By Amilda Dymi
June 15, 2023
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There is large appetite in the marketplace to acquire rental product
Mortgage-backed securities secured by single-family rental proliferated after the 2008-2009 financial crisis, providing plum assets for money ready to work. But commercial interest rate spikes on portfolios among fundamental industry challenges, has sapped energy from that liquidity surge recently.
By June 2, 2023, rental non-amortizing and non-traditional residential mortgage-backed securities issuance year-to-date had declined from $6.9 billion, to $755 million, according to the J.P. Morgan Chase Market Update: Non-Agency Agency RMBS Snapshot published in late May.
The roughly 90% decrease driven mainly by elevated interest rates made purchasing multifamily real estate unaffordable for many, said Victor Kuznetsov, managing director and co-founder of Imperial Fund, a high quality, non-agency mortgage investment firm in Hollywood, Fla.
After a slide of three consecutive quarters, MBS issuance secured by single-family rentals was $650 million in Q1 2023 the lowest quarterly amount since 2019, according to New York Citybased Finsight. It reflects a broader CMBS market softening.
The effect of the current elevated rate environment on CRE rental issuance has been dramatic, said Kuznetsov.
SFR debt yields
The dramatic slide in issuance also has consequences for the yield picture. SFR debt yields rose 55 bps, to 9.9% in Q1 2023, the largest quarterly increase on record.
It is also the fourth increase in the past five quarters, suggesting lenders are being more cautious about the credit risks they are taking on, according to Arbor Data Science, which provides data driven commentary for institutional clients. Yield increases also show SFR property investors
secured less capital for each dollar of net operating income (NOI), or less cash flow, earning $10.12 per NOI dollar in Q1 2023, down $0.60 quarterly and $1.33 annually.
Not a debt problem
Despite the slide in issuance and the yield outlook, professionals insist that mortgage-backed securities financing is still readily available and that the market is active.
"There is large appetite in the marketplace to acquire rental product," according to Michael Finch, an executive vice president at SVN| SFRhub Advisors, a Phoenix, Ariz.-based digital marketplace focused on single-family rental properties. Borrowing costs however, do not make financial sense to many issuers.
The primary reason MBS debt markets supported by multifamily and SFR assets contracted so drastically is because commercial interest rates on rental portfolios, "make it exceedingly difficult to cover debt service coverage ratios, he said. The bigger problem for all rental asset investors, he added, is not the lack of available debt, but the lack of available cash flow to service the debt in most portfolios.
While interest rates are high, compared to recent historic lows, he argued, debt availability remains at around historical averages, which means borrowing today is relatively expensive.
“There is large appetite in the marketplace to acquire rental product”
Michael Finch, executive vice president at SVN| SFRhub Advisors
With both single-family rental home prices and rents at all-time highs, Finch expects the debt shortage dynamic could come into play if prices and rents decline, which seems unlikely.
Demand is strong, due to a SFR supply shortage of approximately 1.7 million units a year, he said.
After massive home price and rent appreciations created abundant debt and equity flows to securitize, he said, single-family rental financing doubled alongside home mortgage interest rates "creating a double-edge sword shift that has increased the cost of doing business.
Pricing has not come down broadly to date, but they could slide during a recessionary period. Finch believes, in that case, the current cash flows will be in a good position to service debt products if they remain at today's levels.
Mezzanine wins
A number of broad real estate market factors have altered the structured credit space in recent quarters. One of the most impactful has been the way high demand for high-coupon MBS has attracted new investors.
Demand has caused significant price increases on outstanding and new-issue, high-coupon MBS, Kuznetsov said. That is creating new classes of primarily fast-money investors, who had previously been less interested in these assets.
Such investors are looking to capitalize not only on price increases due to sparse supply, but also the potential for interest rate cuts in the medium term.
Creditors, such as regional banks, seek out those assets especially, because they tend to have shorter durations and higher coupons than agency MBS, Kuznetsov said, which helps offset the interest rate risk that has been killing them recently.
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