What’s on the Horizon for the SFR Market?

The single-family rental market has, in more than one way, been mirroring the multifamily industry. Both expanded rapidly fueled by COVID-19, low interest rates and robust household formation. But for both sectors that phase ended when the economy started to tremble under the weight of rapid monetary tightening, high inflation, and overall dwindling buying power. All these factors, coupled with extreme volatility in homeownership pricing, set off a new phase in 2023, one defined by a tight and less friendly housing market. Throughout the year, SFRs maintained steady progress, albeit at a slower pace than in 2022.

The SFR market brazenly accepted its position between “yet unreachable homeownership dreams” and “more than an average apartment renter’s capabilities.” In other words, the headwinds impacting the affordability of homeownership are, in fact, tailwinds for the SRF market. These add to the product’s main attributes—plenty of space, mobility, an amenity package found in luxury apartments and no worries about the high costs of homeownership—and help to convert increasing numbers of apartment renters into SFR residents.

Challenges that shaped 2023 (and fuel growth)

The financial landscape of 2023 created a set of challenges that affected all real estate segments.

“A tough capital markets environment, coupled with rising expenses, has made it challenging to find opportunities that fit the return thresholds of today’s marketplace,” Mitch Rotta, senior managing director at TruAmerica Multifamily, told Multi-Housing News.

Rotta has been leading the company’s BTR development division since its launch in early 2022, when the SFR-BTR market was booming.

Coming on the heels of 2022, a year described by Tower Capital Co-Founder & Managing Partner Kyle McDonough as the strongest on record for BTR development, many lenders have stopped funding construction loans because of deteriorating market conditions. Yet, Tower Capital experienced elevated levels of activity throughout 2023, as the market continued to show strong growth and demand. And this demand was mainly fueled by the shortage of affordable housing options in the most desirable areas of the country, according to George Maravilla, senior vice president at the structured finance firm.

“Ultimately, we’re still lacking the necessary housing in our country,” said Rotta. And this will likely continue to drive SFR/BTR demand for years to come. Institutional investors are drawn to single-family rentals due to the undersupply, and also because these communities operate like multifamily assets.

“The appeal for investors is the exceptional renewal rates, and BTRs appeal to a wide range of renters,” said McDonough. “Consumers also favor these communities because they tend to be higher-end properties that live like a single-family residence.”

Bella View is a 91-home BTR community in Snellville, Ga., approximately 25 miles northeast from downtown Atlanta. All images courtesy of Haven Realty Capital
Magnolia Place is a 78-home SFR community in Holly Springs, Ga., some 35 miles north of downtown Atlanta.
Trickum Hills is located in Lawrenceville, Ga., one of Atlanta’s most sought-after suburbs. The BTR property comprises 78 townhomes built around a central park with an amenity pavilion.

Making the best of what is

This year has kept most investors, operators and developers focused on ensuring that their existing projects are properly capitalized, considering the difficult environment where equity and debt are not a foregone conclusion, as Sudha Reddy of Haven Realty Capital puts it. As the sector continues to adapt to the “higher for longer” interest rate environment, operators with projects that are in the lease-up phase or fully stabilized are mainly focusing on ensuring efficient operations and maximizing results, particularly as demand ebbs and flows with seasonality.

Meanwhile, as consumer attraction to SFR/BTR housing projects continues to drive demand for new developments, more builders are pursuing financing for this product type. However, uncertainty regarding how to obtain favorable financing persists, noted Doug Ressler, manager of the business intelligence department at Yardi Matrix. He explained that each of the four phases of construction—pre-construction, construction, stabilization and the operational phase—expose the lender to distinct credit risks.

“It is crucial for the BTR sponsor to demonstrate to financiers that the project will scale up, stabilize and become cashflow positive over the mid- to long-term during a defined period,” Ressler said.

Fundamentally, developers must understand the area and market conditions in which they wish to build. Hence, BTR developers need to diligently study the region’s supply and demand metrics, and include in their research aspects such as social diversity, schools, retail and grocery, and demographic diversity. The BTR product must prove its appeal and ability to provide a fiducial cash flow in relation to other housing asset classes, and competition is harsh because residential housing is among the assets with the lowest investment risk thanks to high occupancy and growing demand amid an increase in the supply-demand gap. The projects that are receiving financing are likely lower leverage with experienced sponsors, noted Reddy.

Empire Group of Cos. secured a $72.8 million loan to develop Village at Golden Triangle, a BTR development roughly 14 miles north of downtown Fort Worth, Texas. Tower Capital arranged the financing. All images courtesy of Tower Capital
Tower Capital also arranged $27.8 million in non-recourse construction financing for a BTR development in McKinney, Texas. The 128-unit project is owned by Hanson Capital.
Tower Capital arranged more than $20 million in non-recourse construction financing for Proximity 7th, a BTR project in Phoenix featuring 77 townhomes.
Empire Group secured $42 million in financing for Village at Skyline Ranch, a 167-unit BTR community in the Phoenix market. Tower Capital arranged the financing.

What is the SFR market outlook for 2024?

Implementing strategies, scaling and delivering products during these troubled times is tough.

“Volatility in the marketplace is really the toughest aspect to address right now,” believes Rotta. Hence, a primary objective is uncovering opportunities that work.

“Optimists are looking for more stability in the marketplace in the first two quarters of 2024, and should that transpire, it is expected to provide more investor confidence,” he added. Nonetheless, he believes that the first half of the upcoming year is shaping up to be a period of “staying patient and disciplined” so that whatever opportunities are chosen, are the ones that can weather the storm.

Reddy expects to see declining operations and decreasing economic occupancy, should the economy weaken, and a recession ensue.

“On the flip side, a weakening economy would probably lead to a decline in interest rates, which would provide some much-needed relief on the debt side,” he added.

Unless there is a substantial decline in interest rates and the economic environment suddenly improves, Reddy expects current rate levels to provide for similar conditions in 2024 as in 2023.

Another big factor to pay attention to next year is supply conditions across both multifamily and single-family markets.

“A tough debt market on the refinance side and increased supply could be a perfect storm to create some challenging situations for developers,” warned Rotta.

All thing considered, next year will be anything but dull for the real estate industry. Labor market shortages, inflation, high interest rates and changing regulatory environments will keep SFR/BTR owners and operators busy. Ressler pointed out that expenses outpacing rent growth will be a major concern in 2024, the severity of which will depend on the depth of a likely recession. Yardi Matrix data shows that the average expense per SFR unit rose to $9,149 in September 2023, marking a 12.2 percent year-over-year increase. This large cost jump pushes operators to focus on operational efficiency, especially since insurance costs are also growing rapidly, particularly in markets located in climates prone to natural disasters.