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CRE Finance World, Autumn 2013

Of additional concern is the fact that expense ratios in single-family rentals are closely tied to the quality of the tenants. Tenants can create costly expenses without being aware that they are “trashing the place”, just by virtue of being inconsiderate of the costs of home ownership and the savings of preventative maintenance. This concern is not unique to single-family rentals but, today, the quality of the SFR tenants has never been better and will arguably only deteriorate from here. Homeownership has reduced from historically high levels (70% in 2005) and is expected by John Burns consulting to trend downwards to 62.1% by 20153. After which, a reversion to higher homeownership is expected as people who want to own a home but are forced to rent now, re-build their credit and save the necessary down payment. As the SFR space begins to lose its best tenants to homeownership, DBRS questions whether the expense ratio will increase as the quality of the renter decreases. Other potential sources of expense ratio volatility (or stability) would include: Real Estate Taxes: Probably the most influential expense to be considered due to its relative weight and also its fluctuation from asset to asset. Good neighborhoods and good school districts — one of the purported incentives of SFR, also experience high property tax rates that are likely to escalate each year. The benefit of course is that the taxes are a known, discoverable quantity and potential increases can be accounted for by careful underwriting practices. Insurance: For large institutional players, insurance would likely be provided using a blanket policy assessment of the portfolio value. Again, a known quantity, that may also benefit from the economies of scale that pools of assets provide. Utilities: Typically utilities are paid by the renter. Management Fees: Can run as high as 10% in an inefficient market. Most of the institutional players assume management fees of 7-8% would attract a good replacement manager. Additional compensation in the form of leasing commissions could also be available. A survey of knowledgeable market participants suggests that the quality of the manager plays a critical role in managing other expense line items. Managers must have knowledge of the local market, by-laws, HOA restrictions, eviction procedures and other local administrative needs. SFR pools therefor need to balance the cost of having localized property managers with centralized reporting and control. Local managers must be properly incentivized to operate in the best interest of the securitized pool for the end benefit of investors. CRE Finance World Autumn 2013 46 As a result of the expense items noted above, DBRS would not be comfortable with expense ratios lower than the multifamily counterpart which averages 45% but could be as high as 55% on SFR pools. Operational Risk As the securitization market for single-family rentals is untested, assessing operational risk is more important than it is with established product types. Rating analysts and investors need to be comfortable with the deal from an origination perspective as well as an ongoing administrative perspective. In the case of single-family rentals, “origination” should more properly be called “investment”, as asset aggregation is the process with the most operational risk if not done correctly from the on-set. Investment characteristics to consider when evaluating a singlefamily rental portfolio include the following: • Asset sourcing methods and personnel • Market and demographic analysis • Property renovations and maintenance Asset Sourcing Single-family rental product can be sourced in a number of ways. Banks, financial institutions and RMBS special servicers often have a large inventory of defaulted homes to dispose. Many times, the homes are listed with a realtor and sold individually. Occasionally, however, dispositions are accomplished through bulk sales, or the sales of multiple assets. In either case, it is important to consider the amount of due diligence the buyer can perform prior to sale. Individual purchases generally allow the buyer full access to the property. However, if the asset is being sold by auction, the buyer likely is allowed only limited access to the property, and may not fully understand its condition. Bulk sales can provide the investor with multiple properties at once. If the seller is a servicer or a financial institution that is disposing of foreclosed properties, the homes could be in poor shape and require more renovations. An additional issue with bulk sales is that a buyer may be forced to “take the good with the bad” and purchase some less desirable properties in order to win the bid. Ultimately, the experience of the SFR investor and its employees is a key consideration. Companies with established track records that hire staff with significant real estate experience over a long period of time are preferred. However, due to the relative newness of this market, even experienced companies are likely to only have Single-Family Rental Securitization


CRE Finance World, Autumn 2013
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