The Build-For-Rent Evolution
Why BFR Communities Have Taken the U.S. Market by Storm
By Mark Peterson
As we head into 2022, the commercial real estate industry is continuing to see new Build-for-Rent (BFR) communities popping up all over the county. These BFR communities of newly-built detached or attached single-family rental homes have taken the U.S. market by storm in a few short years, helping to fill the immense housing shortage for renters and opening new revenue streams for builders and investors.
There are 15 million households renting in the U.S., and current trends show we are turning into a nation of renters. Renters are allured to new single-family rentals for several reasons including the opportunity to have more living space with yards without having the responsibility of home ownership or having to produce a down payment. COVID-19 accelerated demographic changes, such as moving to suburban locations and working from home, escalating demand for BFR housing throughout the country.
What happened in recent years to cause a surge of growth in Build-for-Rent? The BFR investment class reflects similarly to multi-family in its beginning phase. Institutional investors only comprised an estimated 2% of ownership in the 1970’s when multi-family got its start, which has grown to nearly 55% today. Looking deeper at the evolution of this booming asset class, key drivers – including agency financing, increased capital flowing into the asset class, optimization, technology and smart home advancements – have propelled BFR forward with the promise of massive growth for years to come.
Breaking Through Financing Barriers
One of the biggest challenges in BFR was the financing. Four years ago, BFR was not a proven asset class and it was challenging to convince builders that there were actually buyers interested in purchasing an entire community on a forward commitment. Back in the day, the top 20 SFR operators were just getting started with exploring or buying these BFR communities, and trying to convince these developers and builders that they would get a forward commitment from a big capital group that would commit to buying before the homes were built was a daunting task. Before the institutionalization of BFR these SFR operators were exploring the asset class because they realized their capital expenditures on these scattered homes were high and some of the inefficiencies that ran with managing homes scattered across an MSA would be overcome by buying homes that were all in one community.
Fannie Mae and Freddie Mac provided financing on scattered home portfolios as a pilot program for each agency for a brief period. Each entity provided about $1B in debt, most of which was absorbed by the big capital groups to finance large acquisitions. This financing was not available for the BFR acquisitions. SFR experts, such as SVN | SFRhub Advisors, the first commercial single-family residential and Build-for-Rent dedicated brokerage in the country, were an integral part of working with the agencies on educating them on how BFR operates as it was an asset class they had not studied before.
After years of studying BFR deals, Fannie Mae and Freddie Mac learned how a self-contained community operates even more efficiently than a multi-family community, increasing their interest in determining how to provide debt for the asset class. Working with preferred partners, such as Walker & Dunlop, underwriting criteria and programs were created to introduce to builders, developers and capital alike to provide acquisition financing. This evolved into programs for development debt along with vertical construction and bridge loan financing.
Bridge loan financing allowed investors to acquire the homes at certificate of occupancy in tranches through the course of the build-out of the community that was then rolled into agency financing once the community was fully complete and leased.
The permanent financing is the same debt programs the agencies use for multi-family financing and requires showing a trailing three-to-five-month history of occupancy and operations.
This option did not become available until 2019 and was never fully marketed. It was a huge boom in pushing the BFR asset class forward as investors learned agency financing was available for self-contained BFR communities. With true agency debt now in place – arguably cheaper than the typical SFR private lending debt that was available – all the new capital comprised of commercial investors, multi-family buyers and single-family operators entered into the BFR playing field.
Opportunities for Optimization
At the time, buyers were primarily SFR groups, used to scattered lots, who were buying the first or the last 5% to 10% of a community and were not involved in the designing or developing of purpose-built communities. The builders would determine the floor plans and finishes in the homes leaving the buyer or investor to select from the limited options, or even standing spec inventory, resulting in suboptimal returns. Rather than having the ability to select finishes ideal for a rental unit, such as vinyl plank flooring, durable countertops and stainless steel appliances, these newly developed homes would include higher-end options you would find in a for-sale product.
