May 17, 2022
Over the next decade, we believe single-family rentals will play a more significant role in institutional real estate portfolios as investors recognize the sizeable market opportunity and the critical demand drivers behind the already impressive growth of the sector. As we begin to see the effects of inflation, the demand for rental options should increase even more and intensify the already strained supply of affordable rental homes.
Real Estate as a Hedge Against Inflation
Two significant inflation indicators, the 1980 Consumer Price Index (CPI) and the Producer Price Index (PPI), rose to 7.9% and 10.0% in February 2022, the steepest yearly increase since February 1980. The good news for residential real estate investors is that various studies have shown that inflation and rent growth are positively correlated. According to a Stanford University study, residential real estate investments are historically resilient during inflationary periods.
There are three distinct ways real estate can act as a hedge against inflation. First, as home prices rise over time, the increase in value lowers the loan-to-value of any mortgage debt, acting as a natural discount. Second, landlords can adjust rental rates while keeping the mortgage the same, increasing the property’s cash flow while the debt remains the same. Lastly, property values over time tend to stay on a steady upward curve providing recurring income for investors that can potentially keep pace or exceed inflation in terms of appreciation.
Renters by Necessity: A Growing Demographic
U.S. homeownership rates remain well below their peak levels, with more and more Americans unable to afford to purchase a home due to the high barriers to homeownership. Rising interest rates, rising home prices, growing student and consumer debt, and tighter lending standards have made purchasing a home more difficult.
When potential homebuyers tally up the financial requirements of owning a home, many fall short when saving for a down payment or having the necessary credit score for an affordable interest rate as rates rise. Additionally, the monthly mortgage payment for a typical single-family home currently exceeds the average monthly rent by nearly 40% across the U.S.
Source: Green Street Advisors US Housing Dynamics, March 2022
Rising Rental Demand Increases Supply Constraints
The gap between affordable housing demand and supply continues to widen. Americans searching for housing in the last few years felt the lack of affordable housing options in the U.S. more than ever before. Lower interest rates in 2020 and 2021 led to a buying spree, and the supply of new homes and existing inventory could not keep up, further deepening the shortage of affordable homes.
The decrease in supply coupled with the high barriers to homeownership has created unprecedented demand for affordable single-family rental homes. According to John Burns Real Estate Consulting, from January 2020 to present, institutional investors have contributed $47 billion in new capital to the SFR space seeking to capitalize on a growing opportunity in single-family rentals (SFR) and build to rent (BTR). There are nearly 17 million single-family rental households, and less than 3% of owners have more than 100 homes in a portfolio, creating a sizeable market share for NexPoint Homes Trust.