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Build to Rent

Where is Build-for-Rent Headed?

The Market is Still Fundamentally Strong By Adam Stern For context, my firm provides Advisory and Investment Sales Services for regional builders looking to break into or expand in the Build-For-Rent segment, and showing them how to take residential projects and fit them into the Build-For-Rent mold in order to sell their neighborhoods as rental communities to long term buy-and-hold operators. Let’s start with a view of where things just were and where they are right now before delving into what lies ahead.  The Past and Present The housing market in general is coming off a white-hot run where everything from resale homes to new construction homes were flying off the shelves shortly after they were listed. But the market changed in Q4 of 2022. There was a tangible and abrupt shift in the buying patterns of investors in the institutional Single Family Rental (SFR) industry, from the largest publicly traded REITS to smaller private equity and privately funded SFR investment firms. I would estimate buying velocity is down now by as much as 80% from a year ago. Firms that were continually buying particular homes in certain markets have shifted to buying opportunistically. This means they are not so much buying homes that fit a fixed set of criteria, but are now looking for homes that both fit that criteria and have a special circumstance that could lead to a lower than market acquisition price. Those firms that have made the shift are now competing with smaller fund buyers (who were generally always buying opportunistically) for that very inventory. So, professional investment firms active in buying both existing homes and new construction homes overall represents a relatively small segment of the real estate market. These firms, until recently, were very actively funneling capital into the housing market, and are now waiting to see where the market is going before resuming business as usual. Where the Market is Headed Some of those firms from large to small that have been actively pursuing both existing home acquisitions and new construction single-site projects (what is traditionally known as Build-For-Rent), seem to be shifting the majority of their focus to just Build-For-Rent. While the overall pace of acquisition in the institutional SFR sector cools, the desire of firms to see Build-For-Rent projects from builders is actually increasing. It’s a very strange time in this still relatively new and nascent market niche. The economy is slowing, inflation is high and interest rates are high, but inventory is still very low in many markets around the country. Builders are looking at investors to be a second option for them to sell their inventory to while still hoping for strong retail sales. Investors are being very solicitous to see that very inventory, but to make a deal work, both sides of the transaction need to squeeze to make deals come together. Investors need to accept lower overall returns for projects in order to make the option viable for builders, and builders need to be good with thinner margins in order to pen a deal to sell all units in a subdivision to investors. It cannot stay like this forever. So, the question remains… Where is Build-For-Rent headed?  The highest value opportunities being sought by larger scale investors are single-site subdivisions in prime markets that are large enough to house an amenity like a pool and have an onsite leasing office. If a sub-market within a certain Metropolitan Statistical Area (MSA) is proximal enough to the major population centers in that market, meaning being drivable within 30 minutes to major employers, and close to shopping and retail thoroughfares, those communities have been and will continue to be highly sought after.  For a while, there has been talk about the Build-For-Rent trend moving to smaller markets outside of top large markets with populations over 1 million people. I have seen and even attempted to sell projects that fit this mold. It is very difficult to get firms interested in projects in smaller markets unless they are already sold on owning in that market. It is an arduous road. What is happening now on a limited basis and is more likely be the case in the years ahead, is we will see some differentiation in strategies from fund investors where they will do the heavy lifting to get comfortable with certain smaller, tertiary markets and affirmatively start looking for opportunities there. Builders in markets like these will either have to find those firms or set themselves up as evangelists for their particular markets and look to draw firms in with opportunities. This is why Strata SFR was set up to be an Advisory firm to builders first, and an Investment Sales organization second. The task of taking a project that is already under way, building it out, and then structuring the subdivision for sale as Build-For-Rent is a critical first step. Only then does a builder have a chance at either working with a firm like ours or trying on their own to make a market for those communities with a Build-For-Rent investor audience.  The Case for Smaller Projects Behind large single site subdivisions in major and tertiary MSAs are smaller projects that generally are not big enough for an on-site leasing office or amenity. These types of projects, generally ranging from as little as 20 units to high double digits, are a hard sell to most larger fund investors. If a project sits in proximity to other assets or communities of a current rental operator, they can be very attractive, as that operator can look to add doors and scale up their footprint in a particular area. This is only attractive so long as the performance of their current portfolio of homes in the area is strong, and the new units will not directly compete with their already operating inventory. We generally like seeing these smaller projects in good locations in large markets where the potential buyer pool is large and where any firm operating rentals in the area would be a potential take-out buyer. These smaller projects in tertiary markets without large scale investors already owning there generally won’t be

