April 29, 2022
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Today’s home builders are front and center of the industry’s largest shift in generations. As build-to-rent continues its surge, we now have a good understanding of the asset class, opportunity, and players. It’s a far more established industry than even two years ago as rental communities and new homes continue to prove out. Suddenly, it’s the most talked-about sector in real estate.
Newly constructed rental homes and communities are selling fast, rents continue to increase, consumer demand is high, investment is huge, and builders around the country can’t help but take notice. It’s a true mesh of the home building and multifamily apartment industries. We haven’t seen anything quite like it.
We can talk about forecasts, demand drivers, and demographics, as many excellent analysts have, but in the first of this two-part series, let’s zero in on what’s the best play for home builders: the options available through capital, structures, and exits.
Financing Opportunities
Lenders seek to fund the development and construction of new BTR projects. This wasn’t always the case, but as the BTR sector continues to perform, lenders are fully engaged.
Private capital groups and debt funds lead the way, with banks right behind. There are some interesting BTR specialty financing groups, offshoots from their apartment construction practices, that exhibit a diverse array of financing options depending on the size and scope of the project.
For those builders that want to hold their properties long-term, permanent financing is widely available with excellent terms similar to the apartment industry. Bridge loans can be used to take out construction lenders during stabilization. There are some financing groups that encompass the development, construction, and permanent in the same loan product, also used in the apartment industry. These programs have been adapted for both single-family and townhome BTR projects.
Equity is also readily available taking the form of preferred or joint venture. Some equity investors prefer an exit upon completion of the project or when stabilized, while others desire a three- to five-year hold. Equity returns are structured based on a percent of cash contributed by the builder, as well as the type of relationship desired. There are investors who will provide up to 90% of the equity required as a joint venture partnership, while others can be structured as preferred. Being a cash-flowing asset class, BTR has opened the door for many new equity players.
To Sell, Fee Build, or Hold?
As private equity groups line up to purchase BTR homes and communities from builders, different strategies are being used by builders mostly due to financing capacity, de-risking opportunities, and growth models. Some builders are holding, many are selling, and others are fee building.
To Sell: Working with Private Equity Groups
Private equity is using its deep pockets to acquire newly built homes, and competition is fierce. In fact, the latest tally has these groups committing $50 billion toward this endeavor. The opportunities and value proposition being offered to builders is unprecedented.
How are private equity groups deploying their funds? They are contracting with builders to buy homes in new development communities early in the process, before breaking ground. Many like to purchase the homes at certificate of occupancy, although they will take out the builder as early as when land is entitled, after horizontal development, during construction, or at stabilization. The longer the builder maintains control and develops the project, the better offer it will receive.
Pre-selling some homes in for-sale development projects has always been the goal for builders, not only to ensure successful projects but also to secure financing. Can you imagine pre-selling entire communities of homes? This is what’s happening now.
Many private equity groups are even teaming up with builders for programmatic relationships, essentially saying, “We’ll buy all the homes in your next few projects, keep us posted on your pipeline.” Pretty incredible for traditional home builders, and hard to pass up. What’s more, not only will they purchase the homes, but they also will provide ease of capital along the way using a variety of creative financing tools. Examples of this include 1. Enabling builders to use purchase agreement deposits in the project, counting as equity in the deal; 2. Purchasing the land on behalf of the builder, again allowing this dollar amount to be equity in the deal; or 3. Providing financing for the project.
These opportunities are proving irresistible to builders. The best part is any size builder and project can participate.
To Fee Build: A Low-Risk Revenue Strategy
If the project is entitled, private equity groups will purchase the land and provide horizontal funding for the project. They will contract with the builder on a fee basis to develop the property and build the homes.
Builders are finding land, entitling, and fee building, which is a way to grow while de-risking their business. Contracts are cost-plus, or a fixed fee per finished lot delivered and an additional fee per home delivered. There is great interest in this model. Margins are lower than if the builder acquired the property and financed the project themselves, but many builders like the low-risk trade-off.
To Hold: Creating A Real Estate Investment Portfolio
We have to ask ourselves, why are so many institutional investors aggressively seeking to purchase newly built homes for their investment portfolios? Why aren’t more builders looking to create a portfolio for themselves? After all, builders' cost basis is lower than the institutional buyers who purchase their homes, the goal for any investor.
The next article in this two-part series will dive into the option of builders creating an investment portfolio of newly built homes.
BTR private equity, investor groups, and lenders have a lot of cash and seek home builders. They are positioned for growth and have creative programs using tools from the apartment industry. Private equity wants to own homes while lenders are prepared to fuel the growth. Today’s builders have a multitude of options.
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