CMBS’ Role in Helping Fuel the Enormous Growth in For-Rent Houses
Single-family rentals (SFRs) emerged as one outsized winner of the pandemic. The sector was an underdog, whose economic story had been building pre-pandemic and was accelerated as a result of the downturn, like so many other real estate trends.
The commercial mortgage-backed securities (CMBS) market has been there, supporting its growth and institutionalization every step of the way. But, similar to SFRs in the broader market, CMBS is still building and establishing its footing within the rental homes sector.
The first SFR CMBS securitization was a single-borrower deal that came to market just eight years ago, at the end of 2013. Kroll Bond Rating Agency (KBRA) and Fitch Ratings officially established and released ratings methodologies for the sector not long after that, in 2014 and 2015, respectively, according to both firms.
Up until 2020, the existence of SFRs in CMBS had been somewhat of an afterthought, clouded by conduit and single-asset, single-borrower CMBS, as well as its fixed-income sister, residential mortgage-backed securities (RMBS), which only really pool gobs of home equity loans or government agency-backed residential mortgages. CMBS, of course, works within the confines of income-producing properties — in this case, single-family homes that fetch rents — so SFR CMBS securitizations marry a CMBS structure with RMBS-esque collateral.
Macroeconomic housing indicators, like rising home prices and lackluster home-buying trends, that sprouted up in the few years leading up to the pandemic had primed the rental home market for the pedal-to-floor acceleration in investment that came in 2020, which has continued through the first half of 2021.
Large, institutional investors have made big splashes in the SFR space over the last 12 to 18 months, moving to capitalize on these economic developments, as well as demographic trends that have developed among the aging baby boomer population, millennials and Gen Zers alike.
“In the last year and a half or so, we’ve seen a lot of new entrants into the market,” said David Eckels, a senior vice president at Midland Loan Services, a servicing division of PNC Bank that, at the end of 2020, sported an SFR CMBS loan servicing platform of more than 200,000 rental homes, across more than 50 CMBS deals, with an aggregate balance in excess of $25 billion. “In terms of why it’s successful, a lot of large, institutional investors have committed capital to this product, and there’s definitely going to be growth in the sector as this capital is deployed to acquire more rental homes.”
In June, Blackstone (BX) Real Estate Income Trust acquired rent-to-own firm Home Partners of America at a valuation of $6 billion — not long after it sold its stake in Invitation Homes, a major player that it actually took public in 2017 — and Invesco Real Estate (IVZ) and Mynd Management announced a joint venture to spend about $5 billion to buy around 20,000 single-family rentals over the next three years. Earlier this year, Greystar, one of the more well-known developers and managers of multifamily real estate, estimated that it could be managing 25,000 rental homes in the next five years, up from its current management portfolio of 1,500.
In the build-for-rent space, one of the largest U.S. homebuilders, Lennar Corp., announced in March that it secured initial equity commitments from Centerbridge Partners and Allianz Real Estate, among others, to form Upward America Venture, a business that is poised to acquire more than $4 billion worth of fresh, for-rent single-family homes and townhomes throughout the country.
“This [venture] has an opportunity to scale at a pace we do not believe possible for competitors in the single-family rental space, given its direct access to Lennar’s pipeline of over 300,000 owned and controlled homesites,” Rick Beckwitt, Lennar co-CEO and co-president, said upon his firm’s announcement of the Upward America Venture.
Those are just recent examples of what’s been materializing over the last few years. The increased investment has been a boon for SFR CMBS, especially for single-borrower deals sponsored by these types of large investors. For the major bank lenders that originate and issue SFR CMBS deals, it’s a financing opportunity that provides an almost unlimited ability to target this type of housing demand and continually support the major institutional players who are making waves, all while not impacting their balance sheets.
Last year, SFR CMBS reached record highs. Issuance climbed to nearly $9.8 billion, which is comfortably more than twice as much as what was issued in 2019, according to recent data from research firm Trepp.
It has gotten off to a hot start this year as well. In the first seven months of 2021, issuance has nearly reached $8 billion. SFR CMBS issuance, though, is, far and away, outpaced by the conduit and single-asset, single-borrower segments and represents just a small sliver of the CMBS world. But, the sector is poised to grow as more institutional players capable of enjoying a CMBS execution continue to pour money into SFRs acquisitions and new builds.
Institutional players have some work to do to catch up, but activity is certainly mirroring demand. Around 85 to 90 percent of the market is dominated by smaller landlords that own 10 or fewer units, according to information from the National Rental Home Council, a leading industry trade group formed in 2014; the larger institutional investors, which happen to own more than half of the nation’s multifamily product, only account for around 2 percent of the SFR market.
Firms have turned to new builds to gain ground and fill demand. More than 50,000 new homes for rent were built last year, The Wall Street Journal reported in January, citing information from John Burns Real Estate Consulting. That rate is more than 60 percent the annual average over the last 40 years.
William Rahm, Centerbridge’s global head of real estate, said in March after the launch of Upward America Venture, that he believes the single-family rental sector will “continue to outperform” as housing needs and demographics continue to evolve.
That sentiment is bolstered by the recession-resistant nature of the space, which became even more evident during the pandemic, and bodes well for SFR CMBS originators and investors.
SFR CMBS delinquencies — by loan balance — have not risen above 1 percent in the last 12 months, according to Trepp. (One $512 million SFR CMBS loan sponsored by Progress Residential went delinquent in December 2020, which caused the rate to jump to 2.42 percent, but it turned current the very next month, which dropped the delinquency rate back down to 0.4 percent.)
