7 months ago
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Last year might best be described as a risk-prone atmosphere for the single-family rental sector and the related fix-and-flip market.
The risky operating environment has been marked by volatile, high interest rates (with 30-year fixed rates now hovering around 7%), high financing costs and moderating rental rates as an influx of multifamily rental properties continues to come online across the country.
Still, despite the gloomy news of late for SFR and fix-and-flip investors, some industry experts see better fortunes ahead in 2024 for both sectors.
“We didn’t call it a bear market, but we did call it a lack of liquidity, which I think is more accurate,” said L.D. Salmanson, CEO of Cherre, a data integration and insights platform serving the real estate market, including institutional owners of single-family rental (SFR) properties.
“That started in Q4 of 2022, so it’s been about six quarters at this point, and we predicted it would last 24 to 26 months,” Salmanson added. “So, there’s at least two [quarters] left, and I don’t see anything that will turn things around in the next couple of quarters where we’re going to see a massive number of (institutional SFR) transactions. It’s going to be a few more quarters before that happens.”
In addition, any reprieve in the housing inventory shortage created by more multifamily units hitting the market is expected to be short-lived. In recent congressional testimony, Mortgage Bankers Association (MBA) chief economist Mike Fratantoni pointed out that the housing market is now extremely supply challenged.
“While estimates of the needed supply vary widely, it is clear that we are millions of units behind at this point,” Fratantoni said in his statement submitted this month to a subcommittee of the U.S. House Financial Services Committee. “And even though we expect to see a large delivery of multifamily units over the next few years, this will not resolve the broader lack of inventory that we see across the country.”
The inventory shortage — in addition to high financing costs tied to elevated interest rates and related inflation for construction expenses — led to a nearly 30% decline in home flips in 2023, according to real estate data firm Attom.
The performance of the fix-and-flip market — in which investors purchase, rehabilitate and resell homes — can serve as a barometer for housing supply in general, given that the sector adds for-sale inventory to the market.
Last year, there was a total of 308,922 single-family home and condominiums flips, compared with 436,807 in 2022, according to Attom. Gross profits for home flippers also declined last year, to an average of $66,000 nationwide, down from $70,100 in 2022.
Attom points out that investment returns on these projects in 2023 were at levels that “could easily be wiped out by the carrying costs during the renovation and repair process, which usually consume 20 to 33 percent of the resale price.”
“In 2023, the landscape for home flipping across the U.S. became increasingly challenging,” Attom CEO Rob Barber said in a statement, adding that “the sharp decline in the number of home flips likely reflected a combination of a tight supply of homes for sale as well as dwindling returns.
“Either way, it will take some significant reworking of the financials for home flipping fortunes to turn back around.”
Looming rebound
Despite the hardscrabble market realities facing SFR and fix-and-flip investors last year, 2024 could prove to be the year a rebound occurs — even if its full effect is not realized until later in the year.
For one, the Federal Reserve, despite holding its benchmark rate steady at its March meeting, is still signaling plans for three rate cuts this year. That should help to unlock more inventory while also reducing financing costs for leveraged investors.
In addition, new-home construction — including in the hot build-to-rent (BTR) sector — is helping to slowly boost housing supply.
“While existing home inventory is quite constrained, with about 1 million homes for sale nationwide … builders have certainly picked up their pace of construction, and new homes now account for roughly one-third of homes on the market,” Fratantoni told the House committee. “This compares to a more typical 10% share of total home inventory historically.”
There is also an expected surge of housing demand that is likely to translate into healthy sales and rental activity in the years ahead.
“The U.S population currently has about 50 million individuals between the ages of 30 and 40,” Fratantoni said. “This large millennial cohort is in the ages where household formation is at its peak, and we are seeing roughly 1.5 million households formed each year.”
Keith Lind, CEO of Acra Lending, a leading nonqualified mortgage lender, said early indications are that the year ahead looks promising for non-QM and related investment property lending for his institution. Non-QM loans typically serve clients who have nontraditional income sources, including the self-employed.
Lind points out that some 45% of Acra’s non-QM loans are to borrowers purchasing investment properties.
“Our pipeline of non-QM loans is up 30% from January and February of last year, versus January and February of this year,” he said. “We did $2.4 billion last year of (non-QM) originations, and we think we’ll do about $3 billion this year.”
