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Niche Markets

Four- and Five-Bedroom Single Family Rental Homes – THE NEW NORMAL

Meeting the Needs of Consumers, Developers and Investors By Bruce McNeilage In early 2022 I made a prediction. The three-bedroom house would die a slow death. What was once a staple of American construction and homeownership has become as outdated as ‘70s floral couches and wood-paneled living rooms. Consumer demand is pushing builders to create more four- and five-bedroom homes. In addition, existing business conditions make four- and five-bedroom homes the best option for developers and investors. As 2022 played out, my prediction came to fruition. Of the more than 1 million homes constructed in 2022, more than half were four bedrooms or more. That is up from just 25% in 1973. Given current demographics, mortgage rates and work-from-home trends, we expect this trend to continue in the foreseeable future. Older Renters, Work from Home, Drives Need for More Spacious SFR Homes From the consumer standpoint, more bedrooms in a Single-Family Rental (SFR) home makes sense. Most families are clamoring for more space. Millennials, the largest demographic cohort, are entering peak child-rearing years and more space is a necessity. Of course, the global pandemic has played a role in shaping housing trends, as well. More people are working from home and need extra space for one, even two, home offices. More than one-third (35%) of workers with jobs that can be done remotely are working from home all the time, according to a new Pew Research Center survey. This is down from 43% in January 2022 and 55% in October 2020 — but up from only 7% before the pandemic. That’s a five-fold increase in people who need – or likely want – more home office space. While many companies are still hoping to bring workers back to the office, the trend seems to have leveled out. Work from home, in one form or another, is now an entrenched part of the working world and it will continue to impact housing decisions for consumers, builders and investors, alike. Even for a family with only two children, a three-bedroom home no longer has the utility needed for the typical family. Many families are caregivers for an aging parent. In fact, according to Pew Research, 23% of US adults are now part of the sandwich generation — people taking care of an aging parent and a child under the age of 18. These people simply want – and need — more bedrooms, whether they are owners or renters. More families are opting to rent today, as well. The typical age to buy a first home has jumped from 33 years old in 2021 to 36 years old today. It is the oldest ever on record for first time buyers, according to the National Association of Realtors. The rising age is a sign that high housing costs and mortgage rates are pushing homeownership out of reach for younger Americans. Mortgage rates have shot up so rapidly that the average monthly payment on a 30-year fixed-rate loan rose by more than $600 in one year, according to the Consumer Financial Protection Bureau. The CFPB says the average payment for a home purchase loan surged more than 46% — from $1,400 per month to $2,045 — over the 12 months ending December 2022. Likewise, the median total of costs and fees for such mortgages spiked almost 22% to nearly $6,000 in the same period. And with mortgage rates rising to decades-old highs this week, the average monthly payment has almost certainly grown in 2023. This is pushing more people to rentals. Additional Bedrooms Drive up Rental Income, Profits for Builders, Institutional Investors From a business perspective, there is almost no reason for a builder or investor to construct or invest in new three-bedroom homes. If a builder has invested in a lot for $100,000, that is a fixed cost. It is not going to change no matter what they build. A 2,200-square-foot house can be configured with three-, four- or five-bedroom options, so why not go for the configuration that brings a higher profit margin? Won’t an extra bedroom cost more, you ask? Not really. In a 2,200-square-foot house, adding an extra bedroom is a minimal investment up front (approximately $1,000) and will continue to pay for itself over time. Each bedroom can bring an additional $150 per month in rent. That means opting for a four- or five-bedroom house adds $150 to $300 in rent per house per month directly to the bottom line. For builders putting together a Build-to-Rent subdivision, those numbers multiply quickly. A 30-home rental development with five-bedroom homes will yield an additional $100,000 in rent per year. It is as simple as creating a layout that includes five bedrooms. Four- and Five-Bedroom SFR Homes Yield High Occupancy, Positive Cash Flow I have seen this strategy work first-hand. In two of our most recent Build-to-Rent subdivisions, we have opted exclusively for four- and five-bedroom 2,200-square-foot homes in up-and-coming communities. The confluence of demographics (older renters with young families) along with higher home and mortgage costs are pushing more people into high-end rental homes. One key to success is finding cities with growing populations and desirable amenities. Like any real estate transaction, good schools, youth programs, restaurants and entertainment options are important factors. Once you check those boxes, occupancy falls into place. Our occupancy rates are close to 100%, creating positive cash flow, from a demographic of affluent renters with high credit scores. Finally, we anticipate our five-bedroom rentals will add value significantly faster than three-bedroom homes. Whether we hold these assets for one, five or 10 years, the return on our initial investment will be significantly higher with a five-bedroom SFR rental strategy. While no real estate investment strategy is fool-proof, four- and five-bedroom homes show great promise over the next several years. As for the three-bedroom home: You are more likely to see one in the Smithsonian someday.

