Build-to-Rent Turns Stress Into Success
Average Risk-Adjusted Annual Return for BTR Investments Now about 8%
By Greg Godderidge
Prior to the COVID-19 pandemic, the build-to-rent (BTR) model was quietly gaining ground across the country, fueled by a shortage of housing supply and increasing demand for single-family rentals (SFR). Still, it was not on the radar for most SFR investors. However, as the pandemic exacerbated the supply and demand imbalance throughout 2020 and 2021, the BTR market crossed into the mainstream.
What Makes the Build-to-Rent Model Successful?
While home ownership is at an all-time low, according to Harvard University, single-family home rentals are booming. More than a third (39%) of all rental properties in the United States are single-family homes – the highest percentage since 1965. The majority of this demand is driven by the millennial generation. According to the U.S. Census Bureau, approximately 65% of Americans under the age of 35 are renters.
However, multifamily rentals in urban centers are losing favor with the millennial generation as the desire for more space to raise a family and work from home have shifted the preference to suburban single-family homes. The demand for single-family rentals to accommodate the lifestyle of modern millennial families has driven a new niche market: luxury single-family rental communities with amenities like pools, fitness centers, playgrounds and walking trails.
Build-to-rent communities are on the rise to meet the surging demand. According to Census Bureau data, the number of single-family build-to-rent (SFBTR) construction starts set a new record during the third quarter of 2021. Over the past four quarters, 47,000 such SFBTR homes began construction, up more than 17% and over the 40,000 estimated SFBTR starts for the preceding four quarters. That figure doesn’t include single-family homes built for the purpose of selling to a SFR rental operator which some have estimated could be as high as an additional 30,000 homes. Nonetheless, this surge in supply is not enough to satisfy demand for single family rental homes. While there are about 16 million SFR properties in the United States, another 13 million rental households are expected to be formed by 2030, according to the Urban Institute.
An Obstacle Course for Developers
Unfortunately, the BTR industry has not been immune to the challenges disrupting the rest of the real estate market. A confluence of factors from supply chain disruptions to labor shortages have made construction more difficult and more expensive over the past year. Not to mention, there is a shortage of available land in desirable areas for large communities to be built.
First, developers must navigate the choppy waters of local government zoning and permitting. Next, they are up against major competition to acquire sizable tracts of land for BTR projects. According to market research firm Hunter Housing Economics, a site that is well-suited for a build-to-rent community will spark a bidding war of upwards of 10 and 25 offers. The hurdles don’t stop coming once they have buildable land.
Transportation delays and port-capacity limits have throttled the flow of critical building materials such as paint, window units, garage doors, and appliances. Even individual shortages can upend entire construction schedules. The Wall Street Journal reports that freezing weather and power outages in Texas last year led to a critical shortage of resin which is used in many home-building products, sending ripples through the construction industry.
On top of these disruptions, there is a persistent shortage of workers with the skills to build homes. The National Association of Home Builders (NAHB) estimates that there are 400,000 job openings in construction and that the industry as a whole needs to add 740,000 workers a year just to make up for retirements and the industry’s growth.
Supply chain kinks and the lack of labor mean missed deadlines and higher costs. The housing-market research firm Zonda recently reported that about 90% of the home builders they surveyed were experiencing supply disruptions. That’s up from 75% of those surveyed in January 2021. As a consequence, construction timelines for many projects are increasing from the typical 8 months, and that can drive borrowing costs higher which can decrease profitability.
The Federal Reserve Bank forecasts a slow easing of supply chain constraints in 2022 that should help home builders get back on schedule. In the meantime, Robert Dietz, the chief economist at NAHB forecasts that all single-family-home starts will grow by just 1% this year compared to 13% growth in 2020 and the 9% growth in 2021.
An Optimistic View for the Future
Despite the setbacks caused by pandemic-related disruptions to the build process, there are many reasons to expect long term growth and stability in the BTR market. Multiple trends are converging to drive and sustain demand for the foreseeable future.
The housing shortage is expected to persist for years to come—especially for affordable homes—forcing SFR investors to create their own supply. According to Realtor.com, the gap between single-family home constructions and household formations grew from 3.84 million homes at the beginning of 2019 to 5.24 million homes as of June 2021.
Demand for rentals will remain high from Millennials and the emerging Gen Z population. Student loan debt and lack of savings coupled with increasingly high home prices have meant many Millennials — even high earners — are priced out of the homebuyer market in many areas. Others simply prefer the financial and lifestyle flexibility that comes with renting.
Money is flowing into the BTR market. Single-family homes built to rent are delivering strong returns to investors—the Wall Street Journal reported that average risk-adjusted annual return for built-to-rent investments is now about 8%.
The bottom line is that unprecedented demand has turned SFRs and BTRs into attractive opportunity for investors with the ability to securitize thousands of disparate rental properties into high cash-flow producing assets. While developers may be stressed with the confluence of challenges thrown their way throughout the building process, they are rewarded with huge success in the end.
