The COVID-19 pandemic is one of the decade’s—if not the century’s—main turning points in the real estate industry. It changed every property type. Retail was nearly swallowed whole by industrial by means of e-commerce, powered by warehouses and logistical centers. Offices were almost empty during lockdowns and will likely never again house as many workers because work-from-home proved so effective that it seamlessly evolved into remote working. But housing is the property type that changed the most. For two scary years, homes would become all the places people used to visit each day—living and sleeping quarters, food courts, working and learning spaces, shopping and entertainment venues, fitness centers—all under the same roof.
It’s no wonder that the health crisis triggered the “Great American Move” because households and businesses alike started relocating to less dense and more affordable places. Residents were looking for bigger homes, with extra space, preferably with yards, although farther from employment centers. Unsurprisingly, single-family rentals became a popular lifestyle choice for families looking for the comforts and amenities associated with homeownership, but with the flexibility and ease of use offered by renting.
These new migration patterns, doubled by demographic shifts in demand, keep challenging the housing industry, which was already facing long-time difficulties caused by significant undersupply. The housing market struggles to change rapidly, and single-family rentals are an important component of this change.
When it all really began for SFRs vs. today
Single-family rental ownership gained traction after the Great Recession when companies like Blackstone and Colony started buying distressed single-family homes and renting them out, explained Doug Ressler, manager of the business intelligence department at Yardi Matrix. Soon after, it became apparent that this was a viable business alternative in bridging the existing housing shortage gap between supply and demand.
Mark Wolf, founder & CEO of AHV Communities, witnessed this firsthand, having founded his company in 2013. He said that, as with everything new, at first there was some resistance to it, as he fought to pioneer the built-for-rent, single-family rental community concept.
“Many of the larger institutional groups passed on working with us at the time, thinking there was no market for what we were doing,” he said. Today, we’re looking at an overheated market. “$80 billion is chasing very little product, and numerous inexperienced developers have entered the sector and have essentially regurgitated AHV’s business plan and talking points,” Wolf told Multi-Housing News.
Sudha Reddy, founding & managing principal at Haven Realty Capital, a 2010-founded company, recalled that the opportunity back then was in aggregating distressed homes at attractive prices and converting them into newly rehabbed, professionally managed rental homes, thereby providing displaced homeowners and renters with a high-quality rental housing option. Unlike 2010—when the opportunity was clearly defined—today the cycle is in the early stages of the transition as the Fed tries to combat inflation, so it will take time for the opportunity to present itself in the current environment, Reddy believes.
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The SFR/BTR market has grown and changed substantially from a development perspective, too. The early leaders in this space included big, national homebuilders like Toll Brothers, D.R. Horton and Lennar, or as Alex Pollack, director of partnerships at Mosaic puts it, “companies which already had multifamily subsidiaries and could pull these two operations together and be successful in the arena.”
These days, the market expanded to include players with experience that combine sophistication with know-how, as developers are well versed in student housing, multifamily and senior living.
Among them is Shoreham Capital—a company founded by Doug Faron (formerly CIM Group), Steve Figari (formerly Slate Property Group), and Nick Zoumas (formerly JNS Homes)—which brings together more than 50 years of collective real estate experience across investment, construction and development. They saw the tremendous opportunity in residential alternatives—specifically the single-family rental/build-to-rent space—and felt that their combination of experiences provides a strategic advantage in targeting specific opportunities and segments of the market.
Established companies in the multifamily industry such as TruAmerica Multifamily have also taken note and expanded in the SFR market. The company launched a BFR development division this year, acquiring roughly 1,600 lots in three different markets in July. Yet, it’s not all milk and honey in the sector, according to Mitch Rotta, senior managing director at the division. TruAmerica’s purchase was immediately met with pushback because the market changed very quickly “and development deals couldn’t keep pace as most cost data in development projects lags by anywhere from three to six months,” Rotta said.
Single-family rental market trends that shaped 2022
One major trend is not new, and it impacts both the SFR and the multifamily markets—the severe housing shortage. “Excessive local governmental regulation, restrictive zoning and intervention are driving up the cost of producing additional housing, reducing the ability to add where it is needed and increasing the cost of operating quality housing,” Ressler said, calling the current situation “an on-going tragedy that people in the industry are desperately seeking partners in solving,” especially since residents of all backgrounds and from all over the country are feeling the harsh impact of the affordable housing shortage. Of course, these high housing costs are a significant factor in core inflation.
Yet, Ressler believes that it is possible that the housing issues raised and accelerated by the pandemic could result in industry improvements that outlive it, as “the SFR product repetition will allow for innovation and reduced cycle times that could, in the end, solve the problem of affordability faster than expected.” So far, the pandemic’s imperative demand for home offices and flex spaces didn’t give builders the time to create contemporary designs, so they are modifying current ones.
The housing shortage helped keep strong fundamentals in 2022, with rising rent growth, solid occupancy and high leasing volumes all leading to rising capital flows into the SFR industry, explained Reddy. In fact, 2022 was extremely successful for the industry, according to Al Otero, portfolio manager at Armada ETF Advisors, with these metrics at their highest levels since the institutionalization of SFRs.
“The macro themes of the U.S. being undersupplied in housing, coupled with pandemic-driven population shifts to high-growth, Sun Belt markets where SFR tends to be overrepresented, only enhanced demand for this product,” Otero detailed.
Shoreham called 2022 “a year of dichotomy for the SFR/BTR sector,” described as an elevated opportunity sustained by strong demand, but with rising rates and construction costs that slammed the ability to develop more rental housing to meet this demand.