Technology

Real Estate Technology Today

Using the Power of Technology from Acquisition Through Disposition By Adam Stern There is a widely accepted principle called Moore’s law that states the speed of technology will double every two years, so to say technology is advancing at a meteoric pace is cliché. Technology is the backbone of turning a small business into a scalable enterprise and making processes and access to data easier and quicker. When talking about real estate and technology, it almost sounds like an oxymoron. Real estate by its very nature is slow. The development of real estate, whether you are talking about commercial, residential, industrial, or agricultural, is time intensive. Even as you move further up the value chain to building and transacting, real estate is an asset that does not move, literally and figuratively. Real estate technology, however, is an extremely interesting and captivating idea. It is in our DNA to want the pace and ease of the things that we do today to be faster and easier tomorrow. Think about the first computer. It was 50 ft long, weighed 5 tons, and required a team of engineers to operate. Today, we carry one in our pocket that is easy enough for a toddler to use and exponentially more powerful. Looking at real estate technology from a historical perspective helps us to better understand how both real estate and the utility of various asset classes have evolved over time. In lieu of making this short article a 10-volume dissertation, I will focus on technology in the residential housing sector. It is a substantial area that has seen tremendous innovation over the last decade, both on the retail “homeownership” side and even more so on the investment side. I can bifurcate this analysis across two segments; viewing a home as a place to live or as a vehicle to put capital to work. The Evolution of Technology Tech platforms have been around for a long time, and as peoples’ need to gain access to real estate information increased, so have their choices. Not too long ago, to get access to real estate data that was localized to a town or city, you would have to go to a real estate agent who had a book where the information resided. With the proliferation of the internet in the late 90s, websites such as Zillow, Trulia, Yahoo! Real Estate, Redfin and Realtor.com took the power of data and put it into the hands of consumers. This allowed anyone with internet access to search for real estate with ever increasing specificity. While real estate investing is not a new phenomenon, the popularity and accessibility of real estate investing platforms has allowed a larger swath of US investors to gain access to the asset class. In 2018, 6.7% of individual tax filers (about 10.3 million) reported owning rental properties. Platforms such as LoopNet, Crexi and Ten-X provide access to commercial real estate opportunities and deliver data in a more consumable way. The launch of these platforms has allowed investors to search for and find opportunities. Previously, locating investment opportunities took more time and research, and required having a network of connections to find off-market opportunities. Investing in larger, more complex real estate deals was relegated to professional investors and investment firms. Technology Lowers the Barriers to Entry As an off shoot from real estate search sites that democratized access to real estate data, co-investment sites have furthered the investability of real estate to investors with smaller sums of available capital. Websites like Propstream make it possible for private residential investors with comparatively small capital reserves to have access to extremely high-quality data which helps in both finding and analyzing potential investment properties. Websites such as Roofstock provide access to individual investment properties while also offering operational services beyond just the locating and transacting of homes. Other platforms such as Fundrise solve the capital constraint roadblock by allowing multiple investors to invest in a single property which is managed by a 3rd party. Along with services for the largest segment of investors in the residential housing market, which are individual investors that own just one property, tech solutions are being developed in higher numbers and in more nuanced ways, thus lowering the barrier of entry for many investors. Technology in Property Management In terms of property management, firms like Renters Warehouse and HomeRiver allow investors to manage properties through one firm across multiple markets, enabling investors to scale their real estate portfolios. New-age property management solutions such as Mynd have integrated mobile technology into property management solutions, making it possible to manage the marketing of a rental property, the scheduling of property visits and even the analysis of potential rental income available through a mobile application. More than any other facet of rental and investment property ownership, new tech addresses the “time and headache” factor of finding and implementing property management solutions, making it faster and more streamlined. Tech services such as Latchel are a bit different and more centered around tenant experience, allowing tenants to order services such as maintenance requests from their landlord, house cleaning and even furniture assembly services. Transactional solutions for the logistical challenges of closing on real estate have come a long way as well. Applications such as Spruce, which is a neutral third party that helps coordinate transactions between homeowners and their lender or real estate institution, have gained steam as the number of investors selling investment properties to institutional investors have become more commonplace. Document signing solutions such as Docusign and Dotloop are now a mainstay in current real estate closings, enabling investors and homeowners to sign documents from the comfort of their smartphones. Technology has enabled more people to intelligently choose markets, locate property, and close on homes in less time. Homeowners moving into their first or move-up home can now use sites to solve lifestyle-focused concerns such as school quality, proximity to restaurants, and availability of day care. Smaller real estate investors are now leveraging tech to gain access

