What financing fears and other stressors mean for the SFR market
Prior to the COVID-19 crisis, the economy was cruising along on all cylinders. It was a good time to invest in Single Family Rental (SFR) homes as interest rates were low, homes were holding their value, and the cost of entry was relatively low.
Of course, COVID-19 turned the world upside down almost overnight.
How has that impacted the SFR world for real estate investors? So far, it’s a mixed bag. First the downside:
The initial stock market dive, combined with a sharp rise in unemployment claims has spooked many lenders. On March 4, 2020, the Dow Jones Industrial Average was over $27,000. By March 23, it cratered at $18,591. States went on lockdown, business activity plummeted, and unemployment spiked from just over four percent to nearly 15 percent.
The possible negative effect this might have on real estate values has caused banks and other lenders to run scared. Given the historic nature of this crisis combined with the many unknowns about the virus, lender trepidation is understandable.
The biggest short-term impact on real estate investors is the reduction in loans on a percentage basis (LTV or LTC). Pre-pandemic, investors could finance acquisitions at the 80 percent LTV/LTC. Similar deals today are being quoted at 70 percent LTV/ LTC.
What does this mean in real numbers?
A borrower wants to buy a duplex for $200,000. Several months ago this property could have been purchased with just $40,000 down. In today’s new lending environment it will take $60,000 to buy the same duplex. That’s a 50 percent increase in out-of-pocket cash to obtain the same property.
An investor with $200,000 to invest could purchase $1 million of real estate at the lessor of 80 percent LTV/ LTC prior to the COVID-19 crisis. At a 70 percent LTV/LTC today, that same investor can only purchase $666,000 of real estate today. That’s 33 percent less property than they could get with the same capital at the beginning of the year.
What can a small investor do? Shop around. Your traditional lending partner might be skittish, but there might be alternatives in the market.
If you are looking to make a smaller investment of perhaps fewer than four units, consider a credit union. Anecdotally, one friend recently told me he was able to obtain a loan at 80 percent LTC at a rate of 3.875 percent. You can’t do much better than that today.
And, even though banks have reigned in their appetite for risk, don’t be afraid to shop around to different banks as well. Community banks are still looking to strengthen local economies and might be more willing to take a risk on a local project.
Where is the upside in today’s current environment? Interest rates are still low. While you might have to put more money down, loans are still affordable. Also, early returns on real estate sales look as though homes are holding their value despite the economic upheaval.
These are definitely challenging times, but SFR homes still provide a solid long-term investment, in my opinion. Investors need to shop around for the best financing possible, but with a little more legwork, it can be done.