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For U.S. Rental Housing Issuers, Scarcity Is A Good Thing

The outlook for rental housing in the U.S. remains resilient. Despite the possibility of a near-term economic slowdown, we see ongoing strength and growth in the U.S. multifamily and single-family housing market because, at root, there are simply not enough rental homes for everybody who wants one. This undersupply results in persistent affordability issues that continue to boost the demand for rental homes, placing rental housing REITs, at least in the near term, in a position that supports good growth, lower debt, and investment grade ratings.

Household formation this decade has averaged about 1.04 million units annually, while housing production has averaged only about 880,000 units, resulting in a yearly deficit of about 160,000 units. That shortage, combined with wages that have not kept up with resultant higher rents, have generally benefited residential rental REITs. Development activity for new housing has increased in recent years, however. Supply in high-cost coastal markets, including San Francisco has eased a bit, although New York, Seattle, and downtown Los Angeles still face some near-term pressure. Supply in Sun Belt cities like Atlanta and Dallas has increased, but demand is keeping pace due to strong job growth in these metros. But overall, new multifamily housing construction has not kept up with demand due to labor shortages, rising material costs, and sometimes, the difficulty of navigating local political and community resistance to new multifamily housing. Consequently, development pipelines (as a percentage of total gross assets) for multifamily REITs have decreased over the past year, as fewer projects are generating sufficient yields to compensate for the added risk of ground-up development.

When we look at affordable multifamily housing owners and operators, we see similar, if not more challenging, supply constraints. According to the National Multifamily Housing Council, "chronic underbuilding during the economic recession has constrained apartment supply at a time when affordability concerns are at a high."

Credit Check

While the underlying housing shortage can make life problematic for prospective tenants, it can be, in a number of ways, good for a landlord's finances and a rental REIT's ratings. All of our rated rental housing REITS have investment-grade ratings and all have stable outlooks (see table 1).

For one, we believe the performance of rental housing REITs will be less vulnerable to an economic slowdown compared to other property types given the solid demand for housing in the U.S. We expect the rated rental housing REITs to post positive, albeit decelerating net operating income (NOI) growth in 2020 as we enter a period of slower economic growth. for For multifamily and single-family REITs (see chart 1), we forecast same-property NOI growth exceeding 3% in 2019 and in the 2%-3% range in 2020, as demand for housing remains healthy while occupancy remains near peak levels.

Moreover, balance sheets at these REITs have generally improved. We can see how leverage has trended lower since the Great Recession high of about 9x in 2008. Today the average unadjusted debt-to-EBTDA metric for the group stands at less than 5x (see chart 2). During the same period, many of these residential rental REITs have managed to extend their debt maturities—part of the prudent financial policies that we expect will support current ratings.