Single-Family

Single Family Rental Strategies in a Hot Market

Act Quickly, Honestly, and Decisively by Adam Stern The residential housing market is HOT. Inventory is down in all major markets acrossthe country, prices have risen precipitously for consecutive years since the late 2010’s, and the influx of capital into the rental housing space has been steady and ever increasing. Low inventory, cheap money, and the driver? People are renting homes at a faster pace than ever before. The confluence of these market factors could make it hard for incumbent firms with existing rental property assets to acquire new homes and make it difficult for newly emerging investment firms to find an entry point into the asset class. It all comes down to strategy. As a broker that has been focused on identifying capital sources active in the Single-Family Rental space and, on the flip side, identifying, engaging, and servicing those who own, manage and build rental housing, my firm, Strata SFR, has a unique perspective of the various strategies that firms employ across the country. Since Strata does not generally act as a principal in transactions, the velocity of our movement in the space is extremely high vs investment firms that generally stick to a single strategy for buying and/or selling.  Strategy of the Biggs Incumbent firms that have been in the space since the downturn in 2008, many of them public REITs and privately held real estate investment companies, are a good place to start. Their strategies generally have to do with building onto existing footprints, growing market share in the areas they currently operate, pruning their holdings to create higher margins through improving operational efficiencies, and in some cases breaking into new markets while leveraging existing infrastructure. Firms who do not have the scale that these bigger companies possess may think that their tasks are somehow easier than firms that are just starting out, but I find generally it is quite the opposite. After all, once you set the level at which revenue is generated from owned assets, there is only one direction these firms can move to keep investors happy and coming back and keep companies thriving. If progress is not made through continual revenue growth, the market tends to notice. Lots of attention means a higher level of scrutiny from all sides. Forward progress is the only surefire way to ensure long term survival. When my company is engaged by larger firms with existing portfolios, it is generally geared toward the disposition of assets no longer viewed as essential to their long-term strategy. That means pruning existing holdings to redeploy capital into areas that have a better opportunity for future growth. The strategy is to sell those assets and move capital into higher growth areas, including transitional areas, where inventory is of lower cost and higher yielding or where the acquisition of new assets is easier to come by due to higher availability or lower competition. Very often assets are sold to other firms with a more regional focus thereby allowing competing firms to grow to scale. Many firms opt to add new build strategies in areas where one-off or portfolio acquisitions are harder to come by. This strategy, Build-For-Rent, is a longer and more involved way to eventually own and operate assets at the end of the process, but the benefits of venturing into these types of deals provide a huge long term competitive advantage. While cash flow is further out than buying existing assets, often the price that firms pay, on a per asset basis, is lower and at the end of the process, they own a new home that will appreciate faster in a rising market than older homes. An added benefit of moving into the new build space is the experience and know-how achieved buy completing such transactions. Once you have the infrastructure to source land or lots and the resources to erect new communities, the barrier to entering new areas of existing markets or new markets all together with a Build-For-Rent strategy are much lower than competitors without such experience. Once these firms learn how to ride that bike, that skill set cannot be unlearned, and the benefits of this acquired ability will pay dividends for years to come. Strategy of New Firms For newly minted firms, raising capital, whether easy due to reputation or contacts or hard due to lack of experience, is seen by many who have raised it as the easier part of the equation. Once capital is committed, then comes the challenging part of choosing markets, setting up acquisition and sourcing channels, and managing assets. Many firms coming from alternate asset types such as multifamily are making the switch, looking to use their resources to address the challenges of entering the Single-Family Rental space.  At Strata SFR, we love these new firms. They provide an opportunity to source brand new large and medium sized portfolios from some of our smaller regional investment clients looking to exit in a seemingly overheated market. The way these relationships often play out is, the firmidentifies a market or markets they are bullish on; we identify the largest owners of SFR in those markets; and approach them with an exit opportunity. For many owners, the presence of these new buyers is a welcome site as they give smaller operators a path to sell their portfolios at an attractive price, in one transaction, to one buyer. The ability to bring to the table a buyer with deep pockets, a relatively low Cap Rate threshold, and the ability to take down large numbers of rented houses is enough to get an opportunityon the table for our new fund clients. Once an initial portfolio trade happens, setting upon the task of helping these new funds build on early success is the next stage. Often this entails helping them create on-market acquisition strategies or connecting these firms with land developers and builders to build single-site communities. Whatever the method, the goal is clear: fast growth, rapid capital deployment into assets that will deliver a

