KBRA: Challenging Single-Family Rental Fundamentals

(Photo Credit: Blake Wheeler)

Softening operating performance, elevated inflation, labor shortages and decelerating rental rates have produced the most challenging environment for the single-family rental sector yet, reported KBRA, New York.

The KBRA report, Single-Family Rentals: Facing Headwinds, said the sector faces ongoing challenges as the housing market continues to battle higher interest rates. “Since mid-2022, sector fundamentals have faced significant headwinds for the first time since the asset class emerged a little over a decade ago,” the report said.

Challenges have increased over the past two quarters and have been felt predominantly at the owner/operator level, KBRA noted. “While tenant delinquency levels remain meaningfully above pre-pandemic levels, institutional SFR assets have maintained relatively stable occupancy rates and high tenant retention rates despite the headwinds,” the report said. “As the economic cycle evolves, trends in home prices, rental rates and operating expenses will be useful guides to understand the future performance of SFR securitizations and the broader SFR sector.”

While the sector faces headwinds, there are also tailwinds provided by the lack of affordable houses for sale as well as built-in cash-flow and value appreciation in seasoned SFR securitizations. This mixed backdrop tempered KBRA’s expectations about the potential for positive rating movement in the sector, “and the pace of upgrades that the sector experienced in the past will likely slow, if not stall,” the report noted. 

To study home price trends in markets that are most frequently represented in SFR securitizations, KBRA looked at CoreLogic’s Home Price Index changes across the top 10 markets ranked by property count in the KBRA Comp Set, which represent nearly two-thirds of the nearly 92,000 properties in the data set. Atlanta, Phoenix and Charlotte make up the top three markets.

Average monthly HPI changes in the top 10 markets turned negative in July 2022 and remained negative until January 2023, with an average change of -0.7% per month during that time, in line with the national average change of -0.5% during the same period. This decline totaled 3.2% in the top 10 markets (compared to 3.0% nationally) in the period between July 2022 and February. “The general market consensus across the SFR sector is that home prices potentially face further declines in 2023 until the market stabilizes,” KBRA said.

Over the 24 months leading up to December 2022, rents of new leases were on average 11.7% higher than the prior rent at the same property and consistently outpaced rental rate increases for lease renewals (5.2% on average), KBRA reported. Rent growth on new leases peaked in July 2021 at 15.6% (almost double the trailing twelve-month average of 8.1%) and remained above 10.0% in each successive month until October 2022. Rent growth has been decelerating since August 2022 and fell to 7.5% as of December 2022 from 8.4% in the month prior.

Data on the KBRA comp set represents contractual rent on signed leases, which lags market-based asking rents. Market rent data from RentRange shows a different story: asking rental rates for SFR properties are generally declining on a month-over-month basis across the top 10 markets in the KBRA Comp Set. In each month in 2022, KBRA focused on market asking rents for three-bedroom SFR properties given that they are the most prevalent property types in the KBRA comp set. Market asking rents in the top 10 markets declined each month starting in September 2022 with an average decline of 0.9% per month, a maximum decline of 1.5% in December 2022, and total rent decline of 5.3% between September and February 2023.

The market rental rate declines have not yet been observed in the KBRA comp set in a meaningful way, as the typical 12-month lease terms and high lease renewal rates have acted as a buffer for the comp set. However, given the significant amount of new supply of SFR and multifamily units expected to come online in 2023 and beyond, KBRA said it expects upward pressure on vacancy rates and downward pressure on rental rates.

“Additionally, given the economic headwinds facing tenants, including inflation, steep rent increases over the last few years, expected increases in unemployment and a potential economic contraction, KBRA expects tenant delinquency rates to remain elevated, with the potential to increase further if the economy worsens significantly,” the report said.