NEW YORK--(BUSINESS WIRE)-- Elevated cash flow leverage, refinance risk and dependence on property liquidation for debt repayment remain key reasons for our 'A' cap on single-borrower, single-family rental (SFR) transactions. Presale reports for recent SFR transactions justify elevated leverage with current property values and the likelihood of repayment through the foreclosure and sale of the properties, particularly to owner occupants. In our view, this line of thinking may persuade market participants to materially underestimate maturity default risk and the issuers' ability to refinance.
Unlike traditional RMBS loans, SFR transactions do not fully amortize, exposing issuers to term as well as maturity risk. Term default risk is mitigated by the currently low interest rates and interest rate caps. However, loans with balloon payments will default at maturity if not refinanced. To refinance, secured lenders expect property cash flow to cover expected principal and interest payments.
A common measure of leverage and refinance capacity for income producing real estate is debt yield (property cash flow divided by debt). For three recent SFR transactions, Silver Bay Realty 2014-1, American Residential Properties 2014-SFR-1 and Invitation Homes 2014-SFR2, other rating agencies calculate debt yields in the 5% range. In contrast, debt yields for Freddie Mac K Series transactions are approximately 9%.
Debt yield represents a loan's maximum interest rate based on a property's cash flow. Using the Invitation Homes transaction as an example, the break-even interest rate on the loan is 4.0%. If a takeout lender required a minimum debt service coverage ratio of 1.2x, the break-even rate refinance rate drops to 3.34%. If the takeout lender also required the loan to amortize on a 30-year schedule, the break-even interest rate drops to approximately 2 bps (0.002%). This is also illustrated by simply comparing the annual debt service on the loan at 3.34% ($24,049,378) to the balloon balance simply divided by 30 equal annual installments ($24,000,733).
Given the leverage on SFR transactions, it is unlikely a secured lender would refinance the current debt, absent significant improvement in property cash flow. Fitch also believes that debt repayment predicated on foreclosure and liquidation is contrary to sponsor plans to build SFR portfolios, and is inconsistent with high investment-grade ratings.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.
Daniel Chambers, +1 212-908-0782
U.S. Commercial Mortgage-Backed Securities
33 Whitehall Street
New York, NY
Rob Rowan, +1 212-908-9159
Sandro Scenga, +1 212-908-0278
Source: Fitch Ratings