Builders of BFR communities are now purpose designing homes and selecting materials to withstand wear and tear to minimize repair and maintenance and turn-over costs, including laminate faux wood flooring, minimal carpet, seamless countertops and limited front/rear yard landscaping, according to John Burns Real Estate Consulting (JBREC).
Lot size is far less important to renters, but community amenities offered in larger communities can be an important draw.
Top desired amenities offered include on-site management and maintenance (61%), a pool (50%), a clubhouse (35%) and walking trails (31%), based on an analysis of JBREC Build-for-Rent database.
Builders and developers now consult with industry leaders, such as SVN | SFRhub Advisors, to complete a conceptual analysis of every site to ensure builder savings and maximized returns. These experts will review nearly a dozen floor plans to evaluate what the returns per floor plan are in addition to researching the current market, MSA trends and characteristics, rental trends and demographic data.
The importance of optimization cannot be overstated. The table below depicts an example from a 158-home development SVN | SFRhub Advisors analyzed for a builder. The non-optimized column utilizes the floor plans, rent and property management as determined by the builder. After analyzing the site and determining a different mix of floor plans, utilizing appropriate rent, factoring in master policy insurance, and institutional property management, the projected exit value was 50% higher in year four, using a 4% exit cap rate to determine the value for each. This more than makes up for the $6,000,000 increased purchase price by selecting the optimal floor plan mix for the site. Without the ability to select and develop efficiently-built and optimized rental houses, builders and buyers are spending where they will not see returns.
Technology Efficiencies
Opportunities for increased returns for BFR communities have been realized through technological advancements that have benefited residents as well. Before the Build-for-Rent era, SFR operators had to develop and utilize new technology to effectively and efficiently lease their scattered homes as opposed to multi-family groups who have not always had to rely on technology for marketing communities because they had an onsite office with staff that was there every day. Self-showing technology that allows prospective residents to visit a home on their schedule is now being used to lease BFR communities. Professional property management and innovative tech has improved the resident experience and driven a growing desire among all generations to rent over homeownership.
Green Living in a Smart Home
BFR homes are being developed to be more environmentally friendly and sustainable in addition to leasing and management improvements. Globally, investors today are enhancing their portfolios through BFR homes developed to make positive environmental, social and corporate governance (ESG) impacts that benefit both the planet and their bottom line. While attractive to investors, ESG is also important to residents wanting to be part of the solution who are increasingly reporting that they are willing to pay more for products that are socially and environmentally conscious.
An added benefit for residents is reduced maintenance visits. New smart tech can monitor for potential issues such as water leaks, hot water heater problems and HVAC issues so repairmen can show up with needed parts or replacements to make repairs, sometimes even before the residents know there was an issue. With increased returns for investors, improved green living for residents and maximized environmental benefits, ESG will continue to have a positive impact and influence in the BFR market.
The Projected Road Ahead for 2022
A recent Freddie Mac study shows the U.S. economy is 2.5 million housing units undersupplied. There is a huge demand for single-family rental housing today that will only increase over time as housing costs and interest rates rise, fueling a strong Build-for-Rent market. SVN | SFRhub Advisors projects Build-for-Rent will experience further approval as an acceptable institutional asset class with more capital in-flow. As the for-sale market starts to slow down, more builders will view BFR favorably and it will be a larger part of their total sales. According to JBREC, Build-for-Rent will gradually add new supply to the market, particularly in the Southeast, Florida, Texas, and Southwest where BFR already accounts for approximately 10% of all land purchases (finished lots, entitled land/paper lots, and raw land).
An important theme that is expected to be played out in 2022 is increased optimization of developed BFR communities, growing the value of investors’ portfolios by selecting best suited floor plans and unit mixes. While investors and builders are already attracted to BFR due to its current demand, historically strong risk adjusted returns, hedge against inflation, income potential and appreciation, these efficiently tailored alterations will increase already reliable returns, attracting more capital into the space.
