Residential lenders considering new products to grow their business in 2021 and beyond may find single-family rental an attractive option.

By John Beacham

The real estate sector is feeling the effects of the pandemic unevenly. Government response has varied widely across states, and even across markets, creating uncertainty and a wide range of outcomes. Despite this uncertainty, one trend has been consistent: Single-family homes are more valuable now than ever, both financially and intrinsically.

Acceleration of a Trend

Residential mortgage lenders trying to better align their business with the market realities of 2021 and beyond may find single-family rentals to be an attractive option. Macroeconomic trends that were already favorable for the asset class have been accelerated by the shift to remote work and structural changes in buyer demand. At the same time, recent developments in single-family rental lending practices have opened the asset class to a wider pool of potential borrowers.

Even before the pandemic, macroeconomic conditions, especially the chronic shortage of affordable housing in the U.S., created a strong demand for single-family rental homes. During the last decade, median home prices have continued to increase, and housing starts failed to keep pace with demand. In fact, housing starts declined 2.4% year-over-year in 2020, signaling long-term supply constraints that many expect will send median home prices to all-time highs over a multiyear period.

Long-term rental trends reflect this dynamic. From 2005-2015, the number of rental households outpaced the affordable housing stock across every age and income demographic, thereby increasing both rental occupancy and median rents to 30-year highs (see Figure 1). In fact, even the Great Recession failed to put downward pressure on rents. And while home ownership rates began to show signs of growth in 2020, a wide gap remains—tied directly to the affordability factor. When combined with a more transient workforce and a millennial cohort that is reaching peak housing formation age, these trends provide a long runway for continued appreciation of single-family rentals.

Figure 1 Source: Census. From 2009-2020, the number of rental occupancies increased across every age and income demographic.

Impact of Urban Flight

Now as uncertainty lingers and the economic effects of the pandemic continue to unfold, the existing structural trends supporting single-family rentals have accelerated at a rapid pace. As we have witnessed, remote work and extended time spent at home have motivated many to upgrade housing. This has caused a flight from urban multifamily apartment buildings to suburban single-family housing.

That flight has already begun to hurt urban occupancy rates and pricing, especially in high-demand areas like Manhattan, where rents fell 7.8% year-over-year in 2020, and rental inventory increased 70%, according to a recent StreetEasy report. At the same time, affordable housing in all areas, already scarce before the pandemic, is now harder to find than ever, driving up prices and making entry-level housing more difficult to attain. In the end, higher home prices and a shortage of affordable housing make single-family rentals the most viable way to transition out of urban multifamily and into future home ownership.

Though the long-term fallout from the pandemic remains unclear, the fundamentals supporting single-family rentals are both durable and widespread. While digitization and remote work have forced many businesses to reconsider their real estate footprint, consumers are doing the opposite. In fact, consumers are eager to expand and invest in housing.

Though retail and office occupancy has suffered as digitization enabled a shift from physical to virtual, an analogous phenomenon is simply not possible with housing. Moreover, demand for affordable housing is outstripping supply in nearly every major market, even amid an economic downturn and unprecedented unemployment. As such, single-family rentals will continue to be the primary choice of consumers looking for near-term options to upgrade housing for years to come.

New Financing Options

With a growing array of financing options available for single-family investors, the pool of borrowers eligible for these loans is expanding. For example, debt service coverage ratio (DSCR) has emerged as a primary factor in determining investor loan qualification.

Although personal debt to income ratio (DTI) has traditionally been the primary metric used to evaluate borrower credit, a DSCR-based loan qualification system is a better predictor of loan performance. The strength of the DSCR-based approach is that credit decisions are primarily based on the sufficiency of the rent collected from the rental property, not the borrower’s income to pay for the debt obligation of the mortgage payment. That distinction results in less defaults and better loan performance. It also expands the pool of potential borrowers, as qualification depends more on the borrower’s ability to find viable renters than the current assets of the borrower.

Yet, these new products and practices are not the only reasons rental investor loans have become more attractive to lenders. Increasingly, institutional funders have entered the space, which has made capital more abundant, added greater uniformity of credit standards and underwriting, and reduced pricing. Given the strong fundamentals supporting the single-family rental market, it seems that capital markets have stepped in and made the asset class more accessible than ever for lenders.

As we enter 2021, we have had the better part of the year to assess the effects of the pandemic. Though the effects on the real estate market have been varied, the premium being applied to single-family housing appears to be one of the few areas of consistency.

For residential lenders considering new products to grow their business in 2021 and beyond, single-family rental investor loans are an attractive option. With new products and practices and abundant capital, lenders who take note of this trend are likely to find strong demand as continued appreciation of single-family homes drives more and more families to consider single-family rentals.