Single-Family

A Generational Shift in Housing

The Trend Toward Renting vs. Owning by Adam Stern The home ownership rate in the U.S. today stands at 65.8%, which is up year over year. But it is a far cry from its height in early 2004, when it stood at just about 70%. Overall, the trend toward homeownership is down. This trend in U.S home ownership did not happen organically. It was not propagated by consumer demand or sentiment related to the lifestyle choice of owning vs renting. It was propelled by the bursting of the U.S housing bubble, putting millions of people into foreclosure, and thrusting them into the rental market, creating new consumer demand for residential rental homes. A trend that has seen an uptick over the last year was people moving from more densely populated areas and into the suburbs, thus creating an even higher demand for Single Family Rentals. Looking back to this trend, aside from the boom in foreclosures that happened during the 2008 downturn and the resulting increase in rental demand that followed, something more subtle sprang from the ashes of the housing bust and continues today in our post COVID world. And that is an undercurrent in the buying habits of the next generation of would-be homebuyers, those who are now opting to rent homes rather than own them. This shift, simply put, started with the recognition of a simple truth about the U.S housing market which was muted prior to 2008 by decades of government backed pro-housing public relations. That long forgotten truth…home prices can actually decline. That idea, so estranged from previous generations, is now affecting a generational shift in housing. And it is this shift that millions of investors (including some of the largest institutional investors) are now riding, a once-in-a-lifetime opportunity for those who understand the genesis of the shift and how to play it in the years to come. A Historical Perspective Let’s take a step back so we can get a bird’s eye view of where the trend toward renting vs. owning started. The housing bubble burst of 2007 caused a wave of defaults on loans made to “sub-prime” borrowers. These loans, made by lending giants at the time such as New Century Corp. and Countrywide Home Loans, were the product of a little-known subset of the bond market which traded in Mortgage-Backed Securities. Firms such as Lehman Brothers, Bear Stearns and Merrill Lynch were packaging subprime loans into bonds backed by the payments made by the borrowers of the loans and selling them off to other institutions who bought them knowing little more than they were rated AAA by the rating agencies (a rating that denoted the underlying securities carried essentially no risk). This commission-driven bond trading apparatus created massive demand for the very sub-prime loans that backed them, which in turn fueled the supply of cheap money that lenders were offering to less-than-credit-worthy borrowers. The macro-economic trend that had taken hold was that loans being made to people that, when the teaser period for loans expired would not be able to afford the payments, would inevitably default. Once the defaults started happening in early 2007, the collapse of the securities backed by these loans led to the collapse of some of the very firms that created them and the eventual bail out of the rest that survived. Fast forward to 2010. Foreclosures on the homes owned by defaulted borrowers were happening at record levels. Home prices in the markets most affected by the foreclosure boom decimated home prices in those markets, turning homeowners into renters. Firms hungry to snap up those foreclosures at record low prices initiated an institutional trend in residential real estate that would later be dubbed “REO to Rental”. This trend would see hundreds of thousands of single-family homes bought by institutional investors and then turned into rentals, available to be tenanted by the very people that used to own them. As the inventory of distressed homes dissipated in the early 2010’s, investors that saw the housing play as a trade were starting to realize Single Family Home rentals could be a long-term business. The moniker “REO to Rental” would eventually morph into the industry’s current description, “Single Family Rental”, as a reflection of the shifting views and strategies of the large rental home aggregators. This shift away from buying housing to generate a short-term profit and toward viewing it as a long term and operationally minded business, may on its surface seem to be a bet on the health of the U.S housing market. But that is only half the story. This shift in strategy was less about investors taking a long position on the prices of U.S housing as it was a vote on the continued growth of the U.S Single Family Rental Market. A Bull Market So why be bullish on the growth of the Single Family Rental Market? The proof is in the numbers. Although the U.S homeownership rate hit its lowest level in late 2016, residential housing starts had reached record highs and demand for homes was outpacing supply in most markets across the country. This coincided with an uptick in homeownership from 2016 to mid-2020 after which time, according to the U.S. Census, there was a steep decline down to where it sits today. In terms of supply shortage, which has steadily declined throughout the uptick and down tick in homeownership rates since 2016, investors are the reason. They snapped up inventory at multiple price levels to keep up with the growth in demand for rental housing. And throughout this time of rapid portfolio expansion by the large SFR aggregators, vacancy rates, which is a direct correlation to the demand of their homes by tenants has stayed steady. Everywhere you look, evidence of a boom in renter demand can be seen. According to a report released by the U.S Census Bureau in February 2021, this is the lowest that vacancy rates have been in almost 20 years. National vacancy rates in Q4 of

