Build-to-Rent Housing Garners Investor and Lender Interest

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Real estate investors and lenders are taking a closer look at the growing build-to-rent market, an emerging opportunity that could help address the nation’s persistent housing shortage.

The demand for housing—especially in the affordable segment—remains a critical need in many U.S. metropolitan areas.

Innovative lenders around the country have begun to roll out loan products for new construction and to stabilize this emerging class of rental properties. And, although the build-to-rent market has been mostly under the purview of builders and conventional bank financing, new build-to-rent financing programs are becoming available from a variety of private money lenders and will likely attract more local and regional real estate investors.

Plenty of pent-up housing demand still exists as construction starts to fail to keep pace with household formation and the millennials increase their presence in the housing market. Older millennials are now entering their late 30s, a prime home-buying age, while the younger millennials (still in their 20s) are at a prime renting age.

December 2018 housing starts fell 10.9 percent over December 2017 and were down 11.2 percent from November 2018, to just over 1 million units, according to data released Feb. 26 by the U.S. Census Bureau. The estimated 1.19 million starts completed in 2018 were about 3.4 percent above 2017’s 1.15 million starts, but not enough to meet demand. The long-run average for annual housing starts is around 1.5 million to 1.6 million.

Freddie Mac economists put it this way: “After nearly a decade of low levels of building, housing stock is well short of what the United States needs.”

Some of December’s housing headwinds have evaporated, and that’s good news for the 2019 market. The partial federal government shutdown is in the rearview mirror, stocks have rebounded and mortgage rates have fallen. January and February 2019 housing metrics are not yet available, but cautious optimism has returned.

Rental Market Growth

Zillow found a widening gap between the income of homeowners and renters. They note that to become a homeowner today, buyers need to earn more money than households that already own their homes. Zillow found that the typical homebuyer earned 6.5 percent more in household income than the typical homeowner and more than two times the typical renter.

The disparity points out just how expensive housing has become in recent years, and it may point toward why the U.S. has become more of a renter nation over the past decade. In fact, renting is now a more affordable option than buying in 59 percent of U.S. housing markets, according to ATTOM Data Solutions.

“With rental affordability outpacing home affordability in the majority of U.S. housing markets, and home prices rising faster than rental rates, the American dream of owning a home, may be just that—a dream,” said Jennifer von Pohlmann, director of content and PR at ATTOM Data Solutions, according to the report. “With home price appreciation increasing annually at an average of 6.7 percent in those counties analyzed for this report and rental rates increasing an average of 3.5 percent, coupled with the fact that home prices are outpacing wages in 80 percent of the counties, renting a home is clearly becoming the more attractive option in this volatile housing market.”

Both institutional and individual real estate investors have jumped on this opportunity in the single-family rental space.

Invitation Home’s 2017 initial public offering became the second largest REIT public offering in U.S. history when it raised $1.7 billion. Now, two years later, the massive SFR REIT owns 80,000 rental homes around the country. A handful of other institutional-level players have invested heavily in the SFR market, including publicly traded American Homes 4 Rent (which owns nearly 53,000 homes) and private equity firm Cerberus, whose FirstKey Homes owns 18,000 properties and announced plans last year to expand to 40,000 homes.

Growing Build-to-Rent Segment

Now that the SFR asset class has matured, some of these institutional players are building new homes for rent, albeit on a small scale. American Homes 4 Rent built 220 homes last year to rent out.

John Burns Real Estate Consulting notes that the build-to-rent segment is growing quickly, and says it is already tracking more than 50 active and planned communities around the country. The Irvine-based consultancy, which has offices around the nation, says it’s helped multiple build-to-rent operators with product and community amenity recommendations as well as provided assistance determining appropriate base rent rates, premiums, absorption and stabilized occupancy levels.

Institutional players obviously see opportunity in the build-to-rent space. But what about smaller, experienced investors who are active in the fix-and-flip or buy-to-hold area with existing housing stock? These smaller investors have been part of the single-family rental market for decades. That’s not the case for the large institutional players who entered the field about seven years ago.

Part of the reason for the growing build-to-rent segment is that the distressed housing stock that real estate investors and institutional buyers purchased in the wake of the housing crisis is no longer available in major quantities, and rising home prices have increased the cost of market-rate acquisitions. In addition, some homes may be considered too old for acquisition due to the capital costs for renovations. New homes that don’t require renovations can often command higher rents.

In a 2017 article by NAREIT, American Homes 4 Rent noted its relationships with several developers from which it can buy newly constructed homes at a small discount and that are built to match the long-term maintenance needs of its renters. Think laminate flooring, tile and other durable materials as well as small lot sizes. The REIT said it also decided to start building its own homes as it discovered it could do so at a lower cost than what it would pay a developer. American Homes 4 Rent said it plans to continue to expand its build-to-rent program.

Whether seasoned, smaller real estate investors add this new asset class into their investment mix will be closely watched, especially by private money lenders who see opportunities to provide innovative financing to help these investors succeed.

Financing Opportunities

Several specialty lenders have already entered this marketplace to offer construction financing and long-term financing once build-to-rent projects have been stabilized.

These innovative and relevant loan products, which typically cannot be found at a traditional bank or mortgage company, are coming from lenders that formed several years ago to serve the SFR market. These lenders have honed their expertise over the past six years or so in the SFR space and are well-equipped to serve the build-to-rent niche.

Lenders see an opportunity to provide investors with capital that really hasn’t been available to small and midsized real estate investors at this level until recently, when these specialty lending platforms began to emerge in the aftermath of the nation’s financial crisis.

With construction and labor costs rising, the price of a new home is now about 50 percent higher than existing homes, a gap that has doubled since 2008 when the price differential was 25 percent, according to Zillow. Because of the costs to build new housing, it’s likely that real estate investors wanting to grow a build-to-rent business will need outside financing to scale their build-to-rent business beyond the one-house-at-a-time method of growth.

Providing debt capital to traditional fix-and-flip investors for build-to-rent projects could help increase the country’s rental-housing stock, which housing experts say will likely be badly needed for years to come. The build-to-rent market is bright for all sizes of real estate investors and lenders.