Table 1

Rental Housing REITs
Rating/Outlook Key Strengths Key Risks Outlook Statement
American Homes 4 Rent BBB-/Stable/-- Second-largest publicly traded single-family rental operator in the U.S., with ongoing favorable industry tailwinds.Well-occupied portfolio with no meaningful geographic concentration of assets. Relatively efficient operating platform that capitalizes on economies of scale where available, as well as best practices to standardize processes and maximize efficiencies. Limited operating track record, with about eight years of history. Large amount of fixed, unique costs and capital expenditures that are often independent of increasing scale and could pressure margins and credit metrics. Growing development pipeline that adds an additional layer of risk to our view of the company's below average profitability compared to traditional multifamily peers. S&P Global Ratings' stable outlook on American Homes 4 Rent (American Homes) reflects our expectations for modest same-property net operating income (NOI) growth over the next two years because we believe the company will continue to benefit from solid demand for single-family rentals. We believe credit protection measures will stay in line with current levels as the company begins to shift its focus to development.
Apartment Investment and Management Co. BBB-/Stable/-- A more diversified portfolio by geography and price point compared to most peers, which should lead to relatively stable cash flows throughout a complete cycle. Asset recycling and robust redevelopment activity has resulted in above-average operating performance in terms of same-store net operating income (NOI) growth and occupancy. Increasing exposure to higher-barrier coastal gateway markets should lead to solid rental rate growth. Despite capital recycling and redevelopment initiatives, the company's average property age remains above the peer average, which may lead to higher capital expenditures. A secured debt strategy limits financial flexibility somewhat, despite the accelerated principal amortization that helps ladder maturities and keep the company's loan-to-value (LTV) relatively low. Leverage is higher than multifamily peers', although it has been declining gradually. S&P Global Ratings' stable outlook Aimco reflects our expectation that multifamily fundamentals remain sound and will support moderate rent and NOI growth. EBITDA should increase modestly over the next one to two years, which, along with a slight reduction in debt, should result in improvement to Aimco's leverage and coverage metrics.
AvalonBay Communities A-/Stable/-- Large apartment REIT focused on densely populated, high-barrier-to-entry coastal markets. High-quality, well-occupied portfolio that has benefited from steady development activity and ongoing asset recycling. Key credit metrics are among the strongest of all REITs. Geographically concentrated portfolio, with its top three regions representing approximately 64% of net operating income (NOI). Development exposure is higher than peers, although risk is somewhat mitigated by a healthy amount of pre-funding. Supply remains slightly elevated in certain markets, but absorption remains positive, supported by a tight labor market. S&P Global Ratings' stable outlook on AVB reflects our expectations for continued healthy apartment fundamentals to support low- to mid-single-digit same-store NOI growth, continued successful development completions, and lease-up of its sizeable development pipeline that will further enhance NOI. We also expect the company will continue pursuing development opportunities prudently and moderate new starts as conditions warrant, while continuing its current funding strategy to limit financing risk and preserve credit metrics at or near current levels. In our opinion, this should provide the company with some cushion through a period of stress.
Camden Property Trust A-/Stable/-- Camden boasts the youngest portfolio of properties (average age of 15 years) among its rated peers, which reduces its capital expenditure needs while appealing to a greater pool of prospective renters. The company isn't overly exposed to the gateway coastal markets like some of its peers (markets which are perceived to have higher barriers to entry) and focuses on markets that are highly correlated to population growth, job growth, and net migration. While it charges a mid-tier average rental price to its tenants (rental revenue averaged $1,485 per apartment in the fourth quarter of 2018), we think this focus on higher-growth markets will lead to sustained demand for the company's communities. The company's lengthy track record of maintaining a conservative capital structure (and our view that they will continue to maintain it) Development remains a key component of Camden's growth strategy and the company's exposure to ground-up development tends to be modestly higher than that of its peers (development projects in lease-up or under construction total approximately 10.5% of gross assets). While we tend to view ground-up development as risky, these projects are well funded (63.0% funded) and Camden has a solid track record of completing projects on budget and successfully leasing them up. Camden does have modest concentrations in the Washington D.C. metro market (16.5% of NOI including its pro rata share of joint ventures [JVs]) and Houston (10.8%). Other markets where Camden has concentrations include Los Angeles/Orange County (8.5%), Atlanta (8.1%), Southeast Florida (7.2%), and Dallas (7.2%). With the exception of the D.C. metro area, these markets have all experienced greater-than-average employment growth over the past few years. The company is smaller than the other multifamily REITs we rate according to these metrics, but it is sizable enough to gain operating leverage in its 14 major markets. The stable outlook on Camden reflects our expectation for relatively stable occupancy levels and low- to mid-single-digit annual NOI growth over the next two years. In our view, development completions will supplement the company's EBITDA growth as it mitigates the risk of its new development starts with a healthy amount of prefunding. We project that Camden will remain committed to maintaining a relatively strong balance sheet with debt to EBITDA rising only slightly to the mid-4x area and debt to undepreciated capital remaining around 30%.
