How Ratings Could Dramatically Change the Single Family Rental Business


Investors large and small are closely following on the efforts to convert blocks of single family rentals into securities and sell them to securities investors, similar to the way mortgages are securitized into mortgage-backed securities by Fannie Mae, Freddie Mac and leading banks.  If successful, SFR-based securities will become a huge new source of financing and will transform single family rentals and residential real estate investing, just as the secondary mortgage markets changed mortgage finance forever.

One of the most important ways that Fannie and Freddie, who together securitize about half the nation’s mortgages, impact mortgage lending is the rules they set for mortgage originators who want to do business with them.  For example, the huge battle over appraisal standards a couple of years ago, known as the Home Valuation Code of Conduct (HVCC), was essential a fight over appraisal standards proposed by Fannie Mae that every lender it bought would have to meet if it wanted to sell mortgages to Fannie to be securitized.

Fannie and Freddie won’t have that kind of power over securities based on single family rentals, but the ratings agencies that determine the quality of individual securities offerings will.  Ratings agencies carefully review and rate offerings, a function that involves not just price and yield but also risk.  Investors in SFR-backed securities, like those who buy mortgage-backed securities, are expected be a conservative lot, institutions largely interested in a safe return on their investments.  The higher the risk, the lower the quality, the lower the rating, the less demand there will be and the less an offering will realize.

The Fitch SFR Report

Yesterday Fitch Ratings, one of the world’s leading securities rating agencies, issued a fascinating report outlining the standards and criteria it will use to rate securities based on hundreds of single family rentals purchase from small investors and local real estate markets and bundled together by investment firms.   Noting that interest is strong, Fitch said trading in SFR-backed securities could begin as soon as the end of this year or the first quarter of 2013.

Fitch made it clear that the entire class of SFR-backed securities poses some unique risks and that high investment grade ratings will be difficult to attain due to the lack of historical data and “ambitious growth strategies by regional operators”.  From the starting line, Fitch is going to rate SFR-based securities conservatively, which could put them at disadvantage with other securities and investment options.   It views the new asset class as a cross between commercial and residential properties, since rental cash flows and the underlying value of the property may both be needed to service and pay for the transaction.

Securities seeking a better rating are going to have to meet stringent requirements that look beyond price and yield.  The promise of a good or exceptional return will not be enough to win a higher rating.

Fitch outlined the factors that it will use to rate offerings.  First will be the local employment base and the desirability and quality of neighborhoods where rentals are located, since these will determine demand.  Next, the underlying quality of securities will involve property management quality and expertise. Durability of cash flow, stability of value over time, liquidity and other structural considerations will be important considerations.  Fitch will assess management company experience and operating capacity; market analysis; lease terms; tenant underwriting and property marketing; operative efficiency and management continuity.

Signaling the conservative approach Fitch will take to the asset class, it announced it will likely impose rating caps on SFR transactions based on several performance issues such as limited data for the sector and for individual management firms, historical data for market rents, rent roll histories, vacancy rates and supply and demand.

The New Rules: Quality and Track Record

Should the plans securitize SFRs become reality and succeed, how will the rules change of the game change for the SFR business?

First, these rules put pressure of property management firms to meet high standards of operating quality and to be able to prove the quality of the properties they manage with date.  Properties managed by individuals or management companies without a history will be at a disadvantage and will be worth less.  Probably the larger management firms and those being established by the privately financed new entrants into the business to manage the large numbers of properties they are buying will have an advantage.  “Fitch’s analysis will focus on management expertise and continuity, cash flow durability, value stability, and the transaction liquidity and structure,” the report said.

Second, the promise of a SFR securities market has already led to the development of a national market for SFRs as the hedge-fund financed investment companies look for properties coast-to-coast.  The new rules will add value to SFRs located in stronger tenant markets where local employment and the local economic outlook are strong.  Conversely, those located in weaker economies, even though they may be well managed and attractive properties, will be at a disadvantage.  Markets will large numbers of SFRs will not necessarily be more attractive. “While many of the more notable states, such as California, Florida, Arizona and Nevada, have a significant volume of distressed and REO inventory, investment decisions are more driven by local employment conditions and neighborhood desirability,” Fitch said.

Third, the Fitch report suggests that securitizing SFRs will not as easy as some have thought.  “Fitch Ratings said it is unlikely to grant the best credit grades to securities backed by single- family U.S. rental properties, a move that may curb potential sales of the debt if other ratings companies follow suit,” reported Bloomberg yesterday.  The Wall Street Journal said Fitch won’t rate the initial offerings at all, which will make them difficult to sell.

About Author

Steve Cook is the editor of Real Estate Economy Watch and writes for a several leading outlets in addition to BiggerPockets, including Equifax and Total Mortgage. He also provides communications consulting services to leading real estate companies. Previously he was vice president of public affairs for the National Association of Realtors.


  1. Chris Clothier

    Steve –

    Is this in relation to firms who are entering markets with intentions of building huge portfolios intent on bundling and selling?

    If that is the case, I would not buy ANY Mortgage Backed Security offer based on what is happening in multiple markets including Memphis and the offers that have been put on the table. I have yet to hear a single firm discuss quality control or long-term investment plan. Most are looking for decent housing stock, but don’t want to spend ANY money on renovation and even less on maintenance and want the lowest cost management fees to offset dropping below the floor on rental rates to insure occupancy.

    The game plans for operating in this market at least, from what I have heard so far, are ridiculous. Based on your article, the companies I have heard from are not willing to pay for top quality and sure aren’t interested in proper property management. They are very much interested in maximizing their rate of return while preparing to either securitize or sell as a bulk to large corporations who purchase cash flow companies. So the last thing I will ever do, is invest in a Mortgage Backed Security against SFR.

    Good info in the article Steve.

    • Chris:

      Yes, this report from Fitch will have a HUGE impact on the recent well-funded entrants into the REO to Rental business.

      I can’t trecall any of these companies talking publicly about the impriotance of a secondary market in SFR properties to their success, but I wouldn’t be surprised if securitizing SFRs isn’t at the core of their business plans.

      In its very polite and precise way, Fitch said: “We’re from Missouri and if you want a good rating, you will need to jump through some extraordinary hoops that you probably didn’t anticipate and may not have a snowball’s chance to make.”

      Read the Wall Street Journal story in the link above. It gives you an idea of how this report is being perceived… as a body blow to the whole idea.

      The next few months should tell..

      Thanks for your comment.


      • Chris Clothier

        Wow – very good article to write about from the Wall Street Journal.

        I will tell you that my comments come from direct dialogue with multiple different funds including some very large public funds and some very large private funds and several some where in between. All of them have the same exit strategy. Short term gains with long term plans to bundle and sell. One mentioned a plan to sell to large insurance firms who purchase bundled securitized products like this for the cash flow return.

        As I told each of them, I was not worried about the long-term impact on my market as long as they are operating the way they asked me to operate. Very little concern for quality and no concern period for impact on community. We’ll see ultimately if this impacts what they plan on doing.

Leave A Reply

Pair a profile with your post!

Create a Free Account


Log In Here