The Sky’s the Limit With SFR

Single-family home rentals remained a strong market for investors during the last year with good prospects ahead, despite the challenges for owners of other rental properties as a result of the COVID-19 pandemic moratoria.

“The single-family home rental market is absolutely on fire,” said Jeff Pintar, CEO, Pintar Investment Company, echoing the sentiments of other market experts. “In all aspects of it, it’s continued to get stronger and stronger and has continued to evolve. The operational efficiencies of this business are actually far better than multifamily or other asset classes.”

“Most of our customers are adding to their portfolios right now,” added Bill Tessar, President, Civic Financial Services.

The current trend continues the recent strength of the single-family home rental market, experts agree.

“Leading into the pandemic, the single-family rental market was booming based on volume, the appetite for it on Wall Street, and the price the secondary market was willing to pay,” Tessar noted.

That’s not to say that the pandemic didn’t cause some challenges—at least briefly.

“In March of 2020, we were growing quickly, hiring, and growing our platform significantly,” said Damon Riehl, CEO, Property Loan Exchange LLC. “In late March, essentially all our sources of product, the lenders that we partner with, halted their lending activities for a period of 60-90 days, with some even longer than that. It created an environment where we had clients with the demand, but we didn’t have product for them available. Then things started to improve in the fall.”

Now, not only has the lending market returned to full speed ahead, in many ways the products’ pricing is superior to where it was pre-COVID-19.

“I would say loan sizes and LTVs are almost exactly where they were,” Riehl added. “Rates are better than where they were pre-COVID-19, and more and more correspondent lenders have emerged as well.”

Though Lima One Capital was hit hard at the start of the pandemic as loan volume came to a halt, what’s bounced back the strongest are the loans for rental properties, according to Jeff Tennyson, the company’s President and CEO.

“Since the late ‘60s, 35% of the $25 trillion housing stock in America was consistently rental. The rental market has always had a very strong base,” Tennyson said. “COVID-19 has sent a message to real estate investors that a rental product is going to continue in good times and bad, in COVID-19 or with no COVID-19. People want to rent properties and participate those transactions.

“The other thing that’s really driven the surge is that people are really starting to recognize they can work remotely,” Tennyson added.

“If I’m working remotely, why do I need to be cooped up in a one-bedroom or studio apartment in an urban center? There are so many other places I could live and rent for better pricing and have much more room and a much better quality of life. That’s driving the demand for rental product all over the United States.”

Moratoria Concerns

Though government-mandated moratoria have given struggling renters and homeowners the legal right not to make payments, there’s been very little impact on the single-family home rental market, stakeholders suggest.

As long as landlords took care of properties and had a good relationship with tenants, most continued to pay their rents, according to Tessar. “When COVID-19 hit most of our competition, as much as 75% stopped lending and some of those never came back to the market. Many of those who did limped back.”

“We’ve experienced less than a 2% delinquency rate for 2020 on our portfolio,” Pintar said. “People do whatever they can to protect their housing. By and large, people do the right thing. If they can pay their bills, they’re going to pay them.”

Others that DS News spoke with agreed that delinquencies have been extremely low during the pandemic, anecdotally noting that few of their renters had taken advantage of the moratoria if they didn’t need to.

Several single-family rental stakeholders interviewed agreed that government stimulus checks likely helped many renters avoid sliding into delinquency.

Inventory shortages have remained one of the primary inhibiting factors impacting both the broader housing market and SFR in particular.

Jeffrey Tesch, CEO, RCN Capital, told DS News, “There was already a shortage of single-family homes pre-pandemic, and then home listings declined substantially last year because of COVID-19 adding to the problem.

Couple that with low mortgage rates, and competition for properties is at an all-time high throughout most of the country.” As a result, investors are caught up in the same bidding wars challenging other homebuyers.

It’s more important than ever for investors to conduct their due diligence and remain “savvy,” Tesch suggests, “not getting caught up in the frenzy of the market, and [making sure that] the deal makes sense, so they can get a return on their investment.”