Equity Residential A-/Stable/A-2 Largest apartment REIT focused on densely populated, high-barrier-to-entry coastal markets. High-quality, well-occupied portfolio that has benefited from EQR's ongoing asset recycling. Strong balance sheet, ample financial flexibility, and low cost of capital. Geographically concentrated portfolio, with its top three markets representing approximately 56% of net operating income (NOI). Supply is slightly elevated in certain key markets, but absorption remains positive, supported by a tight labor market. Development exposure is expected to increase, although it remains modest relative to key peers. The stable outlook on EQR reflects the company's well-located, high-quality multifamily portfolio, which we project will continue to exhibit strong occupancy and low-single-digit, same-property NOI growth over the next 12 to 24 months. We also expect the company to maintain its relatively conservative balance sheet management, resulting in stable to slightly improving credit protection measures, with S&P Global Ratings' adjusted debt to EBITDA in the low-5x area over the next two years.
Essex Property Trust Inc. BBB+/Stable/-- Large apartment REIT focused on higher barrier-to-entry West Coast markets. Solid wage growth and the lack of affordable housing in its markets support healthy demand. Modest exposure to development relative to peers. Strong liquidity profile with ample availability under the company's revolving credit facility. Geographically concentrated portfolio with its top three markets representing approximately 56% of net operating income (NOI). Increased support for rent controls in the company’s markets could be a longer-term threat to rent growth. While it has improved significantly in recent years, leverage remains higher than the multifamily peer average. S&P Global Ratings' outlook on Essex Property Trust Inc. is stable. We believe generally favorable multifamily fundamentals will persist over the next two years, with steady demand and positive absorption of new supply in Essex's core markets. We expect the completion of development projects will enhance cash flows and slightly improve the company's overall asset quality. We project debt to EBITDA to be in the low- to mid-6x area over the next two years, with fixed-charge coverage (FCC) improving modestly to the mid- to high-3x range.
Mid-America Apartment Communities, Inc. BBB+/Stable/A-2 Strong competitive position in the Sun Belt region with over 100,000 apartment units. Relative to peers, greater diversification across markets and rental price points should reduce cash flow volatility. Conservative financial policies, with lower debt leverage than most peers, along with a largely unencumbered portfolio that increases the company's financial flexibility. Moderate geographic concentration in its top three markets, which represent approximately 30% of net operating income. Increasing new supply in several Sun Belt markets could modestly pressure rent growth. EBITDA margins are significantly below those of key peers, largely due to lower rental rates per unit. The stable outlook on MAA reflects our expectation for continued positive operating performance, with occupancy in the mid- to high-90% range, same-property net operating income (NOI) growth in the low-single-digits, and a disciplined approach to ground-up development. We expect MAA to maintain debt to EBITDA in the high-4x to low-5x area, with fixed-charge coverage (FCC) in the mid- to high-4x range.
UDR Inc. BBB+/Stable/A-2 Relatively well diversified portfolio by price point and location within its markets compared to most peers, which should lead to relatively stable cash flows throughout a complete cycle. A keen focus on implementing new technology across its operating platform has boosted margins and led to above-average operating performance. Modest exposure to development relative to peers, with risk largely mitigated by significant pre-funding. Moderate geographic concentration, with its top three markets representing approximately 42% of net operating income. Increasing new supply in certain markets could modestly pressure rental rate growth. While it has improved significantly in recent years, leverage remains slightly higher than the multifamily peer average. The stable outlook on UDR reflects our expectation that favorable multifamily fundamentals will persist over the next two years, with steady demand and manageable new supply in UDR's core markets. We project growth will continue to be funded in a leverage-neutral manner, and that UDR's exposure to ground-up development will remain modest relative to peers. We expect the key credit metrics to remain relatively stable over the next two years, with adjusted debt to EBITDA in the low-6x to high-5x area and debt to undepreciated capital in the high-30% area.
Source: S&P Global Ratings.

