By Joe Bousquin
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Why single-family lease-ups are quickly becoming the new starter homes.
For years, single-family home builders have lamented that they can’t build affordable, first-time starter homes and still make a profit.
That started to change in 2019, when, after-sales of luxury and move-up homes dwindled in 2018, builders such as Meritage, Lennar, and KB Home followed the lead of D.R. Horton’s Express brand and pivoted toward the entry-level product. The surprising part was they were even able to make money doing it.
But then the COVID-19 pandemic, and the resulting flight of people wanting to move out of urban areas to less densely populated suburbs, hit in 2020.
The result was that after dipping to nearly $300,000 in mid-2019, the median sales price of a new home in the U.S. in June rose back up to $341,100, just $2,300 off its all-time high reached in November 2017. To afford that home’s traditional 20% down payment of $68,220, a household earning the median income in the U.S. would need to save about a year’s worth of salary.
With a sudden surge in demand, new-home builders started hoarding inventory in the third quarter of 2020 to ensure they still had something to sell as prices continued to rise.
“Builders are actually holding on to that product because it’s selling so fast and they’re releasing fewer units,” says Tim Sullivan, senior managing principal at real estate consultancy Zonda. “There’s really a push-me, pull-you dynamic going on where the supply of unsold homes, whether resale or new, is the lowest it’s ever been in many markets. Builders are looking at themselves in a mirror and saying, ‘You know, I’ve got to keep what I have because I’ve got to have something to sell.’”
Now, as traditional single-family home builders struggle once again to pump out enough for-sale homes at a lower price point, other operators are coming into the market to do it for them. Witness the rise of entrants to a new kind of starter home market and an entirely new institutional investment asset class: build-to-rent (BTR) single-family homes and horizontal apartments.
“There is a fundamental mismatch between the increasing demand for affordable, single-family homes and new supply,” says Dana Hamilton, head of real estate at New York-based Pretium Partners, a single-family rental operator that, along with Ares Management, recently acquired single-family rental REIT Front Yard in a $2.4 billion deal to grow its portfolio to 55,000 units. The company says 5% of its portfolio now comprises build-to-rent homes. “BTR is one of the ways that the market is responding to increased demand for single-family rentals.”
Single-Family Rental Growth
According to the Harvard Joint Center for Housing Studies’ Rental Housing 2020 report, the number of all single-family rentals—both previously existing homes and new build-to-rent units—grew 18% from 2008 to 2018 to 15.5 million units or about a third of all rental units nationally.
That growth was spurred in large part during the Great Recession, when institutional investors swept in to buy existing, foreclosed single-family homes in bulk on the cheap and began to rent them out at attractive yields. But when home prices recovered, it became more challenging to find enough homes at easy returns. Maintenance issues with older housing stock, as well as the hurdles of operating multiple units across different geographies, led those early single-family rental firms to explore building entire communities of new homes, and the build-to-rent boom was born.
Look at Agoura Hills, California–based American Homes 4 Rent. Launched in 2012 by Public Storage founder B. Wayne Hughes to snap up cheap single-family homes and convert them into rentals, the firm now operates a portfolio of 53,229 units in 22 states and boasts more than $1.14 billion in revenues. In 2017, the company launched AMH Development, the firm’s internal home building arm, to provide newly constructed single-family homes to its portfolio.
Since then, the company has opened nearly 60 communities across 15 markets, building on a pace to deliver 1,500 to 1,600 homes in 2020.
“I think people in the industry would be shocked to learn there’s a new top 40 builders in the United States, and that it’s us, the rental home guys,” says Brent Landry, senior vice president of development at American Homes 4 Rent who joined the company in 2019 after 15 years at Pulte. “We are quickly closing in on that kind of volume.”
In addition to American Homes 4 Rent, other single-family rental operators that grew up acquiring foreclosures during the recession, such as Invitation Homes and Progress Residential, have also forged into the BTR space.
