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Understanding Build to Rent, Part II
Despite the real opportunities, this evolving space includes pitfalls that builders and investors need to be aware of...
If you've read Part 1, you understand why build-to-rent (BTR) looks so compelling to so many production homebuilders. If you haven't read that short article, it's worth a few minutes of your time as it lays out the potential rewards of this market. Read it here. However that article also noted that while build-to-rent may seem like a natural extension of the homebuilder's business, it's not.
The biggest difference is that this is a long-term play, with the physical act of building the structure being just one piece of it. Everything else is different, including land acquisition, financing, sales and marketing, and how you manage day-to-day operations.
Here are a few points that builders and investors looking at this market need to consider.
Investment Horizons are Different
The first is that BTR isn't the place for someone who needs short-term financial returns. Instead, it's a long-term investment
"Most public homebuilders need turn their capital to keep their stockholders happy," says Mark Wolf, Founder and CEO of AHV Communities in Irvine, Calif. The BTR business model is different in that the initial investment isn't recouped until the project has been built out. "If you're doing a $70 million community you will probably need to put down $25 million in equity. You don't get that back until you finish the project, lease out the properties and refinance. This can be 3 to 4 years."
Because of this, builders venturing into BTR usually start by dipping a toe in the water. "The builders we're aware of who are entering this space start by devoting just 2 to 5 percent of their production capacity to it," says Dylan Rhea of RealFoundations a real estate consulting firm that's also based in Irvine.
Land Choice is More Critical
Land choice can make or break a rental community. For instance Wolf's company looks for single family residential or multifamily entitled or un-entitled land with a minimum 10 acres and 75 lots. They also consider other factors that he says are proprietary and have been developed over several years in business. "We have our own metrics internally that serve us well," he says.,
However the broad outlines of a good development location are no secret. It has to be close to the center of town in area with good schools and other amenities—basically, a location that will support the rental income needed. "Build to rent communities are starting to compete with high end multifamily communities," says Rhea. "People have same requirements as buyers: they want an active area with good schools and restaurants."
Wolf agrees. "Our communities are very close in, what we call urban adjacent," says. "They also tend to be no more than 15 or 20 minutes from job centers." However, a job center alone isn't enough to support the rents needed. "An Amazon warehouse alone won't support a community."
The land also has to be priced such that it will generate positive cash flow when complete, but that's becoming a challenge. "Over the years, good locations have gotten harder to obtain thanks to people flooding the market and driving up land prices," he says.
Some developers are purchasing overpriced land far from town for rental communities, but Wolf thinks they will find themselves in financial trouble. "There will be a shakeout in this industry," he says.
Neighbors Will Object
NIMBYism almost always raises its head on a BTR project. "We hear the same objections on every deal," says Matt Blank of BB Residential in Phoenix. People are afraid that their property values will fall and that the rental homes will attract people who don't respect the community. "However we have lots of data we can use to counter those objections."
Blank hosts town hall meetings with neighbors to help them understand his company's renter profile and business processes. "We explain that our tenants actually have to meet higher standards than someone buying a house, including a criminal background check," he says. He points out that tenants also have to follow HOA rules and that his company will be responsible for any problems.
Watch this short excerpt (2.5 min) from our conversation with Mitch Rotta, Tricor Construction and Margaret Potter, Camillo Properties.
You Need an Operating Model
Built to Rent operating models come in two basic flavors.
The builder builds the community and operates it as an asset.
After the community is complete, the builder sells it to an ownership entity, but retains an equity position.
Even if the builder retains ownership, they need property management capabilities. “If you want to profitably operate the property, you need a to be vertically integrated to include the management component, or else be ready to enter into a partnership with someone who knows how to run one of these properties," says Rhea. "Otherwise it will never pencil."
But while there are proven operating models for apartment properties, single-family rental communities are new enough that operating models are still evolving, and each company will need to create a model that works for their situation.
Rhea, who helps companies create these models, says that three factors need to be taken into account.
Day-to-day business processes. What will be the processes for building the community and leasing the homes? Questions that need to be answered include how you will execute service requests and how the maintenance department will operate.
The people component. What services will be sourced internally? Will the operation be vertically integrated or will operations be handed off to a third party? Will the community employ on the ground maintenance crews?
The technology you will use. As part of the operating model you have to decide what software you will use to manage leases, operate properties and etc. The problem here is that there aren't yet any software solutions specifically for single-family rental communities. "Most operators are using multifamily solutions," says Rhea. "These solutions aren't a great fit but the companies are adapting and making them work."
All of the above makes it wise to for anyone looking at the build to rent space to move slowly and do a lot of due diligence. "We see some builders getting into this business who aren't prepared," says Rhea. "Their attitude is usually 'how different can it be?' The answer is that it's dramatically different."