DBRS Morningstar’s Takeaways From ABS East 2023: Expenses Stack Up for Single-Family Rentals, Threatening Years of Growth

As part of its takeaways series, DBRS Morningstar is publishing several write-ups about pertinent topics discussed at ABS East 2023, an industry conference for the asset-backed securities sector. Single-family rentals (SFRs) are among the better performing asset types in residential mortgage-backed securities, so much so that DBRS Morningstar upgraded 22 tranches last year. Six have occurred so far in 2023, and Adler Salomon, Senior Vice President, U.S. RMBS, noted there are still annual reviews left to do. To give some data, the average vacancy is around 6% and the average delinquency rate is about 4%. However, Salomon did note that these two metrics are worse than what they were pre-pandemic—when the average vacancy rate was around 4% and the average delinquency rate was less than 1%. Still, the collection rate is in the 95% range, and the retention rate for tenants is in the low to mid-80% area.

There are pockets of risk in locations where the vacancy and delinquency metrics are higher than the national averages. These areas include Chicago; Memphis, Tennessee; and Atlanta, per Salomon. When he asked sponsors what’s happening in those areas, they said one reason is that they’re having trouble evicting unpaying tenants, sometimes because of local municipal laws.

SFR issuance has also decreased this year. “Volume in the sector has gone down quite a bit,” said Salomon. In 2023, issuance is still below $3 billion, down from $14 billion last year. And even what does make it to issuance this year is at a discounted price to make the securitizations public.

Owning these SFR homes looks to become more expensive. While home prices have risen, there’s a flipside. “As home prices go higher, property taxes do increase. It is a pretty big percentage of the expense piece,” said James Egan, Managing Director, Co-Head U.S. Securitized Products Research, at Morgan Stanley. Although it varies from deal to deal, he mentioned taxes can be 40% to 44% of underwritten expenses for SFR securitizations. Egan thinks taxes still have room to grow, close to 10% in 2023, as a number of states don’t do annual assessments and have not yet factored in today’s home values.

Another reason SFR operators’ expenses will increase is insurance, especially for particular locations. “I think Florida is a prime case here where insurance costs have almost tripled in certain geographies,” said Pratik Gupta, Director and Head of CLO and RMBS Strategy at Bank of America. “That’s going to affect SFR operators in hindsight.” He expects some SFR companies to dispose of specific locations that are no longer profitable because insurance expenses are so high.

The next few years do look a bit worrisome, Salomon warned. “I am concerned about potential refinancing as some of these transactions become due,” he said; the SFR deals have an interest-only structure that requires full principal repayment at maturity. He sees “a slew of deals coming due in 2025 and 2026.” Assuming interest rates stay as high as they are, it might be difficult for sponsors to pay off some of these securitizations via refinancing, particularly the transactions that were issued after 2020, when home values skyrocketed.

As an aside, Jeff Glass, Chief Executive Officer at Hometap Equity Partners, LLC (Hometap), explained home equity investments (HEIs), a small but growing area of the residential real estate business that finds itself in a similar position to where SFR was years ago. Glass explained “this product is an alternative for homeowners” who have lived in their home for years, made mortgage payments, and benefited from rising home values, and now a large part of their net worth is tied up in home equity. Instead of going into more debt or selling their home, they can sell a percentage of their home equity to companies like Hometap and use the cash to pay for large, unexpected expenses or plan for the future. Hometap then structures a pool of home equity percentages into an HEI securitization. To analyze these deals, DBRS Morningstar uses its “Rating and Monitoring U.S. Reverse Mortgage Securitizations” methodology (Appendix 3).

Written by Caitlin Veno

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