By the Numbers
Renting the American Dream
Mary Beth Fisher, PhD | September 23, 2022
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.
In the aftermath of pandemic and for the next two decades, the number of households that rent looks set to grow much faster than the number that owns. And the demand for rental housing should rise, too. Supply clearly depends on the availability of financing, and government agencies and commercial banks have provided steady funding and picked up steady share. Institutional single-family rental operators have come along as well and have tapped the securitization markets. Investors should maintain an overweight in rental housing, with a focus on affordable housing where supply is the most constrained.
Renter growth should outpace homeowner growth
US housing is becoming a market where more people will rent the American Dream. Median family income jumped sharply several times during pandemic due to Covid relief and fiscal stimulus, which normally would set the stage for homeownership. Much of the stimulus payments went into savings, often used to make down payments on homes. Wage increases also accelerated gains in median family incomes, which are up 9.3% compared to pre-Covid levels (Exhibit 1). But a rise in median home prices dwarfed the gains in income. Median home prices have jumped 51.8% from pre-pandemic levels. Rising home prices combined with rapidly rising mortgage rates have left median family income of $90,600 just barely above the qualifying income of $88,400, which is the minimum income necessary to afford a median priced home. This has pushed home affordability way down (Exhibit 2).
Exhibit 1: Home price appreciation has outpaced the rise in incomes
Exhibit 2: Home affordability has plunged as home prices and mortgage rates have risen
The decline in home affordability should contribute to the increased demand for rentals, particularly for single-family rentals that appeal to higher-income cohorts who have been priced out of homeownership. The median mortgage principal and interest (P&I) payment was $800 per month in the beginning of 2016, and hovered around $1,000 per month throughout 2020, as the decline in mortgage rates offset rising house prices (Exhibit 3). That shifted in 2021 as home price appreciation accelerated. The rise in mortgage rates in the first half of 2022 pushed the median P&I payment up to $1,800 per month, or 24% of median monthly income, up from a pre-pandemic average of 15%.
Exhibit 3: Average monthly payments have risen as a % of income
This shift has fundamentally tipped the balance in favor of renting as opposed to owning a single-family home (Exhibit 4). Single-family homes generally have higher rents than multifamily properties, and single-family tenants tend to have higher incomes. Many of these tenants are potential buyers who have been priced out of the market. These tenants often occupy the cross-over space between homeowners and renters.
Exhibit 4: Renting a single-family home is cheaper than owning
This cross-over to higher household incomes is the target for many single-family rental operators. Single-family homes have higher rents and operating costs than traditional multifamily, and they appeal to suburban families that need more room. SFR operators are typically not competing with low-income or affordable housing providers, in part because the economics of single-family rentals don’t work for the median or lower-income tenants or landlords.
American Homes 4 Rent, one of the largest single-family rental (SFR) operators in the U.S., has an average rent of just over $1,850 per month, about the same as the P&I payment on the median priced home. Renters don’t have the additional maintenance, property taxes, mortgage insurance and other expenses that accrue to homeowners.
The decline in affordability could eventually put some downward pressure on home price appreciation. But the severe supply shortage is years from being materially solved and millennials are approaching peak homeownership, or single-family rental years. The fundamental outlook for SFR has improved as affordability has shifted to renting as opposed to owning.
Beyond the immediate dynamics in housing, household growth over the next few decades looks set to run below historic levels, according to analysts at the Urban Institute, but to tilt toward rentals. Urban projects 16.1 million net new households from 2020 to 2040, comprised of 9.3 million renter households (21% growth rate) and 6.9 million homeowner households (9% increase). US homeownership rates, of course, should decline.
A multifamily market shaped by lenders
On the supply side of the rental equation, not all parts of the market have equal prospects for growth. Rapid growth in multifamily lending supported by Fannie Mae, Freddie Mac and Ginnie Mae along with lending by banks has meant steady growth for properties and borrowers that fit their respective underwriting. Prospects for steady supply in that sector look good. For affordable housing, however, the supply of financing has retreated significantly. Supply in that sector looks likely to be highly constrained.