Brian Flaherty, COO, Global Strategic, ticked off some of the ways that COVID-19’s impact continues to be a factor within the SFR industry, “With decreased rental revenues due to the moratorium, coupled with decreased inventory and high demand, the need to service clients and tenants while managing vendors and costs is more demanding than ever.” Flaherty said that he expects those pain points to shift over the coming months, with a lack of inventory possible being buoyed by an influx once foreclosure moratoria lift. “Then there will be the issues of how to manage an influx of inventory, and placing underemployed, unemployed, or foreclosed-upon tenants into rental units.”

Pintar added that the economy is stronger than many people realize. As such, there are usually people ready to rent a single-family property even if the current tenant is forced to leave.

Despite the challenges of COVID-19, none of Lima One’s rental loans went into delinquency, Tennyson said.

Low Rates Continue to Help Drive Market Strength

The interest rates for single-family investors as of April were lower than they were prior to the COVID-19 outbreak, according to Tessar, who credits Wall Street firms continuing to chase yield. Civic has business-purpose loans for the single-family rental with a sub-6% interest rate.

Tessar expects interest rates to be up next year, so single-family rental investors will likely receive their best returns on investment before that happens.

If rates were to go up 2%, it would create a “market event,” Riehl said, but market experts don’t expect that type of a jolt. Instead, most seem to expect moderate rate increases. When that happens, Riehl says that rent prices will increase to follow suit.

The Federal Reserve is focused on keeping rates low for at least the next several months, which will accelerate market demand, said Jay Tenenbaum, Co-Founder and President of Capital Development at Scottsdale Real Estate Investments. “The only thing that changes this is if interest rates decided to go up, because the Fed says [interest rate easing] is over,” Tenenbaum said. In and of themselves, rising interest rates won’t signal a softness in the single-family rental market.

However, if rates rise and there’s a large jump in defaults and foreclosures, the single-family home rental market will suffer.

The low interest rates represent only one factor contributing to the continued strength of the SFR market. People and their jobs are more mobile than ever before, so a growing number of consumers don’t want to be tied down to a multiyear mortgage and the hassle of selling a property if they choose to move. Consumers are looking for more space for not only their families, but for home offices, remote schooling, etc. Multifamily properties can’t always meet these needs. So, returns for the single-family home rental market remain strong.

Pintar and Tennyson also observed that homeownership isn’t the sign of success and stability that it once was. Many younger people are preferring to rent rather than tying up their money in a down payment in order to own a home.

Kori Covrigaru, CEO, PlanOmatic, observed that “Most tech-savvy millennials and Gen Z audiences start their property searches online, and this has changed the way in which single-family rental properties are marketed today.” Covrigaru noted that digital tools such as 3D virtual tours and interactive floorplans hold strong appeal for younger buyers and renters, since they allow a consumer to visualize a home without having to step foot inside of it. “In many cases, the use of digital tools result in more property interest and faster leasing activity.”

“Millennials in particular are having a significant impact on the market,” Tesch said. “You have younger millennials that are at or approaching the time when they are looking to be first-time homebuyers, and you have older millennials that seem to be in the market to buy-up or upgrade from their current home to accommodate growing families or move to a location to better suit their needs.”

Danny Kattan, Founder and CEO of Sell2Rent, added that some seniors are also looking to sell and then rent back their single-family homes rather than using reverse mortgages because the latter option often involves fees and restrictions that the former option doesn’t.

The sell-and-rent option can also work for people who want to have more available cash but can’t qualify for conventional cash-out refinancing, Kattan added.

Another advantage of these properties over 1-4 family and multifamily units is that renters tend to stay longer, a trend that is increasing.

“One of the largest things that that we’ve noticed is that the propensity for a tenant to renew their lease has significantly gone up,” said Mike Tamulevich, President, National Brokerage, Marketplace Homes. “Typically, we would average in the 60% range for the tenants that are going to renew. Now, we’re in the mid-to-high 70s, with another 10% going month to month.”

