Could Cost of Capital Slow SFRs?

There is more than $30 billion aimed at the sector, but that figure excludes debt, explains columnist Lew Sichelman.

Lew Sichelman

Could the rush of institutional investors into single-family rentals have run its course at the hands of higher borrowing costs?

There’s still a boatload full of capital out there committed to the single-family rental space. At last report, John Burns Real Estate Consulting counted 43 separate announcements totaling more than $30 billion aimed at the sector. But that figure excludes debt, the firm says, noting that it knows “of a lot more than this” that is not public information.

The real number is much higher, according to the report, stating that capital is flooding in.

But that was before interest rates started to climb. And higher borrowing costs are likely to turn some investors off. CalculatedRisk housing blogger Bill McBride was already concerned about “too much money pouring into the sector.” Now he’s wondering whether deals will pencil out because of higher lending costs.

Until the run up, the amounts investors were willing spend didn’t much matter, McBride, said on a recent Burns company podcast.

Now, though, as interest rates continue to shoot upward, they have to question whether investing in rental houses is still a good deal. The verdict is not in yet, McBride told MHN. “This is something I’m trying to figure out,” he said. “Clearly higher capital costs will impact the SFR sector, but I don’t have a sense yet on the extent of the impact.”

David Howard, who heads the National Rental Home Council, also says the jury is still out on rising borrowing costs. Nevertheless, his guess is that momentum in the build-to-rent portion of the business will continue unabated, if not increase, at least in the short-term. “The trend is really taking off,” Howard told MHN. “The product is very much in demand.”

Taking a Closer Look

It will be another month or so before first quarter figures are in. But in last year’s fourth quarter, houses purposely built-for-rent rather than for sale accounted for 26 percent of the properties added to the portfolios of investors in the fourth quarter, Howard’s group says. That’s up from just 3 percent in the third quarter of 2019.

At the same time, investor purchases of existing individual houses declined from 81 percent to 57 percent over the same two-year period, the NRHC reports.

The trade group’s data is based on figures from providers in more than 50 metro areas nationally that collectively manage more than 200,000 properties.

Investments in SFRs as a whole continued on their upward climb in the November-December period, according to Redfin. Investors snapped up 18.4 percent of the houses sold nationwide, up slightly from the 18.2 percent purchased in the third quarter. Numerically, that’s 80,293 houses in the fourth quarter and 90,225 in the third, for a total of 170,518.

In some spots, the spending spree was particularly pronounced. In the Atlanta area, for example, CoreLogic reports that nearly 43 percent off single-family home purchases in Q3 were made to investors.

In the short term, Howard doesn’t think higher lending costs will have much of an impact on the BTR sector. In the longer term, though, the trend “will certainly have an impact,” he says. “But how much, I’m not sure. After all, we’re talking about a product that’s in high demand because it’s satisfying a need.”

If anything, higher mortgage rates should give single-family rentals a boost, the NRHC executive director says, because more would-be buyers will be shut out of the for-sale sector. For them, he explains, “brand new rental houses with all the amenities” represent a viable alternative to renting apartments or buying a house, “if not in the long-term, then certainly in the short-term until the figure out what their long-term needs are.”

Meanwhile, a new entrant in the business is taking a somewhat different tact than others that have gone before it. With a $750 million bankroll, Pathway Homes plans to buy its customer’s preferred houses and lease them back while offering them a path to ownership. The twist is that the after buying the houses, it will set-up rent-to-own options that include fixed, below-market annual rent increases over a five-year term.

Under one Pathway program, renters can move in with an option to buy after providing only a security deposit. Under another choice, residents can build equity toward a down payment with Pathway providing a fixed return and matching contribution. And with a third, customers can buy half the house with a 5 percent down payment and rent the other half.

Pathway is looking for residents with “decent jobs and incomes” but who would not otherwise be able to buy a home due to credit issues or the lack of money for a down payment and closing costs. It says it will work with its renters to ensure they will have the financial capacity to buy by providing financial counseling and support.

People can move into without a commitment that leaves them financially stretched, and they can move out with no penalty.

The company is now offering houses in the Atlanta and Phoenix markets, with an eye toward expanding to the West Coast and Sunbelt regions.

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