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Built-for-rent likely to drive growth of single-family rentals

| March 26, 2021

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

A collision between limited supply and rising demand for single-family housing is creating a new opening for the single-family rental market. Institutional SFR operators and investors have already earmarked $10 billion of equity for built-for-rent programs. A 3-to-1 leverage ratio typical for the sector implies operators could raise $30 billion of debt financing in 2021-2022 with a further ramp up in the following years.

Outstanding public financing for SFR currently totals $26 billion, all backed by portfolios of existing properties. The footprint of institutional SFR operators has grown to 2% of single-family rental homes, but their ability to respond to the sharp increases in demand is complicated by a housing shortage that has been building for a decade. The response in the industry, as discussed in Ten Billion Reasons Why There Is A Built-For-Rent Land Rush, has been for SFR equity investors to seek out opportunities to build homes for rent instead of competing to purchase existing homes (Exhibit 1).

Exhibit 1: Major capital firms’ investments in built-for-rent in 2020

Note: Equity funds earmarked during 2020 for SFR/BFR in millions of dollars. The total equity deployment for 2021 will be over $10 billion, according to projections by Hunter Housing Economics.
Source: Hunter Housing Economics and CBRE Research

Major homebuilders such as Toll Brothers and Lennar Homes have formed joint ventures with financial partners and institutional SFR operators to invest in the built-for-rent (BFR) space. Others are known to be in discussions or have plans to build rental communities in multiple markets.

A housing shortage exacerbated by the pandemic

New household formation has averaged 1.2 million per year over the past 20 years. Census Bureau projections are that the pace of new household formation should increase to 1.5 million a year over the next decade as millennials and generation Z move out of their parent’s homes and form households of their own. The pandemic actually triggered a 128,000 contraction in the number of households from 2019 to 2020 – the first outright drop in household formation since the Census Bureau began estimating the data in 1940.

A U.S. housing shortage has been developing ever since the pace of new single-family home construction fell dramatically during the housing crisis as home sales plunged (Exhibit 2). Prior to the pandemic the housing market was already facing a shortage of 2.5 million units, particularly in the low- to moderate-income categories favored by first time homebuyers. In a December 2018 research report, The Major Challenges of Inadequate U.S. Housing Supply, Freddie Mac analysts identified two reasons for the low level of housing production relative to the population:

  • An increase in home building costs, driven higher by both the cost of land and regulatory costs due to zoning restrictions on lot sizes, building height and open space designations; and
  • A shortage of skilled labor.

Local opposition by residents to new and affordable home developments in many communities put further restrictions on new construction.

The slow pace of home building still remains the logjam. After a decade of gradually increasing, total new single-family home construction recently broke 600,000 units per year, still below the 650,000 units of new supply averaged during the early 2000s.

Exhibit 2: New and existing single-family home sales and new homes under construction

Note: Number of units at a seasonally adjusted annualized rate.
Source: US Census Bureau, National Association of Realtors, Bloomberg, Amherst Pierpont Securities

The estimated housing deficit rises from 2.5 million to 3.3 million units when considering only those states that have a shortage of supply. States like West Virginia, Alabama, North Dakota and Ohio, where the population has decreased, have faced increasing vacancy rates amid a relative surplus of housing. Those surplus units cannot balance out the intensifying supply shortage in states such as California, Texas, Florida, Oregon and Colorado. Twenty-nine states have a net deficit of housing supply, while 21 states are oversupplied, according to the report. The high costs of housing in the states with a significant shortage are hitting young adults the hardest – driving up home prices and constraining household formation.

The housing shortage in single-family homes is particularly acute as the pandemic accelerated home purchases. The inventory of existing single-family homes for sale dropped to a historic low of two month’s supply in January 2021, while the inventory of new single-family homes for sale rebounded slightly off a recent low of 3.5 months to 4.8 months (Exhibit 3).

Exhibit 3: Inventory of single-family homes for sale (month’s supply)

Source: US Census Bureau, National Association of Realtors, Bloomberg, Amherst Pierpont Securities

A strong trend towards renting exacerbated by the pandemic

Since 2007 there has been a 25% increase in the number of rental households compared to a 4% increase in owner households, according to Census Bureau data. This was primarily the result of the decline in the homeownership rate from a June 2004 peak of 69.2% to a local June 2016 trough of 62.9%. Before the pandemic the homeownership rate had rebounded to just above 65% but the majority of new household formation was going straight into rental housing. Moreover, many renters found themselves shut out of homeownership.

The problem is that the tightening of mortgage credit in response to the financial crisis never abated (Exhibit 4). Subprime mortgage originations – those for borrowers with credit scores below 660 (blue and yellow bars) – remain a small fraction of total volume.

Exhibit 4: Mortgage originations by credit score*

Note: *Credit score is Equifax Riskscore 3.0. Data through the fourth quarter of 2020.
Source: New York Fed Consumer Credit Panel/Equifax, from Quarterly Report on Household Debt and Credit (page 6, as numbered).

This tightening of credit accelerated during the pandemic, as record low mortgage rates and a huge surge in demand for single-family homes drove home price appreciation up by 12% in 2020. This put homeownership even further out of reach for those without stellar credit. The credit scores for mortgage originations rose across all percentiles, with the average credit score for even the lowest 10 percent of borrowers rising from 650 to 690 (Exhibit 5). The rise in credit scores is partially due to the impact of the government stimulus payments: many households chose to pay down credit cards and reduce consumer debt outstanding. Unfortunately, this did not increase the share of mortgage originations to borrowers with lower credit scores.

Exhibit 5: Credit score at mortgage* origination

Note: *Credit score is Equifax Riskscore 3.0. Data through the fourth quarter of 2020.
Source: New York Fed Consumer Credit Panel/Equifax, from Quarterly Report on Household Debt and Credit (page 7, as numbered).

Outlook for single-family rentals

The combination of the housing shortage and tight mortgage credit should keep homeownership out of reach of many households as the pace of new household formation rises. The trend towards less urban living in large multifamily buildings and towards single-family rentals will likely persist even as the pandemic recedes as more companies accommodate flexible work arrangements. The ability of institutional SFR operators and BFR programs to scale up rapidly and respond to the demand should become visible over the next few years. This will hopefully provide a supply of high quality, consistently priced, well-managed properties in the suburbs or exurbs of high demand areas to provide affordable housing options for those locked out of homeownership or who prefer to rent.

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