Demand for single-family rental housing is rising, and the sector has emerged as a popular option for those seeking more space and an affordable place to live. During the COVID-19 pandemic, this trend has accelerated as more people flee dense urban cores to the suburbs. It also has led to a new type of starter home and an entirely new institutional investment asset class: build-to-rent (BTR) single-family homes.
Homes that are built specifically to rent is no passing fad. And they provide yet another opportunity for commercial mortgage brokers to complete deals in a sector with willing lenders.
Single-family rentals emerged as an organized commercial real estate asset class in the wake of the Great Recession, when institutional investors bought a glut of distressed single-family homes at a discount and converted them to rentals. These successes have led to a new housing subcategory. Build-to-rent projects are cropping up in settings that previously would have been multifamily developments. They are designed more like single-family homes and tend to appeal to a wider demographic.
Markets like Phoenix are ground zero for BTR projects, but the demand for single-family rental homes is generally growing across the nation. The Harvard Joint Center for Housing Studies’ 2020 rental-housing report indicated that single-family rental homes grew by 18% between 2008 and 2018 to 15.5 million units, and they represent about one-third of all rental units in the U.S.
Single-family BTR homes also continue to expand. Roughly 14,000 single-family BTR units were started in third-quarter 2020, according to a National Association of Home Builders’ analysis of census data, and about 42,000 BTR construction starts were reported during the four quarters ending this past September. Furthermore, the Urban Institute reported in 2017 that the broader category of single-family rentals was the fastest-growing segment of the U.S. housing market.
National companies — such as American Homes 4 Rent, Invitation Homes and Progress Residential — hold tens of thousands of rental homes in their portfolios. Examples of players making big moves in the sector include New York-based Pretium Partners. The single-family rental operator partnered with Ares Management to acquire Front Yard Residential Corp. in a $2.4 billion deal, boosting its portfolio to 55,000 units.
California-based American Homes 4 Rent, which was launched in 2012 by Public Storage founder B. Wayne Hughes, operates a portfolio of about 53,000 affordable single-family units in 22 states, and had $1.18 billion in revenues in 2020. Active companies in Phoenix include NexMetro Communities, El Dorado Holdings Inc., The Empire Group LLC and Harvard Investments Inc. Taylor Morrison is building single-family rental units in Arizona for Christopher Todd Communities. Other active players on the national stage include Toll Brothers, Lennar, LGI Homes, Meritage Homes and D.R. Horton.
Sector drivers
Demand for build-to-rent homes has been driven primarily by baby boomers and millennials. For boomers entering the empty-nester phase of life, the ability to downsize yet still enjoy many of the features and comforts of a house is appealing. Empty nesters and retirees are able to “lock and leave” their home to travel. Build-to-rent homes also typically allow this demographic to comfortably entertain friends or have their grandchildren over while enjoying a yard.
The millennial cohort is drawn to this product for other reasons. Typically, they have more debt than other generations and often can’t make a downpayment to buy a home. Additionally, millennials tend to wait longer to get married and start families, and are thus renting for longer. Many millennials came of age during the Great Recession, which delayed their career start and limited their earnings. So, some millennials may prefer the short-term flexibility of renting.
BTR communities tend to be located in areas of the country where people have been moving. COVID-19 accelerated an exodus from expensive major markets, such as Los Angeles, New York City, San Francisco and Chicago. There has been a flight to lower-cost markets, such as Salt Lake City and Boise, Idaho, as well as many Sun Belt and Southeast cities, including Tampa, Orlando, Charlotte and Nashville. Build-to-rent communities are growing in these locations.
Added space is another major draw during a time of social distancing. BTR communities offer more square footage and bedrooms than standard apartments. The homes tend to be detached units or townhouses, and many of these developments are found outside of dense urban cores.
The extra space makes working from home easier and affords more privacy. During the pandemic, renters have desired more space and less close contact with people outside of their bubble. Another factor that makes single-family rentals appealing to people of all ages is that they tend to be more pet-friendly than apartments. Many of these projects are built with pet owners in mind.
Financing landscape
Although boomers and millennials have driven the growth, single-family rentals appeal to residents as young as 20 and as old as 90, and they span an income diversity ranging from less than $50,000 to more than $100,000 annually. Given the wide appeal, lenders are generally open to hearing build-to-rent proposals. Mortgage brokers will have a number of options for financing projects, but their success will usually depend upon the profile and preference of the equity.
Capital providers, both big and small, have created new programs to deploy capital into the single-family rental space, especially in the Sun Belt states. Banks and life insurance companies provide recourse and nonrecourse loans that range from 50% to 70% loan to cost (LTC) and rates of 3% to 5%. Nonbank lenders can provide construction financing at various rates but are most cost-efficient in the range of 65% to 80% LTC with rates in the mid-to-high single digits.
Additionally, several capital providers are seeking to place mezzanine or preferred equity financing in single-family BTR developments. These lenders will typically provide up to 70% to 80% of the capital stack, although some will go even higher.
Given that build-to-rent communities should continue to perform well and expand, new players are staking out their ground in this asset class. There is an incredible amount of capital pursing single-family rentals. As the demand increases, so too should the availability of financing.
Fad or trend?
The question is, will this asset class last? The year 2020 was one for hunkering down. Last year, many would-be developers and capital providers paused to evaluate the build-to-rent space before deciding how to move forward. In contrast, 2021 is expected to be a year of execution.
A growing number of new developers are entering the market and are hungry for a share. Meanwhile, veteran developers are coming up for air and are ready to execute on their pipeline of deals. As demand grows and expands into more markets, expect the need for BTR development to rise as well.
The demographic shifts alone point to longevity for the build-to-rent sector. Millennials are renting for longer than previous generations but want more space than a traditional apartment provides. Empty nesters are ready to downsize to smaller, private and professionally maintained homes.
A 2020 study conducted by RCLCO Real Estate Advisors found that 700,000 single-family units are expected to be built for the U.S. rental market over the next decade. The researchers stated that this pace still isn’t enough to keep up with the demand. Add the effects of a global pandemic to the mix and it’s safe to say that build-to-rent is here to stay. ●