Secondary market
A review of securitization deals tracked by Kroll Bond Rating Agency (KBRA) that are backed by non-QM loan pools and comprised of at least 30% investment properties (primarily single-family properties) shows that in roughly the first 10 weeks of 2023, there were 17 private-label offerings with a total value of $6.5 billion that closed. This year, during the same period, 20 such securitization deals with a total value of $7.3 billion hit the market.
Peter Van Gelderen is co-head of Global Securitized at TCW, a leading global asset management firm. He points out that investors in the secondary market are attracted to investment properties, particularly in an environment where rates are expected to soon start declining.
“Investors, like asset managers and insurance companies, like investment property loans because they are comfortable with the underwriting — the debt-service-coverage ratio, or DSCR, underwriting,” he said. “But investment property loans also aren’t subject to the same protections as [traditional residential mortgages], meaning they can have prepayment penalties.
“And so, if you have a view that the rates are coming down … you’re going to think people are going to refi more quickly, right? Then you’re going to say [as an investor], “Oh, how can I make some extra alpha, or money, and the way you do that is with the prepayment penalties.”
Geographic growth
A November 2023 report published by The Hamilton Project and focused on the SFR market notes that large institutional investors (those controlling at least 1,000 SFRs or more and have a presence in at least three markets) represent about 3% of the total SFR sector. But the bulk of mega-investor holdings (354,000 of the 446,000 SFRs) are concentrated in 20 markets, which are located primarily in the Southeast and Southwest regions, the report notes.
“For example, Atlanta is the largest single market, with almost 72,000 single-family rental units in the [metro area] held by institutional investors,” the report states. “For this market, institutional single-family investors hold 27.2% of all single-family rental properties and 9.53% of all rental properties (single-family plus multifamily).”
It’s worth noting that data analysis and size groupings in the fast-moving and wide-ranging SFR space vary across studies. They also depend on the timeliness of the data and the specific focus of the research. Cherre’s Salmanson, for example, estimates that the institutional-investor share of the SFR market could be as high as 6% to 7% nationwide.
Fratantoni’s congressional testimony reveals that regardless of the percentage, SFRs are in great demand across the board. His congressional statement notes that some 40.4 million residents, or 39% of the 102.8 million renters nationwide, now live in SFRs.
In terms of expanding their holdings via open-market home purchases, however, Salmanson said the large institutional players have been essentially “sidelined” in the current market.
He expects market dynamics to continue keeping these big players on the sidelines for at least the next two quarters — or at least until the interest rate, inventory and home price environment improves in their favor. In the meantime, these institutional SFR players have turned to a strategy of buying existing portfolios from smaller investors and doubling down on build-to-rent purchases.
Not enough supply
As an indicator of the slowdown in home purchases in the institutional SFR space, data from KBRA shows that in 2023, institutional operators issued four securitization offerings valued at $1.5 billion in total. In 2022, there were 15 such deals with an aggregate value of $10.3 billion.
“So, if I can’t buy in the open market, I either build or buy a portfolio,” Salmanson said. “Those are the two strategies employed in the last 18 to 24 months — rolling up the portfolios [of smaller SFR operators] and more build-for-rent.
“I don’t see any way [rent] goes down,” he added. “It’s not growing at the same pace, but there’s nothing that tells you [a decline] will happen when home prices are still high. The demand is increasing for these types of assets and we don’t have enough supply.”
Brandon Lwowski, senior director of research at HouseCanary — a proptech firm that provides institutional investors, lenders and other clients with residential real estate analysis — said there are currently about 73,800 SFRs available for rent at the national level.
“That’s up 25.7% from last year (as of March 11), so it’s a big increase in inventory,” he added. “Yet the rental price is still staying up.”
“On the single-family rental side is where we’re kind of in this land of the unknown, where we’ve never seen this much inventory, historically, in single-family rentals,” Lwowski said. “So, that’s telling me that … there’s still enough demand to keep (rent) prices elevated even though we’re seeing inventory grow.”
Lwowski added that national rental rates for SFRs are up 2.7% from last year even as inventory has expanded. He pointed out, however, that within the SFR space (which includes BTR), it is the larger homes that are in greater demand and that are propelling rent growth in the space, given “we’ve actually seen price decreases” for the smaller SFRs that consist of one- and two-bedroom homes.
Kurt Carlton, co-founder and president of New Western, a large national private real estate investment marketplace that serves some 200,000-plus investors, said the institutional SFR players are now working closely with builders and “guaranteeing the purchase of a certain amount of their future pipeline” for the BTR market. In fact, Carlton suggests that many of these large SFR platforms now prefer to operate in the BTR space rather than purchase homes on the open market, where they compete with consumer buyers.