In addition to the increase in renewals, rents are appreciating a little more than 4% annually, and the value of the properties themselves continues to grow. The gains are due to a combination of low interest rates and limited housing availability.

“It’s an extremely strong market with plenty of applicants for a property once it comes back on comes back on the market,” Tamulevich said.

In some areas, the values of home rental properties have been increasing by 10% annually, according to Riehl. However, he expects the appreciation in those markets to start to level off.

“Rents are increasing at a higher a higher pace than we’ve ever seen,” Pintar added. “On average, we’re getting about a percent per year. The demand for quality rental housing is continuing to get stronger and stronger.”

Migratory Impacts

People are continuing to move out of California and New York for areas where they can have lower taxes and lower cost of living, Tessar said. Those moves have been made easier by many companies opting to limit how many people need to be “in the office,” even as companies reopen. Additionally, some major firms have also moved out of those states—with employees often following—in search of lower tax costs.

Homes in states with lower costs are often selling above list price, according to Tessar.

“As soon as people move out, other people are moving in.”

However, not all of the movement is to the South. Many investors are finding good value in areas of Pennsylvania, Tessar said.

“There’s still a tremendous amount of dinged-up real estate that was taken back by the banks in the financial crisis.” Some of those single-family properties are in disrepair to the point that they don’t qualify for traditional financing, but companies like Civic, which specializes in the business loan purpose (BPL) arena, can provide interim financing for an investor to purchase the property, bring it up to code, and then resell it or then be able to qualify for conventional financing to live in it or rent it out.

Regardless of the region, quality schools have been the top determining factor as to the community where younger families will rent, Tessar said. However, this could be changing somewhat as more private school options emerge, meaning a family isn’t as tied to a certain public school district.

“A lot of people are starting to rent within the area that they want to live, but then picking up an investment property more on the outskirts where, where they might be able to get a decent yield,” Tamulevich said.

“We saw the mass exodus of people from cities to the suburbs during the height of the pandemic, which caused a greater need for rentals,” Tesch noted. “We are seeing many young families looking to move out to the suburbs, but they are struggling because of lack of inventory and higher home prices, so affordability has become a concern. We’re also seeing other demographics starting to join the mix of folks that are driving rental demand. It’s pretty common now to see younger baby boomers, people in their late 50s, early 60s, looking to downsize and sell their homes at the height of the market, so renting is very attractive for that group as well.”

Tesch listed Texas markets such as Dallas-Fort Worth and San Antonio as strong SFR areas, as well as parts of the Midwest such as Milwaukee, Cleveland, Indianapolis, Indiana, and Columbus, Ohio. Pittsburgh, Pennsylvania, and Evansville, Indiana, are two other good markets, according to Tenenbaum, who added that the middle-market, B- and C-class properties tend to offer the best value for single-family home investors.

Pintar pointed to Austin (as did many others); Charlotte, North Carolina; Salt Lake City; several communities throughout Florida; Las Vegas; Phoenix; and, surprisingly, Bozeman, Montana, as dynamic communities that are also popular markets for SFR. Indianapolis, Indiana, has also proven to be a strong single-family home rental market.

Regardless of the municipality, the Class A properties tend to be too expensive to earn a decent return, Tenenbaum explained. While some investors will look at price first and purchase Class D properties, that can be a mistake, as these properties tend to have unreliable tenants, are often vacant and, can require costly repairs.

Property Differences

Renters are typically looking for single-family rentals offering at least three bedrooms and 1.5 bathrooms, according to Pintar. However, some on the lower end of the market will consider two-bedroom, one-bathroom homes.

Tamulevich said the appetite for two-bedroom homes for investors and renters alike has largely evaporated. As a result of the pandemic and people working from home and having to manage remote schooling, renters are increasingly looking for moderately priced, 2,000-square-foot homes offering four bedrooms and two or more bathrooms.