A raft of other firms, including Tricor Homes, NexMetro with its Avilla Homes brand, and AHV Communities, are focusing almost solely on purpose-built rental homes.
For-Sale Builders Piling Into BTR
Traditional single-family home builders have jumped into the fray, too, with Taylor Morrison building single-family rental units for Christopher Todd Communities in the Phoenix metro area, and Toll Brothers partnering with real estate investors Matt and Sam Blank to take downland and provide design and construction to BB Living.
Lennar, LGI, and Meritage all have a foot in the BTR game, and D.R. Horton, which has pushed into the multifamily space in recent years, said it’s doubling down on single-family rentals during its fourth-quarter earnings call.
“We are also continuing to evaluate our opportunities in the single-family rental home market,” said Michael J. Murray, D.R. Horton’s chief operation officer, on the call. “During fiscal 2020, several of our home building divisions began constructing and leasing homes to the single-family rental properties. On Sept. 30, 2020, our home building fixed assets included $87.2 million related to our single-family rental platform, representing 10 communities totaling 740 single-family rental homes in finished lots, of which 440 of these homes are complete. After each of these rental communities is constructed and achieves a stabilized level of leased occupancy, we expect to market and sell the entire community. We expect our total investment in our single and multifamily rental platforms to more than double by the end of fiscal 2021.”
Multifamily Players Make Moves
Middleburg Communities, a fully integrated multifamily development, investment, construction, and management company, launched The Hamlet in September to satisfy the growing demand for single-family rental properties in high-growth Southeastern markets, including Charlotte and Raleigh, North Carolina; Charleston, South Carolina; Jacksonville, Florida; Nashville, Tennessee; and Richmond, Virginia.
“Industry research as well as our internal proprietary studies make a compelling case for single-family rentals, with strong and unmet demand due to a lack of product,” notes Patrick Lynch, Middleburg’s vice president for research. “Our communities will tap proven design models with backyards and privacy that provide the consumer with the best of the single-family rental product with apartment- like amenities and a maintenance-free lifestyle.”
At the Multifamily Executive Conference in October, both Mill Creek Residential, which ranked No. 8 on the National Multifamily Housing Council’s top builders list and No. 6 on the top developers list in 2020, and Continental Properties, No. 15 on the top developer's list, said they would be entering the single-family BTR market this year.
Mill Creek Residential formed a division in mid-2020 to focus on the single-family rental market. “It’s a market that has just taken off,” says Samuel Simone, senior managing director at Mill Creek Residential. “We’re going to be focused on that largely in Southeast and Southwest high-growth markets. We expect to start our first communities in early 2021.”
Continental Properties also has been working on the product type for about a year, says CEO James Schloemer, adding that the firm hopes to roll out its first communities by the end of the second quarter.
COVID-19 ‘Poured Gasoline on BTR’s Fire
Brent Gibadlo, vice president of operations at the 5,000-acre, mixed-use, master-planned community Nexton in Summerville, South Carolina, which includes 282 BTR single-family homes in its initial phase, captures the tenor of the moment succinctly.
“Build-to-rent is hot,” says Gibadlo, who vetted several BTR builders at Nexton before kicking off the community’s plans. “A wide range of developers and operators are moving into the space.”
Given the COVID-19 pandemic and the resulting race for space as people have left densely populated cities, that momentum has only gotten more intense in 2020.
“Prior to COVID, we were leasing our new homes and our overall portfolio extremely well,” says Zack Johnson, executive vice president of acquisitions and development at American Homes 4 Rent. “COVID has just poured gasoline on the fire and has really driven folks from the urban areas to the suburbs.” Case in point: On its third-quarter conference call, the firm reported its occupancy was at 97.5%, an enviable benchmark for any rental operator.
