In recent years, there has been a surge in demand for single-family rental (SFR) homes. Investors have recognized this and are eagerly looking for homes to buy and rent out. And while the SFR market was dominated immediately after the Great Recession by large institutional investors, a growing number of small and midsized investors are buying, renovating and holding properties to rent for the long term.
Private investors typically need short-term loans to acquire a property and prepare it for a tenant. This short-term debt can automatically transition into a long-term mortgage once the property is stabilized or is refinanced separately. Investors need commercial mortgages for single properties or for covering an entire portfolio of dozens of rental homes.
A sector to watch
For a commercial mortgage broker, the buy-to-rent model is a sector to watch in communities across the country. With a flight to the suburbs as renters look for more space for offices and home gyms, this is a great time for your clients to be in the single-family rental market.
It also is one of the best times to obtain long-term debt. Interest rates have rarely been lower. That said, however, the COVID-19 pandemic threw up some obstacles. Material and construction costs — which were already rising in pre-pandemic days due to tariffs and labor shortages — shot up after the virus emerged in March 2020.
Some of this price inflation was due to a disrupted global supply chain that dried up inventories. Although a sheet of plywood might cost $35 today, a few years ago that same piece of wood may have cost $15. According to the National Association of Home Builders, aggregated residential building-material costs were up 12% year over year this past spring. Earlier in the year, the cost of paint also was on the rise due a nationwide shortage. Meanwhile, construction labor shortages have been a problem for many years since the recovery from the Great Recession.
Given that the bulk of SFR properties need some amount of renovation before they can be rented, the rising costs of construction labor and materials can be discouraging for investors. Your clients may mistakenly believe that these recent increases in expenses will kill their cash-on-cash return — in other words, the cash returned on the amount initially invested in the property.
For investors in SFR homes, these added costs are an extra burden. The owner will need more money on hand to complete the renovation. But for the investor planning to hold a property for long-term rental purposes, the increased costs for materials and labor are miniscule compared to the long-run savings yielded from the low cost of financing today.
Buyers of single-family rental homes should view these properties as long-term investments that will generate income over the next 10 to 30 years or more. In this regard, a short-term hit by construction costs is of little importance when evaluating an opportunity. In today’s market, the unusually low interest rates on long-term mortgages for investment properties is the key factor to highlight.
Interest rates for single-family rentals are commonly less than 4%, which is historically low for these types of properties. This has made mortgage payments more affordable and has increased the purchase power of the investor. Also, unlike other types of commercial real estate, lenders are still offering high-leverage loans for SFRs. The higher leverage has expanded the opportunities to buy homes in competitive markets at a time when for-sale inventories of single-family homes are tight and home prices are rising.
Investors in single-family rental projects should feel good about these investments, despite the higher rehab costs, for a number of other reasons. First, investors in rental homes have more opportunity to recoup their initial investment. Unlike fix-and-flippers who rehab and quickly sell an asset on the open market, investors who plan to hold properties have a longer window to recover their initial investment by increasing rents over time.
Rents for multifamily properties are rising and are projected to climb further as the pandemic subsides. The outlook for single-family rentals is particularly attractive. During the health crisis, renters have been looking for more space and are moving away from dense apartment buildings in city cores to the suburbs where SFRs are typically available. Given these trends, the majority of SFRs are likely to draw a high level of interest from prospective tenants. This demand should support healthy, ongoing rent increases.
There is another reason why it is a good time for investors to take out inexpensive long-term debt. The U.S. is likely to see some inflation in the coming years that could drive rent prices — as well as the value of rental-home assets — up even more.
Driven by dovish federal fiscal and monetary policy, trillions of dollars have been pumped into our economy by the federal government and the Federal Reserve. Some economists are predicting that inflation will finally begin to rise quickly after remaining at a subdued level of growth for nearly 40 years.
The real winners of inflation are holders of long-term fixed-rate debt. This is because the cost of the debt stays the same while assets increase in value, causing cash flow increases due to higher rents or sales prices. All of these factors combine to make it easier for the borrower to pay down debt that was locked in at low interest rates. The key factor for ensuring the best cash flow and highest returns possible is to take advantage of the low rates.
Investors in single-family rental homes can expect their future profits to far exceed the initial costs. As the holders of affordable long-term debt, owners will gain the benefits of higher rents and asset values. The key point for mortgage brokers is that your clients should not worry about minor issues, such as the increased costs for paint or other construction products. The initial costs of a rehab will not have a major impact on long-term revenue flow. Instead, focus on buying real estate right now because interest rates are so low.