One type of property that investors are largely steering clear of are condominiums. The initial investment, homeowner’s association fees, and other costs make it difficult to maintain positive cash flow on this type of rental property.

Some investors are looking for properties they will rent out for only a short time, selling the property when the value appreciates sufficiently. Others look to build large portfolios of rental properties for ongoing cashflow. To do that, an investor needs large sums of capital, Riehl said.

“If they have a significant capital base to do the number of projects they want, then they can decide on a property-by-property basis to hold it, to lock in cash flows with the low, fixed-rate mortgage, and not only re-capture the capital that they put into it, to use on the next deal, but also put $300 to $500 a month plus all the interest benefits and all the depreciation benefits of a rental.”

Property Management Concerns

Good property managers are one of the major keys to success in the single-family home rental market, Tenenbaum said.

His top advice for those looking to get started or expand in the single-family rental market: “Make sure your property management team is the cornerstone of your investing career. People who are local can do both (invest in the properties and manage them), but I invest all over the country. The local property management team can be the key to your success or the key to your downfall.”

Property managers are the pulse of the investor’s portfolio, Tenenbaum explained.

“They’re a wealth of information. They know the contractors, they know the values, they have better referrals to real estate agents than you can find yourself, unless they’re local to the area.”

Good property managers will find responsible tenants. Poor ones will have more unrented properties, will have collection issues, etc., according to Tenenbaum.

One way an investor can distinguish good property managers from poor ones is via their level of responsiveness, Tenenbaum said.

“The sense of dedication and commitment to managing our assets goes hand-in-hand with communication. When I ask a question, I get a timely response. The response is complete. I know that they’re dedicated and efficient what they’re doing. “We’ve had the good, the bad, and the ugly with our properties’ managers.”

With a responsive property manager, the investor stays informed about why properties are unoccupied, Tenenbaum added. He gives much of the credit for the excellent performance of his single-family rental portfolio in Evansville, Indiana, to his property manager there.

Looking Ahead

The single-family home rental market will remain strong for the foreseeable future, according to Tessar. “Next year, we’ll have a better idea of what’s going to be in this new tax bill. Everyone on the real estate side wants to understand what impact it’s going to have on capital gains and 1031 exchanges.”

The next 12 months will also provide more clarity on how much of the work-from-home trend will remain, Tessar added.

“The asset class is going to continue to evolve,” Pintar predicted. “You’re going to see a lot more communities being developed specifically for rent. There’s, there’s a lot of core capital that’s looking for safe, predictable returns. Outside of food and water, housing is people’s greatest essential need. Being able to deliver and provide a nice-quality product for people is always going to be in demand.”

“What COVID-19 taught us all is that our work can be done remotely,” Flaherty observed. “Taking that reality and constructing an office plan and overhead reduction plan needs to be paramount for 2021 and beyond. Controlling costs with flexible work environments is bringing home office monitoring software and outsource solutions to the forefront. Also, having now been burned by an unforeseen pandemic, a focus on disaster planning, technology, and redundancy contingency planning needs to be factored into the bandwidth and budget of every company in any vertical, but particularly the SFR space, which will definitely feel the crunch of another tide shift soon.”

Tennyson said that nonagency rental lending is a $40 billion market, providing a large opportunity for lenders like Lima One to provide loans “to improve the family neighborhoods so that others can live the American Dream.”

Pintar added: “We can’t get these things built fast enough. Institutional investors that initially shied away from this product type are learning that the efficiencies of this asset class are better than any others. On a risk-adjusted basis, you’d be hard pressed to find a better opportunity than SFR.”

On Wednesday, May 12, the Five Star Institute will present its Single-Family Rental Summit 2021, an in-person event at the Four Seasons Resort and Club Dallas at Las Colinas. The event will feature top subject matter experts and skilled SFR practitioners, leading discussion panels and training sessions answering questions and offering viable solutions related to property acquisition and management, financing, strategies for small, midcap, and large investors, and new developments related to technology and professional services.

Click here for more information and to register for SFRS 2021.