Perspective

2020: A Year to Forget For Most, But Not For SFR

The SFR Industry Resiliency By: Adam Stern, CEO, Strata SFR There are some industries that tend to do better than average or even flourish during times of economic downturn. If we look back to past recessions in the US, those tended to be segments of the economy where demand does not much fluctuate based on changing prices; sectors such as basic household staples, healthcare, and consumer goods. The reason these sectors tend to outperform the rest of the economy during times of economic contraction is simple! People’s basic needs and their desire and ability to fill them, regardless of the economy, stay consistent. Other sectors do well for other reasons. Segments such as discount retailers and fast food do well because when times are tight, eating and buying cheaper is more appealing. Since the inception of the Single-Family Rental Industry in early 2008, back when the trend was still referred to as Foreclosure-To-Rental, it was speculated that SFR was going to be a “recession-proof” industry. The rationale made sense too. It was widely proposed that SFR would do well during economic expansion as higher home values would push many to rent as homes became less affordable to many, including cash-strapped millennials with high college debt, and at the same time create good returns for SFR portfolio owners as equity in homes increased creating the opportunity to leverage that equity to foster expansion. The flip side of that coin was if the economy tanked, it would mean higher unemployment and stagnant wages, driving many to rent, and in a shrinking economy, SFR investors would reap the benefits of lower home prices and higher returns.  All of this was speculation until this year. With the proliferation of COVID-19 and its resulting effects on the world economy, I don’t think anyone can argue that SFR has been a beneficiary of some stark economic, demographic and lifestyle shifts that have seen the trending toward people living in Single Family Rental Homes and especially those investing in SFR, to take a swing to the positive. Reasons for the Win How the SFR industry won in 2020 reflected a somewhat atypical recession cycle. The current situation, triggered by a worldwide pandemic, has changed the way many people live and work. It also coincided with one of the most divisive and hotly contested elections in recent memory. From top to bottom, there were many winners along the value chain in the SFR industry and few losers which I will outline briefly below. Let’s start with the incumbent SFR industry players, those that have amassed huge portfolios by steadily buying SFR throughout the mid-2010s. Firms such as Tricon, American Homes 4 Rent, Invitation Homes and others have seen strong appreciation in stock prices as the industry has matured. These firms have proven to Wallstreet that scale and efficiency equate to predictable returns. The steadily increasing Net Operating margins of these various platforms, combined with strong earnings from streamlined operations, have attracted new and cheaper capital. This has allowed publicly traded SFR companies to be competitive in a tightening market. As 2020 unfolded, amid uncertainty caused by the pandemic, many firms pulled back on acquisitions which allowed them to focus on operations. This shift in buying habit did not seem to have hurt them though. If anything, it proved that these firms, through their sheer size and organizational prowess, are relatively safe bets for capital to ride out uncertain times. Mid-Cap and Small Cap SFR firms have also seemed to fare well based on the strategies they chose in the years before the pandemic arrived. These firms, like the larger SFR REITs, focused on reinforcing operations and have chosen asset types and geographies that have held up well during the pandemic. They have seen strong income with little change to delinquency and vacancy rates. As such, many have remained well positioned to attract follow-on and newly raised capital from investors hungry for cashflow and yield. This in turn put them in a good position to expand upon their build acquisition infrastructure to deploy capital. Some segments of this category have struggled however during the pandemic. Firms that chose markets and targeted tenant bases that were exceedingly susceptible to the ravages of the pandemic, such as areas where tenants are in lower rent bands or where wages and jobs were adversely affected by the pandemic, have seen higher delinquencies, evictions (in areas where they remained legal), and stagnant or decreasing rent levels. THE NEW WINNER—B4R A huge winner in 2020 has been the new-construction rental sector or as many know it, Build-For-Rent. As overall inventory levels have reached historic lows in many markets around the country, combined with the seemingly insatiable appetite of renters for newly built, more modern rental housing, Build-For-Rent has seen an influx of investment capital through various avenues. These avenues include incumbent SFR firms and not too surprisingly, new entrants such as multi-family investment firms. Other types of real estate investment companies have come into the space as well. For example, those who have been able to leverage their current operations in other real estate food groups as a way to entice institutional capital to back their play in this asset class that is now competing with the other core commercial verticals. To clarify, Build-For-Rent is the practice of buying land (raw or developed) and engaging with lot developers and builders to construct single family detached homes and townhomes for the purposes of holding as rental properties. There are several strategies players are implementing in this space. Building scatter site new construction homes for example is not a new phenomenon, as many investors bought distressed lots in broken subdivisions that resulted from the downturn and have been buying and building homes for rent on individual lots over the last decade. But the new strategy being employed by many SFR REITS, multifamily investment firms, and newly formed Build-For-Rent operators is the single site SFR subdivision. This new “thing” that many are figuring out has become the

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