Delinquencies fell further in July 2021, along with the special servicing rate, which dropped to 0.31 percent that month after peaking at a mere 0.66 percent, per Trepp. The broader CMBS market was not so lucky, with delinquency and special servicing rates topping out at a whopping 10.32 percent and 10.48 percent, respectively, in June and October 2020. Calculated by loan count, rather than balance, delinquency (3.71 percent) and special servicing (4.24 percent) rates in July were higher, which Trepp indicated is a sign that larger SFR loans have performed well and stayed current on payment obligations, keeping overall rates down.
“Overall, pay downs for some of the early deals that are still outstanding are strong, and there are relatively low delinquencies and very little actual losses at all. Performance has been good,” said Tamon Hayes, a senior director at Fitch Ratings, which rated its first multi-borrower SFR CMBS deal in 2015; the company hasn’t rated any single-borrower deals. “Leverage has increased over time, with all the investor demand out there. From a borrower perspective, there certainly is demand out there and more competition, so with the natural interest rate environment, we’ve seen a compression in mortgage coupons.”
For servicers, dealing with SFR CMBS deals is a much more rigorous exercise, from a reporting and surveillance standpoint, than dealing with traditional CMBS.
Some single-borrower deals can have thousands of homes, like the FirstKey Homes deal from June that is sponsored by Cerberus Capital Management; there were more than 9,000 homes in that $2.1 billion securitization (FirstKey Homes 2021-SFR1) — the largest deal of the year, by far. Insurance and property releases are two of the most labor-intensive components of a servicer’s work in SFRs, said Midland Loan Services Chief Operating Officer David Harrison.
“If every property has an insurance policy, and some percentage have flood policies and other various insurance requirements, that is operationally intensive, which is different from [basic] CMBS,” Harrison said. Many traditional conduit and single-borrower CMBS loans include much smaller portfolios or a single piece of real estate and are covered by blanket insurance policies. Also, releasing properties from a loan is more common in SFR CMBS deals than traditional conduits, Harrison said.
“That requires a payoff quote to be generated and an analysis of the release request, and potentially an analysis of substitution collateral, if something new is being brought in, and, also, analysis of how the portfolio performs once the released properties’ cash flows and values are taken out of it. It’s not a more complicated work set, but just more of a work set,” Harrison said, adding that “there’s nothing new under the sun about the work on these loans and properties … there’s just hundreds of thousands of them, so it’s truly a volume game.”
From a reporting perspective, technological capability is important for servicers, given the sheer volume they’re handling.
“There’s a large amount of collateral, so we have to track each piece and the items associated with that collateral — taxes, insurance, homeowners association fees, etcetera,” Midland’s Eckels said. “We’re taking in a large amount of information. We’re able to leverage the [CRE Finance Council Investor Reporting Packages] in CMBS and make modifications to cover the SFR rental business.”
In terms of deal structure, single- and multi-borrower SFR CMBS deals are akin to traditional CMBS, with terms in the five- to 10-year range, according to Daniel Tegan, KBRA senior director of single-family securitization, whose group has rated 70 SFR CMBS deals since 2013. They mirror multifamily in CMBS in that loan structure is driven by cash flows derived from rents to pay debt obligations and the factoring in of a probability of default. And being that the assets themselves are residential, RMBS methodology is borrowed to take into account home price declines to determine loss given default, which is a measure of losses should the borrower default.
Fitch Ratings handles multi-borrower deals only and “leverage is the primary factor,” according to Hayes. “We take an income-focused approach, and everything is driven by cash flows. Compared to single-borrower deals out there, [multi-borrower deals tend to be] more geographically diverse — good representation throughout the country. Regional concentrations are no more than mid-20 to 30s percent on average for these deals. The benefits from the multi-borrower space come from diversity — loan and geographical diversity.”
The fervor in the space has led some to wonder whether the asset class has become too frothy too quickly. In the spring, Tom MacManus, president of commercial real estate lender Money360, said he felt that pricing dynamics in the market weren’t conducive to long-term success.
“Developers and builders of single-family [homes] can get top-notch pricing,” he said on a panel at GlobeSt.’s Apartments Spring 2021 forum. “Some of that, to me, doesn’t sound like it passes the test for the long term.”
Behind the curtain of the big, showy investments and large-scale, future development strategies in single-family are rising costs of construction and soaring rents — which happen to be coupled with strong occupancy.
Single-family rental rates climbed 5.3 percent in the 12 months ending in April, more than doubling the 2.4 percent annual increase in April 2020, according to information from financial services and research firm CoreLogic. Residential construction costs jumped 34.1 percent on the year in June, according to the Bureau of Labor Statistics.
Unemployment and labor force woes, as well as regional and national eviction moratoriums and worries about COVID-19 persisting, are all looming factors that could adversely affect single-family rentals, according to research from KBRA.
Still, baby boomers and millennials should continue to fuel demand for single-family rentals, a trend — at least, from the latter generation — that had been developing years before the pandemic. Recent research on sentiment from Gen Z should also help demand.
A survey conducted in late 2020 by the National Apartment Association found that 44 percent of the Gen Z population preferred the suburbs over urban city living, and 43 percent indicated that they’d rent single-family homes after graduating from college.
In a first-quarter 2021 report on single-family investment trends, officials and researchers at Arbor Realty Trust wrote that, “if there were three real estate headlines to come out of the pandemic, they would focus on work-from-home trends, online retailing and single-family rentals. By the end of 2021, the latter may be the only one of the three to avoid some post-pandemic reversion.”
Mack Burke can be reached at firstname.lastname@example.org.