A decade of strong multifamily property price appreciation coincided with a shift in financing as the GSEs built market share in multifamily lending. The convergence of these trends has prompted some consolidation of multifamily holdings into the hands of institutional operators, primarily utilizing lending channels of the GSEs and commercial banks. The dearth of very low income housing is real, as direct federal or municipal government financing of public housing has plunged. The very conservative lending standards required of the GSEs and commercial banks, with only a trickle of public housing, will likely contribute to underbuilding in affordable housing and continued upward pressure on rent growth.
Multifamily mortgage financing has changed significantly since the late 1990s. Outstanding multifamily debt has risen from roughly $300 billion to approach nearly $2 trillion, with the share financed by Fannie Mae, Freddie Mac and Ginnie Mae rising from 18% to 48% (Exhibit 5). Financing from commercial banks has dropped modestly from 37% to 30%. Financing by insurers has stayed roughly around 10%. Financing from federal, state and local governments has plunged from 21% to 6%. And financing from non-agency securitization has dropped from 16% in 2007 to less than 4% today.
Exhibit 5: Multifamily mortgages outstanding
With the GSEs and commercial banks providing nearly 80% of financing, their lending standards have important impact on the shape of multifamily properties and borrowers. The GSEs and banks both maintain lending standards subject to strict capital limits and regulatory controls. The GSEs, for example, naturally prefer multifamily owners and operators with substantial track records. This gives an edge to institutional operators, who then can accumulate large portfolios with the benefit of competitive financing. Smaller, private owners still tap the banks for financing, though they are competing with the deep pockets of private equity, and private equity can operate properties on thin initial cap rates while waiting for longer-term property price appreciation to earn larger returns.
The impact of lending standards is shaping the multifamily landscape slowly. There are approximately 19 million multifamily units with an estimated asset value of $5 trillion. Private, non-institutional investors still comprise the bulk of multifamily property owners, accounting for nearly two-thirds of multifamily assets by value (Exhibit 6). Institutional operators, or those that own large portfolios of properties, account for 10% of multifamily assets, while public REITs and private equity combine for 17%. Multifamily buildings that also serve as the primary residence for the owners are 12% of the stock.
Exhibit 6: Multifamily asset value by owner type
The impact of lending standards is clearer in recent years. Multifamily transactions surged during the pandemic due to a combination of rent growth, property price appreciation and historically low costs of financing. This accelerated a marginal shift away from small, private multifamily operators towards institutional and private equity ownership (Exhibit 7).
Exhibit 7: Sales volume by buyer type over the past 12 months
Institutional and private equity firms accounted for over a third of buyers, while private owners, public REITs and users were net sellers (Exhibit 8). Part of the very recent selling by REITs can be attributed to the compression on cap rates and higher cost of financing as the Fed raised interest rates in 2022.
Exhibit 8: Net multifamily buying and selling by owner type
GSE and bank lending is likely to continue dominating multifamily finance, so the supply of properties that fit most easily into GSE and bank underwriting is likely to grow at the fastest pace. Demand is obviously part of the equation driving rents, but supply in properties that fit the GSEs and banks should be less of a force for rent growth.
The double whammy for affordable housing
The attrition in spending for very low-income housing is evident in the decline of federal, state and local government multifamily assets, which now barely accounts for 6% of multifamily mortgage debt outstanding. Financing affordable to moderate income housing is also considered riskier since the housing crisis tightened lending standards for banks and the GSEs. Capitalization rates for multifamily 1- to 3-star buildings, which provide the bulk of affordable housing, are higher than those for 4- and 5-star buildings (Exhibit 9). These buildings do tend to be older and require more maintenance, the tenants can have lower credit scores, and tenant turnover can be higher. Building new moderate-income housing in urban areas has also run up against zoning issues and faced pushback from community organizers, which has contributed to the lack of supply.