Now, storm clouds are gathering, brought on by the dimming economic prospects. Many capital providers turn cautious and take a wait-and-see stance until there is more clarity surrounding inflation, interest rates and asset pricing. “This is evident across the board, with both investors and tenants,” specified Pollack. Still, there are those who continue to pursue the expansion of their SFR/BTR portfolios, confident in dividends in the long term and hoping for more favorable prices in the meantime.
Rising inflation and the Fed’s aggressive strategy to combat it by increasing the interest rates have impacted 2022’s SFR performance in many ways, and not just negatively. With the cost of buying a home rising and the average rate on the 30-year, fixed-rate mortgage above the 7 percent mark for the first time since 2002, the SFR market has been thriving. And even though it is also dealing with cost overruns due to supply constraints, rent growth has kept pace with the increase of construction costs, Ressler pointed out.
Still, for most of the second and third quarters, the market paused, according to Wan Bridge CEO & Founder Ting Qiao. While this doesn’t present an issue for projects that are already underway, it is challenging for investors who underwrite projects. The scarcity of new for-sale projects translated into no jobs for trade partners, and this impacted both the cost of labor and the availability of workers, shortening the construction schedule for SFRs underway. This enabled Wan Bridge to deliver 80 homes in October.
Supply chain issues and cost volatility remained high on the challenges chart this year. Relief began to materially surface in the third quarter, said Pollack, and the majority expects this momentum to carry us through the rest of the year and into 2023.
Another trend that was evident in 2022 is the slowdown in migration. Following massive population migration out of major, expensive coastal cities and markets into burgeoning Sun Belt regions, the wave has cooled down.
Wind of change in the SFR market
Rotta singled out the biggest change in the market: the lack of capital from an equity and debt perspective. “From October 2021 to October 2022, the ability to raise capital went from one of the easiest to the most difficult in a six-to-nine-month period,” he said. “With the fundamentals of the business being one of the best we’ve ever experienced, coupled with a capital markets environment that’s completely upside down, it makes for a very interesting combination to try and get deals done.”
Lender capital offering for the SFR/BTR sector is dwindling, affected by the Fed’s repeated actions to halt inflation. Banks have broadly and significantly pulled back their lending and, although there are still options for both construction financing and stabilized financing, these are more expensive, with both rates and spreads blown out, according to Shoreham experts. More so, the cost of capital has a direct impact on the overall cost of the project in conjunction with investor expectations rising to hedge against risk.
But investors are starting to see some signs of opportunity as homes sit on the market longer and inventory levels of unsold homes move up from historically low levels, according to Otero. “It is expected that the acquisition environment for SFR will improve in 2023 as the Federal Reserve eventually ‘pauses’ in its aggressive interest rate stance and the yield curve reflects slower growth and moderating future inflation,” he added.
Yes, possibly, probably, but short-lived and shallow, according to Otero. The undersupply of new housing over the last decade means that the SFR opportunity will continue even with an impending economic recession. Moreover, with housing affordability being stymied by higher rates, the renter pool will only increase further, buoying demand, Shoreham specialists explained.
Rotta depicted recession as a “painful moment,” which will subject those in the SFR market to the first real headwinds. “A lot of smaller groups that were formed over the last two years will not make it, while the larger, more seasoned sponsors will find opportunities to form relationships, which will set the stage for the next growth chapter of this asset class,” he expects.
Wolf describes the brewing recession as a “double-edged sword for the SFR sector”—one side presents strong fundamentals like declining building costs, a weeding out of less savvy players from the market, more labor seeking work, people not buying homes and home sales starting to plummet; the other side shows skyrocketing cost of debt, unknown cap rate adjustments and equity pulling back at what really is the best time to be pushing dirt and creating new rental communities.
Bottom line, the recession is real, it’s bound to happen and it will, and the SFR sector won’t be immune to it. But it is not an ominous threat for the sector. Fundamentals will soften—rent growth will slow down, delinquency will increase due to job loss, occupancy will falter. But people will still need a place to live and the SFR sector “will perform well relative to other real estate asset classes,” concluded Reddy.
2023 and beyond
The best describing word for what is to come is uncertainty. By the second or third quarter of 2023, the Fed might stop the increases in the interest rate, but this uncertainty will put investors and lenders on hold, which will make it hard for developers to put deals together, explained Qiao. Consequently, supply will decrease dramatically. But “risks justify the return,” he said, “because anything constructed in 2023 will be much cheaper than in 2022, and the rent in 2024 and 2025 will be the same.” Qiao also believes that in 2024 and 2025 there will be lots of potential buyers to bid for the few available BTR communities making both exit cap rates and returns higher.
Of course, hard times create strong relationships, and Rotta foresees substantial relationships between well-seasoned operators and homebuilders. “As we move forward, this will create a lot earlier planning between groups of how we can integrate these two development styles into one so that we develop neighborhoods with the intent to help cater to all demographic categories and preferences,” he added.
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The slowdown in activity will be accompanied by a cleansing of the fringe players, location and product. “There are a lot of mediocre SFR players and, frankly, bad and poorly located communities that got built, and that type of activity needs to clear out of the sector,” Wolf said. “We need to get back to basics and proper fundamentals going further.”
Still, there also is some certainty—Millennials and Gen Zers get older and want more space, and this will drive growth in the overall SFR market, according to Ressler. In addition, he identified four significant housing trends that will begin to reappear in the rental housing functional space in the next decade, all possible in the SFR product: more function in the same-sized home—spaces added as an extra bedroom and additional flex or office spaces; balance between public and private spaces; private outdoor spaces gaining traction—small patios, decks and balconies instead of one larger yard; and greater density affordability.