Single Family Residential Portfolio Financing: The Pixilation of Commercial Real Estate A Balancing Act y now, most in the industry will have heard of or had experience with the single-family rental (SFR) market, which typically involves a pool of single-family residential properties — usually at least several hundred and often several thousand of them spread across various states and localities within those states. Due to the size of the collateral pool, the asset class presents some unique challenges when it comes time to press the property into service as collateral. The typical commercial loan diligence standards and continuing arrangements during the loan term are not always practical or appropriate for SFR collateral. Financing SFRs calls for some unusual approaches on certain fundamental aspects of the mortgage loan process. On the one hand, uncertainty with respect to a relatively untested asset class coupled with the necessarily limited diligence that can be performed on distinct assets of such scale tends to push lenders in the direction of higher standards/stricter requirements in some aspects of the loan arrangements. On the other hand, however, the diversification of some property risks that are inherent in the SFR collateral can wind up being the solution to some of the unique problems arising from the asset class. Balancing those pressures can be an interesting process, to say the least — especially as both sponsors and lenders wait to see how the investment community will ultimately view the asset class as it matures. Financing the SFR Asset Class Various favorable market conditions (including high inventory and attractive yields) have driven private investors to buy large portfolios of REO properties to rent. Recent estimates are that, within the past two years, some 200,000 single family homes have been acquired by owners with the intent to rent them, meaning institutional investors are the new landlords. Capital can be brought to bear in a number of ways; in fact, several institutional SFR owners are REITs, some have financed through single loan (or at least singleborrower) securitizations and certainly some SFR pools have been financed by portfolio lenders. Currently, loans are being closed on SFR portfolios with the intention of securitizing those loans in multi-borrower securitizations. It is there that the clash between the peculiar characteristics of this new asset class and the triedand true customs of the mortgage industry becomes most stark. In general, the result has been to start with an approach that would be made in any multifamily property financing and, from there, to start shaving off square corners to prepare the things for round holes. CRE Finance World Winter 2015 14 SFR Financing/ Diligence Challenges An in-depth analysis of all challenges facing the legal team charged with completing an SFR financing is beyond the scope of this piece, but a few examples of issues that arise in the due diligence and documentation aspects of a transaction are instructive as they illustrate the types of matters that require approaches that differ from those customarily pursued in financings secured by other types of assets. As further discussed below, one overall safeguard will be that the owner/borrower will have the ability to release and potentially substitute one or more troubled properties (up to a certain extent). Here are a few diligence issues that must be addressed: Environmental Analysis. In traditional asset classes comprised of one or more multifamily, retail or office properties, a formal environmental report prepared by a reputable consultant is a fundamental component of due diligence; the significant liabilities that can attend environmental contamination and the costs and time associated with obtaining the report render the cost/benefit analysis an easy calculation. With SFR, however, the properties may be widely dispersed over numerous states, and even more counties and cities. Rarely would two or more properties even be located on the same street. A Phase I environmental assessment of the type normally expected in commercial real estate financings on each property in an SFR portfolio would simply be cost-prohibitive; a “desk” type review is the only sensible solution in most cases. Of course, an environmental problem with one home in a portfolio would not represent any indication of an issue within the remainder of the portfolio, so the lender has tremendous diversification of this risk to ameliorate the lack of certainty with respect to each individual property. Property Reports. While required in connection with traditional CMBS and commercial loans, the volume of SFR properties in the collateral pool makes obtaining individual ALTA surveys, zoning reports and even evidence of compliance with local laws practically impossible. In some cases, the borrower/owner may have obtained pieces of the diligence such as surveys or zoning letters in connection with its purchase of the assets, but if not, the lender may end up limiting or eliminating the survey or zoning requirement altogether. Broker price opinions are very likely to replace traditional appraisals. Waiver of the requirements for these customary property-level materials may seem an anathema to the traditional mortgage lender B Lucia Graziano O’Connell Counsel, Real Estate Finance/Land Use McGuireWoods LLP T. Craig Harmon Partner, Real Estate Finance/Land Use McGuireWoods LLP Paul J. McNamara Associate, Real Estate Finance/Land Use McGuireWoods LLP
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