What's Ahead in the 2023 Single-Family Rental (SFR) Market

Turmoil and Opportunity Amongst Generational Shifts

Rampant inflation, high interest rates and uncertainty made 2022 a tumultuous year for single-family rental (SFR) investors and prospective tenants alike. But amidst the turmoil, dynamics in the Millennial generation continue to create opportunities for SFR investors.

Let's first take a look at the market by the numbers. It all came to a head in the last few months of 2022. Rents for single-family homes leveled off as recession fears grew and relocation plans were put on hold.

But with inflation cooling and unemployment at its lowest level in over a half-century, those fears have subsided, and rents are once again climbing. From December 2022 to January 2023, the asking rent for three-bedroom single-family properties rose 7.4%, to $1,848, according to Dwellsy.

An upswing in consumer sentiment isn't the only reason single-family home rents are rebounding. After all, the median asking rent for a one-bedroom apartment actually fell by 1.1% in that same period. The difference comes down to demand, and that will be the key consideration for SFR investors as they navigate 2023.

Next, we'll look at the sources of this demand, from maturing millennials to industry consolidation.

The pandemic continues to impact SFR demand

Prospective tenants with their eyes on single-family houses are generally looking for a safe, quiet place to expand their household — sharing a home with a partner, adding a pet, making room for other family members or having children.

In a post-pandemic world where remote working has become the new norm, extra space for a home office is also on the wish list. While single-family renters come from all age groups, the bulk of demand for the foreseeable future will come from millennials.

Millennials are the largest generation by population, with 83 million members, and they've been through a lot. Born between 1981 and 1996, this generation had already lived through 9/11, the subsequent wars in Afghanistan and Iraq and the Great Recession by the time COVID-19 struck. They're also the first generation of digital natives.

These dynamics may help explain why millennials gravitated toward city living more so than earlier generations. One 2019 study projected that millennials loved living in central city neighborhoods so much that they would shun the suburbs even after they married and started having children.

Of course, like so many other things, that all changed with the pandemic, which caused a large swath of millennials to rethink their housing preferences. Having walking access to restaurants, shops and entertainment has become less of a priority.

Post-pandemic millennials are now looking for larger homes with more space and privacy. Post-pandemic millennials are no longer interested in cramped urban apartments. Instead, they are seeking larger homes that provide more space and privacy.

The millennial "baby bulge"

The pandemic didn't just change millennials' housing preferences, it caused 17% of them to hold off on having kids, according to a survey by Morning Consult. Unlike their parents and grandparents, who started families in their 20s, the socioeconomic instability of their formative years had already compelled this generation to have kids later, even before COVID-19 emerged.

As a result, many Millennials are just now becoming parents. Many who thought they'd be fine raising kids in a fourth-floor walk-up studio apartment now realize that works better in theory than in practice.

Unlike the Zoomers who are just beginning to generate households of their own, millennials starting a family no longer have the flexibility to continue crashing on someone's couch or putting up with that annoying roommate until conditions are more favorable for them to buy. They need more space, and they need it now.

High interest rates will keep rental demand robust

While millennials see homeownership as an important life goal, the reality is that many of them can't afford to buy given the current market conditions — making them great tenants for SFR investors. With the 30-year fixed mortgage rate more than doubling in less than a year, these would-be homebuyers opt to rent while waiting for rates to come back down.

But, renters waiting for low interest rates may be waiting a long time. The Federal Reserve has stated that it will continue raising rates until inflation is cut in half. As a result, interest rates are expected to continue rising through most of 2023, even as the rate of inflation falls.

What's more, like firefighters continuing to douse a smoldering fire, the Fed is expected to keep high rates in place for some time to ensure that inflation doesn't flare up again. The takeaway for SFR investors is that demand from homebuyers being redirected into the rental market by high mortgage rates will remain strong into 2024.

The untapped demand of adults living with parents

If and when conditions become more favorable for real estate investors to begin acquiring properties in earnest, they'll not only face competition from millennials anxious to transition from rentals to homeownership. It will come from a segment of the population that isn't even a current player in the housing market.

You guessed it! Enter the Zoomers. Nearly half of the adults ages 18 to 29 in the US live with their parents, according to surveys by PropertyManagement.com and Morgan Stanley.

This population of young millennials and Gen-Z represents a powder keg of pent-up demand that promises to explode in the event of larger-than-expected rent decreases, home prices, or both. The good news for existing real estate investors is that this group should backfill units left vacant by their peers who've been able to purchase a home. This is propping up demand and preventing a collapse in rents.

For real estate investors focused on expanding their portfolio, however, the awakening of this sleeping giant would represent a huge source of competition for a weak supply of available properties.

Consolidation means competition for mom-and-pop investors

Another source of competition for available properties is institutional investors. Most SFRs are still owned by investors with ten or fewer rental homes, while institutional investors control only about 2-3% of the market.

These firms are quickly making inroads in the sector. They also possess an enormous war chest of funding that they will bring to bear as rates level off and if home prices start to fall.

This consolidation in the sector is a threat to individual investors. That's because as these firms grow, so will their ability to enjoy the benefits of scale and favorable revenue, cost and cash flow dynamics.

Don't wait for the perfect deal with the perfect rates—there are opportunities out there now that will pencil out

The changing needs of millennials alone will drive strong demand for SFRs through 2023. Still, as the economy stabilizes and interest rates level off, individual real estate investors need to keep in mind the other sources of demand and competition waiting in the wings for the right moment to re-enter the housing market.

Given the current vast supply and demand imbalance in single-family housing, any substantial decrease in mortgage rates or home prices will likely mean a swift return to the feeding frenzy and sky-high valuations.

While analysts aren't expecting that kind of upheaval in 2023, it's worth bearing in mind that there are multiple layers and sources of demand and competition for SFRs. Each time rents, home prices or mortgage rates drop, another one of these layers will unlock. Investors who delay acquiring single-family rental houses until rates fall may face other risks and costs.

So what's the smart play in 2023? It's to line up financing early and err on the side of acting sooner rather than later.