Exhibit 9: Multifamily capitalization rates by building class
The GSEs make important contributions to affordable housing by asking developers to include affordable units. But if the finished building stabilizes and eventually sells without new GSE financing, the new owners can turn the affordable units into market rents. The affordable housing supply encouraged by GSE policy may not be permanent.
Private developers of affordable housing face significant costs in time and money to resolve zoning disputes and navigate neighborhood activism. Strict regulatory standards also reduce the incentive for commercial banks and the GSEs to lend to smaller borrowers, and for projects that are perceived to be riskier. All these factors contribute to a low- and middle-income housing supply shortage that is not being addressed. The downside for tenants is that the supply shortage looks unlikely to resolve anytime soon. Qualifying for affordable housing loans and other programs also often requires keeping rent to a fixed percentage of area median income, so there is a limit on rent growth. But the likely lack of supply implies little margin for rents to do anything but stay at their maximum allowable level.
Strong fundamental outlook for multifamily and single-family rentals
Over the next two decades, renter households are projected to grow at twice the rate of homeowner households. Housing supply is already well short of demand, and the zoning, regulatory and financing hurdles to building new renter housing are arguably higher than those for single-family owner-occupied housing. This will likely support rent growth and rental property price appreciation for a decade or more as they both normalize from pandemic-driven levels.
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The stock of owner versus rental housing
There are approximately 122 million occupied households in the US, with 64% owner-occupied (78.8 million) and 36% renter-occupied (43.6 million) (Exhibit 10). Total US housing stock is roughly 143 million, which includes vacant, seasonal and other homes that are not used as primary residences.
Exhibit 10: US owner and renter households
The majority of owner-occupied homes are single-family structures (69.7 million, which is 88% of owner-occupied households), while the majority of renters live in traditional multifamily buildings (29 million, which is 67% of renter households). Of the 84.4 million occupied single-family structures, 14.7 million of those (17%) are occupied by renters. Although there has been a lot of media and Congressional focus on institutional ownership of single-family rental homes, it still comprises a sliver of the market. Recent estimates are that institutional single-family rental (SFR) operators own about 350,000 homes; that is 2.4% of of the 14.7 million single-family rental homes and 0.4% of total single-family households. Nearly 80% of single-family rental homes are owned by mom and pop investors that have 10 or fewer properties.
The differences between renters and homeowners
There are some significant differences in the demographic and financial profiles of renters versus owners. Renters tend to be younger than homeowners: 35% of renters are below the age of 35, compared to only 10% of homeowners (Exhibit 11). Renters also tend to have less education than homeowners, with less than 30% of them completing a bachelor’s degree or higher, compared to nearly 40% of homeowners.
Exhibit 11: Renters tend to be younger and less educated than homeowners
Homeowners are more frequently white and have significantly higher mean incomes than renters (Exhibit 12). The median income for homeowners was over $81,000 in 2020, compared to a median income for renters of $42,000. Nearly 40% of homeowners have incomes above $100,000 compared to just 16% of renters. Some of this difference is due to the younger age profile of renters, though over time the lower educational attainment is correlated to lower lifetime earnings.
Exhibit 12: Renters are more ethnically and racially diverse, but skew to lower average incomes
The median monthly housing cost for renter-occupied homes was $1,096 in 2020, compared to $1,142 for owner-occupied properties. Across income levels, the percentage of renters who are cost burdened – meaning they spend 30% or more of their monthly income on rent – is typically much higher than the percentage of homeowners. The percentage of owner and renter-occupied households that are cost burdened declines as income rises. At income levels below $20,000, 89% of renters and 76% of homeowners are cost burdened; this falls gradually to 28% and 23%, respectively, for household incomes between $50,000 to $75,000. The difference between renter and owner households mostly converges at higher household income levels, where 7.2% of homeowners with incomes above $75,000 are cost burdened, compared to 7.6% of renters.