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Single-family rental market slammed by headwinds

Some nonbank lenders, however, are positioned to profit from the market gale

The nation’s single-family investment-property sector and the lenders serving those borrowers face some major challenges in 2023 as rent growth is slipping, vacancy rates growing, home-value growth faltering, and a possible recession looms. 

For the non-QM lenders serving the single-family investment-property space who have managed interest-rates well to stay ahead of the market, however, there’s still plenty of opportunity to pick up market share, industry observers argue. 

In addition, secondary market investors continue to show interest in well-underwritten, higher-rate loans secured by single-family rental properties. That, in turn, could lead to improved liquidity outlets for loans secured by single-family investment properties — through the private-label securitization (PLS) market and via insurers, pension funds and other institutional investors that hold loans or mortgage-backed securities in portfolio. 

Ben Hunsaker, a portfolio manager focused on securitized credit for California-based Beach Point Capital Management, said there are already at least three investment-property backed PLS deals in the cue this year. They include a $405.2 million offering backed by 842 loans, OBX 2023-NQM1 Trust, which is sponsored by Onslow Bay Financial, according to abond presale report released by Kroll Bond Rating Agency (KBRA) on Jan. 5. “Approximately 36.8% of the subject [loan] pool is secured by investment properties,” the presale report states. 

Another of the planned offerings is a $485.9 million deal backed by 902 loans that is sponsored by VMC Asset Pooler LLC, an affiliated of Invictus Capital Partners. The offering is dubbed Verus Securitization Trust 2023-1, according to a KBRA bond presale report released on Jan. 11. The fling shows that 460 loans in the offering, or nearly 40%, are investment properties, with the balance being non-QM loans secured by owner-occupied properties and a handful of second-home loans. 

The third deal in motion, also backed in part by investment properties, is now undergoing due-diligence review. It is an estimated 470-loan securitization — with no value yet assigned in the due-diligence documents filed with the U.S. Securities and Exchange Commission. The pending offering, called NRMLT 2023-NQM1, is sponsored by Rithm Capital, formerly known as New Residential

“It looks to be about 50% investor properties,” Ben Hunsaker said of the planned NRMLT offering.

The PLS deals in the pipeline are a sign that investment-property mortgages are still in demand — both by borrowers and bond investors.

Still, it’s far from all good news for nonbank lenders. High interest rates and inflation are projected to shrink overall mortgage originations in 2023 — including in the investment-property space— compared with 2022, a year in which the bleeding had already begun.

National real estate brokerage platform Redfin reports that investor home purchases dropped more than 30% year over year in the third-quarter of 2022, which is “the largest decline since the Great Recession, aside from the second quarter of 2020,” at the height of the pandemic.

The Mortgage Bankers Association’s (MBA’s) most recent market forecast projects that overall mortgage origination this year will dip to $1.45 trillion — down by 15% compared with 2022. Mortgage production in 2022 nationally was down about 50% from $4.44 trillion in 2021 — a year in which 30-year fixed mortgage rates were about half of what they are today.

“We are expecting a recession in the first half of 2023, which will result in the unemployment rate increasing … to 5.5% by the end of 2023,” the MBA’s December market-forecast report states. The nation’s unemployment rate stood at 3.5% as of December — with an estimated 5.7 million unemployed people.

That market contraction, along with a more difficult inflationary operating environment for property owners and businesses generally, is also expected to be a drag on the potential volume of loan originations secured by single-family rental properties. That is happening in the context of a shrinking universe of lenders capable of serving that market, however, creating an opportunity for the healthier non-QM lenders to expand their market share, according to Hunsaker. 

“I think if you look at the landscape for originators … the guys [non-QM lenders] who survived, who thrived, managed their interest-rate risk well and are still able to quote and lock [loans],” Hunsaker said. “They were quoting and locking [loans] at probably [a range of] 8.75% to 10.5%, and while you’re seeing investor non-QM origination rates down, [they’re down] less than owner-occupied non-QM loans.”

He added, however, there also are many non-QM lenders that have not fared as well and now don’t have the warehousing capacity or the interest-rate risk-management capacity to excel in the current market.

“And so, what do you have to do? You have to cut your production and keep it to what you can fund with cash on hand or with a relatively conservative warehouse capacity,” he added. “I think that cohort of the origination market [those not prepared for the current market dynamics] has probably seen more volume declines than the cohort that either has balance-sheet capacity or has forward-flow agreements or has some sort of a [liquidity] take off.”

Although there is already some PLS deal activity involving investment-property loans cued up early in 2023, projections from the Kroll Bond Rating Agency (KBRA) show that overall PLS issuance in 2023 will be down by as much as 40% in 2023, compared with 2022. And 2022 was off by some 17% from 2021. Securitization has traditionally been one of the major liquidity channels for many nonbank lenders.

PLS offerings backed by investment properties across the prime and nonprime space, based on deals tracked by KBRA, slowed considerably as interest rates rose in 2022 —  with the rate on a 30-year fixed mortgage starting the year at 3.22% and ending 2022 near 6.5%, according to Freddie Mac. Rising rates and associated volatility made executing securitization transactions profitably incredibly difficult for most deal sponsors. 

KBRA’s data show that for the full year in 2022, there were some 43 PLS offerings valued at $17.5 billion that were backed in whole or in part by investment properties. Only 10 of those deals, worth about $3.3 billion, were issued in the final six months of 2022, however. Those deals involve investment properties owned by individuals or small “mom and pop” landlords and do not include securitizations undertaken by large institutional owners of investment properties — the so-called Wall Street investors.

