October 05, 2022
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Market fluctuations don’t change the fact that long-term real estate investment can generate exceptional returns.
America is in need of affordable housing, and home builders constructing build-to-rent projects provide just that. It’s a cost-effective way to live in a house with a yard and garage, in a well-maintained, often amenitized community. This new housing concept works, and demand is substantial. Newly built single-family and townhome projects for rent are 98% occupied.
In the second article of this two-part series, let's discuss how now may be an excellent time for builders to consider the opportunity of holding their BTR projects long term. Three years ago this option wasn’t even a thought for most in the home building industry. But with rental homes as a new and proven real estate asset class, builders can take advantage of the moment.
As prices institutional investors pay for BTR homes soften and some uncertainty exists in the market, builders should take a good look at the builder/owner option. Home prices and rents don’t always rise at an accelerated pace. A sustainable operation for the long term while building wealth is what most are after, and build-to-rent for your own portfolio offers this.
Builders Have Opportunity
BTR continues to thrive as new-home production solely for rent is expected to grow over the next few years from the roughly 100,000 units in 2022. Most of these homes will be acquired and held by institutional investors.
Why don’t more builders consider holding their homes? I’m seeing most builders sell or fee-build in conjunction with institutional capital. Why not hold for a while and then sell or refinance, or hold for the long term? Builders should at least examine this option more closely.
The infrastructure for builders to create their own BTR portfolio is already established. Builders have existing operations and expertise to create the product, and other necessary tools are accessible such as financing, investors, and management companies.
Institutional capital will be there to purchase a well-positioned rental project down the road. It’s now accepted as a mainstream real estate asset class just like other forms of commercial real estate. This is not new, just new to the home building industry. Multifamily apartment developers have always had these options.
Matching Capital With Goals
I work with many local and regional private home builders, and we regularly discuss which BTR strategy is right for them; sell, fee-build, or hold. Many decisions are based on equity needs and the ability to scale. Institutional investors therefore end up driving BTR strategies, with a short-term exit for the builder. This doesn’t always have to be the case.
One builder I work with has a large financial commitment from a private equity group to build and develop projects. The partner will provide the equity in their projects and obtain the homes at certificate of occupancy. This builder has the option to stay in deal for the long term, if desired, for a portion of ownership interest.
Another builder develops land and constructs homes solely to hold. Their company prefers to be the builder who “quietly builds a great portfolio for the long run.” They seek out capital partners who have the same long-term goals. They are building a “sustainable organization for the long term that can withstand economic cycles.” This particular builder/owner continues to grow and is currently in seven markets.
BTR ownership is within reach if you bring in capital partners with the same goals. You can maintain a percentage of ownership for the long term while hedging risk.
Reasons Builders Should Consider Holding Their Homes For Investment
Institutional investors have billions of dollars earmarked to purchase homes from builders and hold for investment. Let’s examine some reasons when holding can favor the home builder:
A fantastic way to diversify a home building business;
The transformation to BTR ownership is seamless;
Cost basis for builders on each home is far lower than institutional investors, a huge edge here;
Builders have the land pipeline and product, which is the hardest part for institutional investors;
Maintenance and capital expenditures are low on new homes, especially as more thoughtful materials are being used for the long term;
There are many innovative third-party management companies seeking builders as clients;
Once builders turn over the homes to a management company they can “have no contact with tenants,” according to a top 50 building firm that is now holding for its own portfolio;
Tax benefits can be substantial;
Leverage benefits—ROI and cash-on-cash returns are strong versus other investments;
You can refinance, a way to obtain cash while still holding the asset;
High consumer and institutional demand;
Demographics and household formation—millennials and Gen Z favor BTR;
Mortgage rate increases are pushing potential home buyers to renters;
Low rental home and apartment supply;
Lower vacancy rates than apartments and other real estate investments; and
Asset appreciation and rent growth over time.
Financing and Portfolio Options
BTR has become a proven and thriving asset class, and lenders want to participate. Debt financing is available for land acquisition, development, and construction. Private capital groups as well as traditional sources seek to finance experienced builders in good markets. Permanent financing programs for long-term holds are available and attractive, for both balance sheet and agency.
Equity investors seek to invest with quality builders for the long term. In fact, being a cash-flowing asset, BTR has opened the door for many more equity sources to enter the home building industry. These groups can provide a substantial portion of the equity required for the project and will partner for a mid- to long-term hold. These are multifamily apartment type investors with their sights set on cash-flowing, appreciating assets, such as new rental homes.
BTR will continue to be a welcomed and important revenue generator for the home building industry. It changes historical business models, and builders have options. Holding cash flowing assets for the long-term is an excellent way to diversify a home building business. It’s a hedge against downward market cycles while achieving cash flow, appreciation, and a solid return on investment. Building a real estate investment portfolio has stood the test of time for generations and has created wealth. The BTR opportunity today provides a seamless way for home builders to accomplish this.
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