Perspective

Turning a Profit in the Post-Pandemic Housing Paradox

2023 Will be All About Disappointment…and Opportunity By Bruce McNeilage When the New Year rolled around at midnight on January 1, 2023, we entered what could be one of the most opportunity-filled years for real estate investors in more than a decade. On the other hand, we also entered one of the most treacherous years in housing that we have seen in over a decade. Now that the country appears to be emerging on the other side of the pandemic, the only certainty among most investors and analysts seems to be that the euphoria is about to end. Naturally, this is a source of great concern for some people and great excitement for others. The reality of the situation is that there is always opportunity in real estate, but only if you are looking for that opportunity in the right places. Big Changes are Coming, and There is No Easy Solution At the end of the first quarter of 2023, the shifting market was already starting to emerge. For starters, what was working like a charm in 2020 and 2021 when it came to flipping houses had started to stall out in 2022 and came nearly full stop for many investors in 2023 thanks to rising interest rates and the cost of labor. Of course, the cost of materials was an ongoing concern throughout. Nevertheless, when you could borrow money at around 3% interest, flipping was a great business model. Now, however, that interest rates are hovering closer to 7%, it is not a good business model. In my business of building homes to rent and for retail sale, my funding costs have nearly doubled over the past 16 months. Something has to make up for those new costs, and investors will be limited in how they can reduce and accommodate new budget constraints. For example, for investors who own rental properties, 2023 brings rising taxes, rising insurance rates, rising costs of materials, and rising costs of labor. While rents are rising as well, it is unrealistic to simply double rents to make up the difference, which is what most investors would need to do in order to continue “business as usual” in 2023. Tenants cannot handle that kind of rate hike nor should they be expected to. Rents already rose last year by between 10-20% in most areas of the country. In my rental developments, we are hoping to lower rents slightly to keep our tenants housed. This might mean our revenues are lower — possibly around 5 % — but since they spiked in the two previous years, we expect to see positive, solid averages and reliable, long-term tenants in response to this strategy. As the cost of acquiring a home rises for retail buyers as well, investors will be well-served to pivot from owning traditional rentals to exploring creative strategies like rent-to-own. While it may be increasingly difficult for residents to purchase homes via the traditional route of a 30-year, fixed-rate mortgage, it will not become less appealing to own a home rather than rent one. In fact, about nine out of 10 millennials and “zoomers” who currently rent say they want to own their own homes — a far cry from forecasts in the mid-2000s that predicted these post-housing-crash young professionals would be content to rent their entire lives. These generations are typically quite comfortable thinking outside the traditional home-buying box, making them excellent candidates for rent-to-own models and, as an added bonus, they are usually reliable tenants as well. Breaking Down the “Affordability vs. Reset” Conundrum Two terms we are hearing more than ever in real estate are the words “affordability” and “reset.” First, the discussion deals with the topic of affordability. You tend to hear that in many states, only about half of the population has any chance at all of being able to buy and afford a home. Then, you learn that less than half of young (younger than 30) and young-ish (between 30 and 40) adults currently own their own homes even though roughly two-thirds of all Americans are homeowners. Then, the lecture continues in this vein, addressing the legitimate concern that rising interest rates, stagnating wages, and rampant inflation are going to price many of these young professionals right out of homeownership until they are well into middle age. The conclusion is always the same: The nation needs more affordable housing. The need for affordable housing established, the speaker then shifts topics. Now, they tell you about how housing is headed for a “reset” in the post-pandemic years. This is likely accurate. Since 2010, if an investor was reasonably active and ran their numbers with any degree of care at all, they could generate some fat margins on their deals. Around the time the market might normally have started correcting in 2019 or 2020, the pandemic “accelerated” the market into an unprecedented mini-boom fueled by government intervention and buyers’ fear of the unknown (and apartment living). Throughout 2020, 2021, and the first half of 2022, homes that went on the market in the southeast, for example, were sold within a day and tended to have multiple offers within the first few hours of listing. Then, somewhere around the end of the summer, things shifted. The bottom did not fall out of the market, but suddenly the only people making full-price offers were the i-buyers, and they were not necessarily moving terribly fast. When an algorithm is the only potential buyer offering you full price, you immediately know two things: Something in the market is changing or the software has not yet spotted the change. Of course, today there are far fewer algorithm-driven buying systems operating in the housing market. Investors will soon discover the coming “reset” is not going to be like 2008. Today’s market, with tighter lending standards, higher housing prices, historically low inventory, and as-yet unpredictable rates of inflation, is likely to experience a long, slow decline in some of the most expensive markets, a slight slide followed

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