The fledgling single-family rental (SFR) market—formed in the wake of the financial crisis as institutional investors amassed large portfolios from foreclosure auctions and short sales—is on the verge of some major developments. Deals securitized since the first-ever SFR securitization by Invitation Homes in November 2013 have been substantially alike, with investors primarily being large institutions. But that is about to change as new lending programs alter the profile of the collateral and the investor base expands.
The SFR market has expanded substantially in the past few years and will continue to do so as demands for SFR homes and rents are expected to continue to increase, property management becomes more efficient and historical performances have demonstrated generally low rental vacancy and delinquency rates. With housing prices rising, institutional investors will seek to cash out their SFR portfolios and, together with heightened demand for SFR houses from millennials and availability of new lending programs for retail SFR investors, SFR market is likely to shift from large institutional players to smaller individual investors. What is more, a new asset class—landlord loans—is expected to grow substantially.
Where We Are
To date, there have been 23 SFR securitizations. Exhibit 1 shows the timeline of these securitizations. SFR industry has expanded tremendously in the past two years. According to Commercial Mortgage Alert, the US CMBS issuance was about $94 billion and the US SFR issuance was about $6.8 billion in 2014. As of July 2015, year-to-date US SFR issuance is $5.42 billion up 53% from $2.85 billion for the same period in 2014 whereas year-to-date US CMBS issuance is $55.74 billion up 22% compared to the same period in 2014. The SFR bond market is currently estimated to be a $12.65 billion market with Blackstone’s Invitation Homes unit having a leading market share of 42.1% through its seven offerings totaling $5.32 billion. American Homes 4 Rent stands second at $2.08 billion followed by Colony American Homes at $1.75 billion.
Typical structure is as follows: an investor first forms a REIT or LLC and raises debt and/or equity financing to acquire a portfolio of SFR homes and then transfers such portfolio to a borrower (typically an LP or LLC) where it serves as the general partner owning 100% of the borrower. The borrower then obtains a loan secured by the first priority mortgage on such portfolio. The loans typically have two to three year terms with the borrower’s option of multiple one-year extensions for a total of five years. The lender then transfers the secured loan to depositor (typically an LP or LLC) who will deposit such loan in a special purpose entity that is bankruptcy-remote and will issue debt securities. These debt securities are callable and/or non-callable bonds with first lien security interest over rental incomes from the collateralized SFR homes and sometimes are also backed by pledge of equity interest in the borrower and guarantees from sponsors. Similar to CMBS issuances, these SFR offerings typically elect REMIC structure.
Every SFR offering to date has received triple-A rating on its most senior tranche. Credit rating agencies have adopted methodology that leverages elements of CMBS and RMBS criteria because the collateral underlying an SFR transaction has both commercial and residential characteristics. Loan-to-value (LTV) ratio ranges from 63.1% to 78.9% with an average of approximately 73%. Later deals tend to have higher LTV ratio as the industry becomes more comfortable with the asset class and issuers consider structuring deals with an added risk retention tranche (5%) that allows the securities to be sold in Europe, as was the case with the Invitation Homes 2014-SFR2 offering. All but four offerings have been priced using LIBOR with coupon size for its top tranche ranging from 113.7 to 163.6 basis points. Two of the four fixed rate bonds have been issued by American Homes 4 Rent in September 2014 and March 2015 respectively; and the other two fixed rate deals were by FirstKey Lending in April 2015 and Progress Residential in May 2015. The underlying portfolios for the SFR securitizations issued during the past year ranged in size from 2,876 to 4,661 properties with an average of 3,728. The largest offering to date is the $1.2 billion floating rate, interest-only offering by Invitation Homes secured by mortgages on 7,265 income-producing SFR homes issued in June 2015.
As SFR securitization market develops, there have been several structural variations. The first three deals offered were structured to amortize whereas the following seven deals have been structured as interest-only loans. The offerings by FirstKey Lending and B2R Finance in April 2015 were the first multi-borrower SFR securitizations (backed by multiple loans to one or more entities). Prior to these offerings, transactions have been backed by one loan from a single borrower. Some later offerings involved additional investor protections such as back-up property manager that would step in and gain control in the event of materially adverse conditions.
Is SFR securitization market competitive?
While the growth of SFR market is expected to slow as foreclosures slow and housing prices recover, bottom line can be strengthened as institutional investors become more focused in particular MSAs and experienced at managing properties, rental market remains strong with overall rents increasing, and delinquency and vacancy rates remain low.