“There’s some of that [investment-property collateral] going into securitizations [now], but we don’t think the backlog is very big relative to where you historically have seen it in the December-January time frame,” Hunsaker said, adding on a positive note, however, that “we’ve seen securitization spreads firm up over the past 20 or 30 days.” That is happening in the context of inflation showing signs of abating as well — down from annualized high of 9.1% in June to 6.5% as of December, based on the Consumer Price Index.

“We’ve also heard a lot of it [single-family investment-property collateral] has gone to … more balance-sheet oriented end users, such as insurance companies, banks, and some non-securitization [players] using private credit funds,” Hunsaker added. “I think [institutions] like that are stoked to get a 9% to 10% yield range on those assets — maybe a little bit less.”

Empty sails in single-family

The economic doldrums slowing growth in the overall housing market, including rental rates more recently, if not reversed, will continue to negatively affect both new loan originations in the year ahead and the profit margins for single-family rental investors. That includes rentals owned by so-called mom-and-pop landlords — with 10 or fewer properties. Those smaller-scale landlords account for the bulk of the nation’s single-family investment-property market. 

Although the single-family rental market is distinct from the multifamily apartment market, they both compete for the nation’s pool of renters. And across the apartment market over the past four months, rental and occupancy rates been declining, with “more multifamily units under construction than at any point since 1970,” according to a recent report by rental marketplace Apartment List, which has some 6 million rental units listed on its platform, 

“We estimate that the national median rent fell by 0.8 percent month-over-month in December … the fourth consecutive monthly decline, and the third largest monthly decline in the history of our estimates, which start in January 2017,” the Apartment List report states. “The preceding two months (October and November 2022) are the only two months with sharper declines.

“… In the most recent four months from August through November, it [the vacancy rate] has increased by 0.8 percentage points, reaching 5.9% this month [December, up from 4.1% in October 2021]. …We expect that 2023 will be a year of flat to modest rent growth, but it is unlikely that prices will fall significantly throughout the year.”

Short term rental growth is slowing

In addition to the economic strain being felt by mom-and-pop landlords due to increasing costs fueled by inflation as rental and occupancy rates plateau, market experts say the economic drag will hit even harder the short-term rental sector — which is dominated by less-experienced investors listing their rental properties through online platforms like Airbnb and Expedia’s Vrbo

A recently released report by short-term rental analytics firm AirDNA projects that this year the supply of short-term rental units will increase by 9% while demand for rooms is projected to increase at only a 5.5% clip. The result, according to the report, is that revenue per available room is expected to decrease in 2023 by 1.6% year over year — compared with a 2.1% year-over-year gain in 2022 and a nearly 28% bump in 2021.

“So, in 2022, we saw about 20% demand growth,” said Jamie Lane, vice president of research at AirDNA. “[This] year, we’re expecting [less than] 6%. 

“That is a significant slowing.”

Lane added that the projected supply growth for 2023 is likely to come, to a large degree, from homeowners who now have very low interest rates, compared with the current market, and “maybe were thinking of moving, but they don’t necessarily want to give up their home with that 3% mortgage, so they’ll rent it out” instead.

“What you’ve seen [in the short-term rental market] is you go from premiums of about 80% [in 2021] — i.e., the revenue that you’d earn is almost double what the cost of that revenue is,” Lane said. “And that’s gone down [as of late 2022] to about 10% or so.

Staying alive in single-family

There is opportunity ahead in the single-family investment property sector, however, for lenders and borrowers alike who do their homework and understand the peculiarities of the markets they are operating in today — and act accordingly, market experts say.

“In certain markets, like in Phoenix, certain parts of Florida and the Southeast, [for example], I agree there were basically fields of homes built, and they were built based off the extreme growth we saw in 2020, 2021 … and that [development] may have outpaced the demand growth in those areas,” said Doug Faron, a founding partner of Florida-based Shoreham Capital, a build-for-rent and multifamily residential developer. “We’re really thinking about rental yields. 

“We’re thinking about what the end buyer wants, which with us is an institutional fund. What yields are they [the end buyers] targeting for their investments and can we — because of where we think rents are going [in a specific area] and how we’re going to manage this asset — achieve a yield and exit that makes sense.”

It may well be a case of not letting the good be the enemy of the perfect when it comes to investment-property plays in the current dour housing market. As evidence that some investors seem to see it that way, loan-aggregation platform MAXEX reveals in a December market report that its investment-property loan-trading volume has expanded significantly over the past few months, with nearly two-thirds of locks “coming in the form of investment-property loans.”

Nadia Evangelou, senior economist and director of real estate research at the National Association of Realtors, also provides some indirect rational for continued optimism about the single-family investment-property market overall in the current high-rate environment.

“With the qualifying income near the $100,000 threshold, 32% of all households and [only] 15% of all renters can currently afford to buy the median-priced home,” she said. 

The MAXEX report concludes that the high cost of financing a home purchase “has relegated many would-be homebuyers to the sidelines, where renting is the more affordable option for the time being.” 

“… This has created a strong market for real estate investors who continued to buy homes despite elevated home prices and higher interest rates,” the MAXEX report concludes.

Rick Sharga, executive vice president of marketing for real-estate research firm RealtyTrac, explained in a prior interview that the time horizon for most investors in the rental-property market tends to be longer-term.

“So, even if there is a [home]-price correction, with a longer time horizon, you’re more likely to be able to ride that out and get back to where you were, and actually ahead of where you were,” he explained. “In the meanwhile, you’ve been renting it out, at least at a breakeven number for that that whole period of time, and in most cases probably cashflow positive. 

“I personally think the rental sector of the market is a little less vulnerable to bubbles, to price increases and decreases.”

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