multiple lenders with vastly inconsistent terms. This creates costly and time-consuming inefficiencies for the borrower. 

Lender flexibility

To reduce red tape and maximize total return, today’s SFR borrowers are increasingly turning to nonbank lenders that offer greater flexibility and terms better suited to this asset class. Free from capital and credit restraints, nonbanks offer products designed to match the market realities and strategies of SFR investors.

A 12-month bridge loan paired with a more permanent financing structure, for example, addresses both immediate and long-term plans. Bridge loans minimize underwriting delays and fund the time-intensive work needed to convert existing — and often empty — single-family homes or townhomes into stabilized rental properties. Upon expiration of the bridge loan, permanent financing with competitive terms can take effect. Because these loans are nonrecourse, personal assets are unencumbered and interest costs are lower.

A second loan structure supports borrowers who plan to build their portfolios in stages according to a predetermined time frame. With aggregating permanent loans, a lender pledges to fund a series of stabilized transactions over a specified period. Borrowers make payments only on the principal used as each new transaction closes. 

GSE influence

Commercial mortgage brokers also can help investors identify different levels of potential risk and return within today’s diversified SFR market. These include assets with vastly different value characteristics. Some of the highest risk-and-return opportunities are available in urban frontiers and economically distressed regions.

With aggregating permanent loans, a lender pledges to fund a series of stabilized transactions over a specified period.

Returns from well-timed and carefully targeted SFR investments in older, industrial-heavy cities, for example, can match or even exceed earnings from large multifamily developments in top-tier markets. Depending on the market, Class B multifamily properties are producing capitalization rates in the range of 5 percent to 6 percent, while comparable SFR portfolios have cap rates of 6 percent to 9 percent.

As a result of the recent entry of the government-sponsored enterprises, or GSEs, into middle-market SFR financing, “nonrecourse” and “recurring capital” are the market’s current buzzwords. Under Freddie Mac’s new affordable-housing initiative, low-cost SFR financing is available for experienced investors who own at least 50 properties.

Freddie Mac is targeting the larger owners in this space by offering a minimum loan size of $5 million. Freddie has designated nine lenders as authorized sellers and servicers to help broaden the investor base and institutionalize a previously illiquid, distressed housing sector.

•  •  • 

As investment options for single-family rentals continue to diversify, commercial mortgage brokers will benefit. They can provide their clients with highly accurate pricing and occupancy trends. To complete their due diligence, investors also need mortgage brokers to help them identify local pockets of supply where value-creation opportunities may have been overlooked.

Lastly, commercial mortgage brokers can play an important role in matching financing packages to an investor’s risk parameters. For many SFR players eager to rehabilitate older properties or build new rental homes, nailing down a consistent funding platform is pivotal for growth. 


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