Although single-family, build-to-rent should be a profitable niche for builders willing to make long-term investments, advice from veterans is to proceed with caution.
Despite historically low birth rates, many young people are, in fact, starting families. During his presentation at the Housing Innovation Alliance’s online Staycation event in April, Matt Blank of BB Residential noted that 1.2 million new households had been formed in the previous 12 months.
It’s a demographic he knows well. BB Residential has been building new, single-family for-rent communities in the Phoenix area since 2012. Their current inventory is about 1000 homes and their average tenant a 30 year-old couple with two kids and a household income of $100,000. These people intend to buy a home eventually, but need a few more years to save the down payment. In the meantime, they want a new, 3 or 4 bedroom rental home in a desirable area, usually a close-in suburb with highly rated schools and a short commute to job centers. Blank’s company is focused on meeting that demand.
But while Millennial households are a huge potential market, they’re not the only group in need of rentals. Dylan Rhea of Real Foundations, an industry consultant who also presented at the event, notes that overall homeownership rates have been falling since 2008. That’s thanks in large part to rising home prices and stagnant wages.
Watch their presentation here (49 minutes):
Of course this isn’t news to homebuilders, who have been grappling with affordability for a long time. And it should come as no surprise that more builders, from local and regional companies to the big public homebuilders, are eyeing build-to-rent as a possible hedge.
Last June for instance, CNBC reported on a $100 million IPO by ERC Homebuilders to fund more than 1,000 rental homes in Florida. That same story also mentioned Toll’s $60 million investment in a joint venture with Blank’s company, and Lennar’s announcement that it would be “moving further into the space.”
That was a year ago, during what was generally regarded as a strong economy. As we write this in early May of 2020, much of the economy has been shut down and NAHB’s most current New Residential Construction data shows a 22.3% dive in home sales over the preceding month. With millions of Americans out of work, some people fear a long downturn.
The result? Demand for rental homes is far exceeding supply, a situation that will likely intensify.
Of course every market has pros and cons, and while there are good arguments for considering a venture into build-to-rent there are also real pitfalls you need to avoid. People who have been doing it for a long time warn that it’s a different business than building for-sale homes, and caution builders against diving in too quickly.
We’ll cover the pros here, then look at the cautions in the next article.
Why Do This
It’s easy to see the advantages of build-to-rent communities. They include an easier build, lower overhead, less legal exposure, ongoing revenue and higher property values when it’s time to make an exit.
Easier build. Single-family production builders face the complexity of managing design options chosen by each customer, and many builders indicate that no one home they build is the same as another because of an ever-changing mix of options and design changes. “This complexity wastes time and causes inefficiency, which drives up cost without driving up value,” says George Casey, President and CEO of Stockbridge Associates and Chair of the Housing Innovation Alliance.
By contrast, a for-rent community typically has only a few floor plans with no options. This is a perfect environment for an efficient, Even-Flow production model: the trades can learn your playbook and execute it on a consistent basis.
More efficient costing. “Most builders focus heavily on initial cost when specifying products inside of the house,” says Casey. “But with build-to-rent you can look at total life cycle cost.” For instance you can afford to pay 10% more for an appliance that will last 15 years instead of 10, because it costs less money in the long run.
Lower sales expenses. In the build-to-rent model a lot of sales-related expenses disappear. You don’t have to pay broker commissions or hold broker events. Advertising becomes part of the community’s operating cost, rather than the construction cost. You may not even need a model home.
In-house salespeople are also a bargain. “While you might end up paying a good commissioned salesperson as much as $150,000 per year, you can get a leasing agent for $50,000,” says Casey.
Reduced liability. In a 2017 article for Professional Builder magazine, Glenn Cottrell of IBACOS cited a DuPont study on how much money construction defects were costing 13 publicly traded home builders. According to that study, the average big builder spends $4,919 per house on warranty claims alone, but if you add in construction defect litigation that number balloons to $22,278. Ouch.
A builder who owns the house obviously doesn’t have to worry about getting sued by the homeowner, so most of those costs go away.
Long-term financial gains. Besides generating cash flow from monthly rents, Casey points out that if the builder/owner decides to sell off a community in the future, money made from property price appreciation will be treated as a capital gain by the IRS, which is taxed at a lower rate than business profits.
While these advantages are compelling, however, this business is far from easy. Build-to-rent brings its own unique set of pitfalls, and most builders lack the experience and the systems needed to succeed at property management. That’s why many opt to partner with someone who does have that experience, as Toll is doing with BB Residential.