Being a finance guy, and getting the opportunity to review multiple projects every day of the week, it’s become a very hot topic of conversation. Why is that? And what’s all the fuss about? Here are few observations I’ve made from these conversations with real estate developers and builders about what’s happening in the build to rent space in America.
What is “build to rent”?
Much like it sounds, build to rent is the concept of constructing single family homes with the intention of renting them out in the same way one would an apartment building. It’s not a new concept. In fact, it’s been happening for years. Especially since the 2008 housing bubble burst. Except now it’s gained what I believe is maximum velocity due to the perfect storm where housing and capital markets intersect, as well as a few similar factors to 2008’s housing crisis. Read on, and I’ll explain.
Why is build to rent so popular? And why now, more than ever?
First, there’s an excess of capital available on the sidelines trying to find a home (no pun intended). Simply put, there’s a ton of money sitting around, and the people who manage the money need to try and come up with ways to get a return. If that money was earmarked for home construction or development projects, but as we all know, they just can’t build them fast enough these days (I’ll write more about why in a different blog post soon), then they’ve got to find somewhere to get that return. So big money gets creative. In this case, they discovered that they could build a bunch of single family homes which were specifically to rent out. Why is that any different than just building a subdivision and selling the homes? Here’s why:
- You can build a rental property in a less desirable neighborhood or location. Why? Because renters don’t care about the property’s value as much as a homeowner would. Let’s face it, if you’re renting, it’s transitional. Sure, you may continue to rent in the future, but possibly in a different place, or a bigger or nicer place, because your financial situation improves as you get older, more experienced in your work, etc. So if you’re looking to buy a house, you want it to be in a neighborhood with good schools, or easy access to downtown (or wherever jobs are), or amenities like entertainment, sports, or mountains and beaches. But if you’re just renting it, then who cares? Sure you don’t want to live in a dangerous part of town, but if the location is a little bit further out, or more industrial instead of suburban, then you don’t mind, as long as the place is nice, well kept, and the price is right.
- For this reason above, it allows developers and builders to find cheaper land than they can elsewhere. If a developer wants to build an average home in say a city like Denver, then they’re going to have to be able to sell it in the $600,000 and above range to really make any money. But to buy the land where someone would be willing to pay that much for a house is extremely difficult to do, because land owners with those locations are holding out for top dollar. That is one of the things which is slowing down the housing market’s ability to keep pace with demand, but as I said, I’ll save that for another blog post. In addition, home buyers have more difficulty qualifying for mortgages in that price range, so renting becomes more of a necessity. Especially in expensive cities. So developers are finding more marginal properties, at more affordable prices, and much more plentiful, on which to put these developments. Near a freeway? Maybe. Industrial area? Possibly. More remote and less suburban? Could be. But it allows them to build at a cost including land which makes these homes affordable enough to rent out and still make money long term.
- Wages aren’t keeping pace with housing prices. Now I won’t belabor this point, because we get enough of it on the news and social media every single day. But as home prices rise, and wages stay stagnant or rise considerably slower, affordability drops. At some point, people who once believed they could afford to purchase a home resign themselves to renting. But rather than go rent an apartment, with shared walls on all sides, no yard, and limited space – instead they can now go rent a single family home or house as some call it. It’s desirable, and more affordable than attempting to purchase one, where even a 5% down-payment on a $600,000 dollar house is $30,000, and not easy for everyone to come up with.
- Home price appreciation, or HPA as they refer to it in the business. All this means is that over time a house that they own goes up in value. If they sell that home once construction is complete – they lose all the future appreciation, and actualize their profit on that date of sale. But if they hold it, and rent it out, they not only get the cash flow, depreciation, and debt pay down over that period, but they also get the equity increase. So if that house is worth $450,000 on the day they finish construction, and they lease it out to tenants over a 10 year period, by the end of that period the home could be worth $600,000 or $700,000, or if things keep going the way they’re going right now, maybe $1,400,000, right?! Point is, if you own a subdivision of homes, let’s say 200 houses, and they each appreciate $100,000 over 10 years, that’s $20,000,000 – yes, twenty-million dollars of equity to their bottom line if they sell at that time. In actuality, it’s probably much greater than that, but you get the idea.
- Debt is cheap. It’s cheap for traditional homebuyers, with mortgage rates at all time lows, but that also means it’s at an all time low for developers, builders, and investors. So, they can borrow cheaply. Rents are at all time highs. So they can collect really healthy rental returns. Thus, cheap debt service or payments, and high returns or rents, which ultimately means better yields on their investment properties.
- Alternative investment. It’s a creative way to invest in real estate, with tangible assets, without having to find existing properties to fight over in bidding wars against other sources of capital just trying to find ways to put their money to work and get a modest return.
All this to say, in my line of work, I’m seeing two primary investment strategies in real estate development and construction today more often than any others. One is build to rent. The other is modular home construction, which I will also discuss in another post soon.
If you’re a developer, builder, or real estate investor, and you’re seeking funding for your build to rent project, please connect with us now by CLICKING HERE! We’d love to discuss your project, and how we may be able to help with build to rent construction financing.