Chart 1

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Chart 2

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More Renting, Less Buying

The constrained and high-priced single-family housing market supports the strong demand for rentals. This is further exacerbated by the challenge that first-time homebuyers face to accumulate a down payment and buy rather than rent. Even as the economic expansion since the Great Recession has been the longest on record, we expect the recovery of homeownership to remain slow.

The Joint Center for Housing Studies at Harvard University said in its 2019 State of the Nation's Housing Report that today's relatively low homeownership rates among households aged 35-44 years old "imply continuing demand for rental housing, with overall growth in renters projected to average 400,000 per year in 2018-2028." As of second-quarter 2019, the home ownership rate was 64.2%, slightly lower than historical average of 64.5% and far less than the peak of 69.2% in 2004 (see chart 3). While the home ownership rate has recovered from its lowest point of 62.9% following the housing and financial crisis, growth in homeownership has been slow due to high levels of student debt and a lack of home purchase affordability, among other factors.

Chart 3

image

Student loans total about $1.6 trillion. They rank a distant second to mortgages in U.S. household debt, but total more than auto and credit card loans. Student loans remain a burden for potential buyers, including Millennials, delaying their ability to buy a home. College students graduated with an average of $33,654 in student loan debt with an average monthly payment of $393 according to the Dept. of Education and Federal Reserve. A March 2016 study released by the Federal Reserve Board found that "a 10% increase in student loan debt causes a 1 to 2 percentage point drop in the homeownership rate for student loan borrowers during the first five years after exiting school." This study also leaves open the possibility that "student loan debt acts as an even greater drag on home-ownership now that lenders are more sensitive to DTI (debt-to-income) ratios and low down payments."

In addition to the college loan issues, younger buyers at all educational levels are more interested in renting because of changes in how they live. Young adults are typically choosing to marry and have children later in life, delaying home ownership decisions. While we still expect household formation to increase, the lack of affordability, undersupply of homes, and sizable down payments will continue to impede first-time home purchases and drive the growing demand for rentals.

Finally, another big reason for more renting and less buying is the change in tax laws. Home affordability in high-cost coastal markets is especially sensitive to this. The recent limit on the federal tax deduction for state and local taxes has weakened the attractiveness of owning homes in these markets. Growing affordability issues remain a key concern, though the level of affordability varies across states.

Public Sector Multifamily

S&P Global Ratings rates both affordable housing owners and affordable housing lenders. Public housing authorities (PHAs), which have historically housed very low-income households, with government support and under strong management, have diversified their housing stock to include moderate-income and workforce housing units. This diversification has boosted asset quality and cash flow and been a credit positive for PHAs. We also expect continued stable performance for housing finance agencies' (HFAs) multifamily lending programs. Projects financed by HFA multifamily programs continue to demonstrate strong performance, with median debt service coverage (DSC) of more than 1.5x and vacancies of less than 4%. Multifamily programs maintain rating strength and stability on the backs of strong HFA oversight, sufficient cash flow strength to absorb loan losses, and high levels of government support for their loan portfolios.

In contrast, we expect continued rating volatility for the rated stand-alone affordable multifamily rental housing subsector due largely to continued deterioration in property performance and our assessment of project owners' deficiencies. Declining financial performance, caused by higher operating expenses, increased vacancies, and weak strategy and management, have led to downgrades and negative outlooks this year. Military housing issues were the exception, with most ratings in the 'AA' or 'A' category.

Affordability And Rent Control

Because there is not enough rental housing to meet demand, rents have risen—sharply and quickly in some markets—and the situation is exacerbated by wage growth that has not kept up with the rent increases. As a result, we are seeing calls for various forms of state or local rent control. Although we don't see rent control as an immediate widespread threat to the industry's health, given the growing support for rent control in many states, we think there is the potential that future legislation could limit growth.

The epicenter of the affordability issue is the West Coast. As of 2016, seven of the nation's nine most expensive rental markets were in California, according to the U.S. Dept. of Housing and Urban Development. The median rent in these seven markets increased by an average of 45% between 2005 and 2016, while the median income rose an average of only 26%. Similarly, in Oregon the median gross rent from 2007 to 2017 grew to $1,079 according to U.S. Census data, which was the fourth largest increase among states during that time. And just in 2017-2018, Oregon renters' housing expenses grew by 26.7%.