“What I think is going to happen when these institutions do come back is they’ll start to focus more on constructed, new-build inventory,” Carlton said. “It’s just easier for them to forecast and manage those properties.
“They’re evolving to a state where they can do that, and it won’t make as much sense to focus on infill [by purchasing homes on the open market and competing with individual homebuyers].”
The National Association of Home Builders (NAHB) estimates that about 8% of all single-family starts are now BTR construction. Salmanson estimates that the figure is closer to 16% because “a lot of the pipeline just isn’t captured yet by the data.”
Even if the BTR market slows down a bit as projected, it’s still expected to play an outsized role in the new-home market given the larger forces that affect the housing market at large.
“Demand by investors for single-family rental units, new and existing, has cooled in recent quarters as financial conditions have tightened,” NAHB reported. “Given affordability challenges in the for-sale market, the (single-family BFR) market will likely retain an elevated market share even as the sector cools in the quarters ahead.”
Optimism ahead
New Western’s Carlton points out that there also are some 15 million vacant existing homes in the U.S., with one-quarter of these built prior to 2008 and starting to “enter a phase where they need to be rehabbed for the first time.” He said this is a prime market for fix-and-flip investors given the shortage of for-sale inventory.
“For example, there were 50,000 new homes constructed by builders last year in Dallas-Fort Worth,” he said. “And there were 17,000 homes that were purchased and then resold as flips.
“So, that’s about [one-third] of the new inventory that’s coming from homes that have been remodeled and returned to the market. … I see fix-and-flip investors as one way to help alleviate [the housing inventory issue] because they can at least bring what was off the housing market back to the market.”
John Burns Real Estate & Consulting conducted a recent survey of fix-and-flip investors and found that 49% of those polled expect to acquire more properties in 2024 than they did last year, despite the challenges they faced in 2023.
Arvind Mohan is CEO of fix-and-flip lender Kiavi. Mohan said the John Burns survey is already hitting home for the lender, which he said posted “a notable uptick in fix-and-flip loans in our pipeline in the first six weeks of this year relative to the same period last year.”
“The biggest challenge for flippers in 2024 is acquiring new properties while housing stock/inventory is limited and there are few ‘good deals’ available that make sense from an investment perspective,” Mohan said.
Still, despite the challenging market in 2023, last year was a banner year for Kiavi. The company funded a record $4 billion in fix-and-flip and bridge loans across some 13,000 loans to 5,800 individual investors, representing a 7% year-over-year increase in volume, according to a company announcement.
One sign of the proverbial sun starting to peek through the clouds that have hovered over the market since early 2022 — when the Federal Reserve began to raise benchmark rates — is the return of institutional capital to the private-label securitization market, which is facilitating greater liquidity in the primary market.
“The outlook for Kiavi’s RTL (residential transition loan, aka fix-and-flip] securitizations looks strong this year,” Mohan said. “Our recent deals (including a $350 million offering that closed in February) have been consistently oversubscribed, which is a good sign of investor demand.
“That gives lenders, myself and others more confidence that we can sustain our pipelines and service our customers well. What I would say is over the last, like, two to three months, we have reduced pricing to customers, just given the trends in the capital markets and so forth. We definitely see an uptick there.”
Although 2023 was a difficult year to navigate for large and small investors alike, as well as “solopreneurs” in the fix-and-flip space, there is reason to hold out hope for a brighter time ahead by reading the tea leaves.
“It’s just like there’s a lot more confidence in the directionality of where things are going, more than in how quickly they’ll get there,” Mohan said. “But the good thing is it’s moving in the right direction.”
Another change for the better in the SFR market that shouldn’t be underestimated, Carlton noted, is that recent advancements in technology are now being driven down to the smaller investors, making it easier to find, finance and manage properties — whether for sale or rent — in the SFR sector.
“A lot of the benefits that the institutions have, that they’ve built up over the years with technology, is starting to reach these independent real estate investors,” Carlton explained, “because when these institutions went on pause, a lot of these (tech) vendors had to find new customers, so they made that technology available to smaller investors.
“So, now it’s a lot easier for me, if I live in Seattle and I’ve got some money, I can invest in Ohio and buy some houses because now there’s better technology, there’s better ways of managing, there’s more of a network of property management across the U.S.”
“I think the real tailwind, however, is just that there is a fundamental, authentic demand for single-family homes simply because we just haven’t built enough homes,” he added.
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