More than two years after the first single-family rental securitization, the single-family rental market continues to evolve and grow. The rise of single-family rentals reflects both a demographic shift among the American population and a reactionary change in consumer habits resulting from the financial crises. According to U.S. Census Bureau, the percentage of Americans that own homes has decreased from almost 70% in 2004, to 63.6% in the first quarter of 2016, the lowest percentage in over 25 years. Over 13% of Americans rent single-family homes – a 4% increase from before the crises, accounting for approximately 36% of all rental homes. The decline in homeownership and the increase in the percentage of Americans that rent single-family homes reflects several key demographic and economic changes:
- As a result of tighter underwriting standards after the financial crises, many income producing, subprime individuals (who were able to obtain a home loan prior to the great recession) are unable to obtain home loans. For families unable to obtain a home loan, single-family rentals are an attractive alternative.
- Former homeowners who were subject to a foreclosure during the great recession are generally locked out of the housing market for seven years, and are only now becoming eligible to purchase a new home.
- Baby boomers, who are beginning to retire and downsize, are more likely to rent than to own a home as they age.
- Millennials, who are only now entering the age at which they would historically be likely to purchase homes, have demonstrated a preference to rent, rather than to purchase.
- Despite increasing rental rates in many markets across the county (in some cases – e.g., San Francisco – to unaffordable levels), rental properties remain relatively affordable in comparison to home ownership.
The result is that rental vacancy rates are at a 30-year low.
A rational argument can be made that the decrease in homeownership in the United States is a temporary response to the worst financial crises in 70 years; however, demographic shifts in the American population make it more likely that the rapid decrease in homeownership is an acceleration of a process that would likely have occurred over time.
Whether the single-family rental industry will continue to grow (and how quickly) is dependent on a number of variables. Will the federal government, through GSEs, continue to support homeownership by providing cheap and readily available home loans? Will Congress repeal the mortgage interest tax deduction, removing a major incentive for home ownership? Will foreclosed homeowners reenter a housing market that they have been shut out of for so long? Will millennials jump into the housing market (as their parents and grandparents did), or continue to rent? The next few years will prove whether the post-recession trend is permanent, but I am inclined to say yes. I expect the rental market, and the single-family rental market, to continue to grow in the short and the long term.
Although institutional investors have received the majority of the headlines for the acquisition of large numbers of single-family rental homes in the past few years, the single-family rental market remains dominated by the “mom and pop” investors who own less than ten houses. Institutional investors have confined themselves thus far to the western and southern United States, and have very little exposure elsewhere. Consequently, the potential market share for institutional investors remains largely untapped.
Ownership of single-family rental homes is in stark contrast to multi-family properties, which are predominately owned by institutional investors. The dominance of the single-family rental market by “mom and pop” investors has led many to prophesize that the future of single-family rental finance will be small balance loans to investors owning less than ten homes.
Many lenders have begun offering small balance loans secured by one to ten properties, and expect this product to be the biggest driver of growth over the next five years. Last year, FirstKey, B2R and Colony American Finance each issued bonds secured by relatively small balance loans, and B2R has publically stated that it expects to market a new multi-borrower securitization soon. Much of the talk among lenders in the industry centers around a shift in single-family rental loan securitizations from large, single-borrower deals, to pools of small balance loans secured by single homes – essentially an RMBS model.
Does this mean that the institutional investors – and the large, single-borrower securitizations that made headlines over the past few years – will become obsolete? I may be taking the contrarian view, but I think the future of the single-family rental market will be dominated by the institutional investors.
Fast food, retail and even multi-family housing were not always dominated by large corporations and institutional investors. History has taught us that most nascent businesses and industries begin on a small scale, so called “mom and pop” shops, and as the business model proves itself to be profitable, the “mom and pop” shops, through organic growth and consolidation, become institutionalized. Before it was the largest corporation on earth, Apple began life in a garage.
Walmart began as a single five-and-dime store in a town of 2,900 people.
Institutionalization of the single-family rental industry makes sense for several reasons. Due to economies of scale, institutional investors can provide better management services at a lower cost than small investors. A major concern among investors and lenders when single-family rental began on an institutional scale was the ability of the institutional investors to effectively manage a large portfolio of properties spread throughout many metropolitan areas around the country. Institutional investors have since built large management platforms and proven the ability to effectively manage large portfolios of single-family rental properties, in many cases more effectively than the small, local landlords.
For example, if you rent a home from an individual who owns one or two homes in your town, it may take days to get a plumber to the house to make repairs, and landlords may be resistant to making improvements to the property due to cost. Institutional investors, on the other hand, may own thousands of homes in the area, and employ a local management team with on-staff maintenance.
Let’s be honest, if you are renting a home, rather than owning, you probably do not want to be cutting your own lawn or repairing your own toilets. Institutional investors can leverage economies of scale to obtain services, appliances and materials at lower costs, increasing renter satisfaction and profitability for the landlord. As a result, the institutional investors have been able to closely replicate the multi-family experience that many renters look for when choosing a home.
One area of potential growth that has begun to percolate is build-to-rent. It is easy to imagine future developments of planned communities of single-family rental homes, owned by institutional investors, providing many of the amenities that renters now expect in a multi-family property, filling the suburban landscape. Homebuyers may not be able to afford a pool, a gym, a playground, or other conveniences in their back yards, but they can likely afford to rent a home in a planned community that contains these amenities. It may seem fanciful, but planned industrial communities have existed in America for decades – Gary, Indiana, Pullman, Illinois and Hershey, Pennsylvania are all cities originally founded and developed by corporations to house employees.
As the single-family rental market continues to grow over time, the opportunity to leverage economies of scale will also increase, and market dynamics will cause the single-family rental industry to become more and more institutionalized. So, my bold prediction is that over the next five, or ten, or fifteen years, the single-family rental market will follow the path that so many other business have before towards institutionalization and consolidation. Finance follows the dirt, and I expect that the financing of the single-family rental industry will continue on an institutional scale, and likely grow. Single-family rental is here to stay.