In response, states and localities have taken steps to protect renters. Earlier this year, Oregon became the first state in the nation to impose rent control on landlords statewide, limiting rent increases to 7% each year plus inflation. Exemptions to this cap include units with subsidized rent, in new construction for 15 years, or where tenants leave voluntarily. In the City of Portland, the city passed a law requiring landlords to pay relocation costs for tenants in the case of no-cause evictions or large rent increases that lead to tenant departures.

In June 2019, New York State enacted comprehensive rental regulations, which strengthened protections for tenants in New York City's already regulated apartments and extended certain protections to all renters in the state. The legislation, among other things, limits security deposits to one month's rent, institutes notification requirements for rental increases and non-renewals, and provides new protections for tenants facing eviction.

In November 2018, California voters rejected Proposition 10—which would have allowed localities to expand rent control to single-family homes. But barely a year later, the state found another way to implement expanded rent controls. In October 2019, the state passed California Assembly Bill 1482, that imposed a cap on rent hikes of 5% plus inflation (as measured by the CPI). Unlike Prop 10, single-family homes and condos are exempt from this rent control bill, protecting smaller real estate investors.

The impact of these laws do not have a meaningful impact on rated rental housing REITs at this juncture. However, given the growing support for rent control in many states, we think there is the potential that future legislation could limit growth.

The Ongoing Shortage

The U.S. housing market remains undersupplied and the lack of sufficient affordable housing should drive continued growth in the rental market over the next few years. We expect housing starts to remain at about 1.3 million, below the historical average of 1.5 million units, and well below the historical peak of nearly 2.5 million. "Housing starts fell far short of historically normal levels, with only 9.6 million new housing units added in the past decade; compared to 15 to 16 million that would have been needed to meet our growing population and 20 million new job additions," according to the National Association of Realtors.

And scarcity means higher prices—prices that many simply cannot afford on salaries that haven't risen as much. As the U.S. recovered from the Great Recession, housing price increases far outpaced income growth. Per capita personal income rose 20% to $53,700 from 2013 to 2018. Over the same period, median asking sales prices for single-family homes rose 46% to $208,000. That is a challenge, particularly for prospective first-time homebuyers who can instead end up in rental housing.

Both private and public sector developers are slowly chipping away at the shortage of rental housing. But we think that this undersupply will not be short-lived. Barring a significant economic slowdown (we place the possibility of recession at 30%-35% in the next 12 months), the dearth of rentals will continue supporting high rents, strong ratings for our residential rental REITs, and anxiety and hardship for too many Americans looking to a rent a place to live.

Related Research

  • Housing Finance Agencies Are On Solid Foundations Amid Shaky Federal Landscape, Oct. 18, 2019
  • Home Is Where The Funding Is: West Coast Housing Issuers And The Recent Capital Flow, Oct. 10, 2019
  • An Influx Of Capital Is Set For West Coast Housing Affordability Challenges, July 29, 2019
  • Will The Froth In U.S. Housing Bubble Over Again? We Think Not, Feb, 22, 2019
  • For U.S. Affordable Housing Issuers, Debt Service Payments are Key To Ratings, But What Else Matters? Oct. 2, 2018

This report does not constitute a rating action.

Primary Credit Analysts:Ana Lai, CFA, New York (1) 212-438-6895;
ana.lai@spglobal.com
Marian Zucker, New York (1) 212-438-2150;
marian.zucker@spglobal.com
Secondary Contacts:David Greenblatt, New York + 1 (212) 438 1383;
david.greenblatt@spglobal.com
Tom Schopflocher, New York (1) 212-438-6722;
tom.schopflocher@spglobal.com
Michael H Souers, New York (1) 212-438-2508;
michael.souers@spglobal.com

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