Institutional investors are becoming much more selective in new portfolio acquisitions and are shifting their focus to managing their properties, collecting rents and improving operations. For example, Invitation Homes has recently agreed to sell about 1,300 Atlanta-area residences in order to focus on creating highly-efficient SFR infrastructure in certain MSAs. Focusing on particular MSAs will make property management more efficient and homogenous which is an important factor for many of the SFR bond investors, as the continuity of net cash flows from the underlying properties depends heavily on the ability of their owners to manage large numbers of SFR homes, which are often geographically dispersed and uniquely constructed, hence cannot be implemented with a one-size-fits-all approach.
SFR market is not likely to contract any time soon and overall rents have been and will continue to rise. According to Moody’s SFR homes make up about 13% of the U.S. housing stock, up from 9% before the financial crisis. The number of SFR homes has increased 35% since 2006 to 15.1 million from 11.2 million and, as of July 2015, single-family rentals comprise 40% of the rental market which nearly equals multi-family rental share of 42%. As millennials start to form families but are typically unable or unwilling to buy homes, the rental numbers are expected to go up. Strong demand for rental homes have translated into rents increase and the median asking rent has been continuously rising, as seen in Exhibit 2. Rent growth is expected to accelerate this year as landlords plan to raise their rents as much as 4% on renewals and 5.7% for new tenants and will average nearly 3% per annum through the end of the decade. Combined with lower rental vacancy rates (Exhibit 3) and lower homeownership rates (Exhibit 4) in the second quarter of 2015 in comparison to that of 2014, bottom line is expected to further improve. Exhibit 5 shows that the rental vacancy rate is at a historic low.
According to Morgan Stanley, large buyers have spent about $68 billion amassing about 528,000 SFR homes. Given that $12 billion of securities tied to approximately 90,000 homes have so far been issued, there are still plenty of SFR properties available in the market to be securitized. Additionally, historical performances of the prior SFR offerings have been quite assuring. Granted the very first SFR securitization had initially sparked concerns as collected rents declined by 7.6% within 3 months of the cut-off date, with a stabilized vacancy rate (8%) higher than the issuer’s prediction (6%). However, these vacancy numbers were still well within the rating agencies’ stressed parameters and more importantly, despite a reduction in rental cash flows received, payments were nonetheless made in full to bondholders. As the market develops, both delinquency rates and vacancy rates have been generally low and stable. According to Morningstar, the month-end delinquency rates of May 2015 ranged between 0.2-1.3% with American Rental Properties 2014-SFR1 deal being an anomaly with 2.3% and the vacancy rates among SFR securitizations remaining relatively flat month-over-month at an average lower than 5% despite a general trend of a rising number of lease expirations.
Where is SFR market heading?
Although institutional investors are likely to remain involved in the SFR market for quite some time in the face of rising interest rates, climbing home prices, high student debt, tight credit conditions and depressed incomes that limit opportunities for would-be homebuyers, the SFR market is expected to eventually shift from larger-scale investors to smaller, individual investors.
With housing prices having recovered nearly their pre-crisis peaks, these institutional investors will want to cash out and realize their profits by liquidating their portfolios rather than holding properties and associated market risks on their balance sheets. Both Invitation Homes and Starwood Waypoint Residential Trust plan to sell about 5% of their SFR portfolios every year. Moreover, although millennials are expected to rent for the next few years, they will eventually want to become homeowners as they form families and become financially more stable, and may even be forced to buy houses if rents outpace housing prices. Additionally, access to credit is set to increase for retail investors looking to purchase SFR properties. Private equity firms have already begun, or are seriously considering, offering so-called landlord loans and rent-to-own programs. The Blackstone Group, Colony Capital and Cerberus Capital Management are providing landlord loans to small and midsize investors buying single-family homes. Over the last year, subsidiaries and affiliates of all three private equity firms have reportedly lent about $1.5 billion collectively where most of these loans range from $500,000 to $50 million in size, are two to five years in length, have interest rates of 5-6% and are backed by mortgages on the properties and sometimes the rental payments on the homes. Blackstone is also considering whether to offer rent-to-own programs or future financing options for tenants who will eventually become homeowners.
These new lending platforms are generating another exciting securitization opportunity as these firms are gearing up to bundle those loans into bonds. Indeed, the first landlord loan securitization is expected to hit the market in the next few weeks. Given little competition these firms face with the only other significant SFR lenders being Fannie Mae and Freddie Mac, which limits their financings to true mom-and-pop investors, and hard-money lenders, whose loans tend to be for short periods of time and carry higher than normal interest rates, demand for landlord loans is expected to grow fast.