The number of single-family BTR homes posted a year-over-year increase for the third quarter of 2020. According to NAHB’s analysis of Census Bureau data, there were roughly 14,000 single-family BTR starts during the third quarter of 2020. Over the last four quarters, 42,000 such homes began construction, while the Urban Institute pegs the broader single-family rentals category—which also includes existing homes—as the fastest-growing segment of the U.S. housing market.
The Factors Driving BTR’s Growth
Why it’s happening ties back into many of the same reasons that fueled multifamily investment’s rocket ride since the end of the Great Recession. Millennials are still saddled with student loan debt and have gotten older, which means they’re seeking more space to spread out in with their families and pets, but often still can’t afford the down payment for a new home.
Then, there’s the endemic challenge for home builders to pump out enough entry-level for-sale homes in the first place—as the rebound in the median new-home price in 2020 shows. That has been coupled with the demand from the “renters-by-choice” cohort of millennials, Gen Xers, and downsizing baby boomers who don’t want the maintenance or obligations of owning, but who also don’t want the shared walls, corridors, and limited private outdoor space of your typical five-over-one apartment community. Finally, the pandemic arrived to conspire with all of those forces to spur city dwellers to flee toward the suburbs and the increased space they provide to create distance from their fellow human beings.
“The single-family BTR demographic is the more mature demographic currently living in rental housing,” says Blake Okland, vice chairman and head of multifamily investment sales at New York-based Newmark Group. “They’re seeking good schools, extra space for a home office, and reasonable proximity to employment centers.”
The suburbs are precisely where build-to-rent single-family rental housing works best. While the BTR movement essentially started in Phoenix, it has now spread across the Sunbelt to pop up in those locales where land can still be gotten on the cheap, relatively, but which also are in close proximity to an abundance of jobs.
“Growth of the single-family BTR market is determined by an area’s availability of large tracts of land at more affordable price points, economic growth, and relocations of upwardly mobile demographics,” says Okland says. “It’s growing in the Southwest, Southeast, West Coast, and Sunbelt markets.”
Getting enough cheap land is crucial to making BTR communities work. The reason why, of course, is that, unlike for-sale prices, there’s an upper limit to how much BTR residents are willing to pay. The sweet spot, observers say, is building homes that can rent out for somewhere between $1,600 and $2,000, or $2,500 at the higher end, and still pencil out, while providing a stand-alone home for families that’s more affordable than the combined payment of a mortgage, tax, and insurance that residents would have to shell out, in addition to a down payment, if they bought.
“To oversimplify the markets where build-to-rent works best, it’s in the lower-priced markets with lower-priced land and lower-priced homes,” says Sullivan. “Housing is a monthly payment business, and people look at what they can qualify for, whether it’s to rent or to own. So it’s much more difficult to find these opportunities in coastal markets, but as you move to the center part of the country, in Texas, the Carolinas, Florida, Arizona, I think that’s where the long-term opportunities are because of the relative affordability and the relationship of monthly payment to incomes.”
Targeting the Missing Middle as BTR Residents
For Jim Jacobi, a developer who recently launched Alpharetta, Georgia–based Parkland Residential to focus on building entire BTR communities, targeting those residents who have a good income, but not an extremely high one, is the key to making BTR work.
“BTR is best suited for households making less than $100,000 annually because they typically have the longest occupancy duration,” Jacobi says, with the best BTR single-family product coming in at less than 2,000 square feet.
The reason why that type of resident is a great target demographic and product type for BTR developers is simple: It helps qualify more people to rent out the homes, who often have longer rental tenure than more upwardly mobile workers.
“More people can afford a lower monthly payment,” Sullivan says. “It’s a self-selecting demographic.”
American Homes 4 Rent’s average lease comes in right around $1,700, and ranges up to about $1,850 for the newest homes in its portfolio, according to Landry.
“We’re offering people brand-new product at a sub-$2,000 cost per month,” Landry says. “That’s not been easy for most production builders to execute against. They’re fine at the $2,500 to $3,000 range. But if you look at it how customers are looking at it, there are not a lot of good choices if your total budget is $1,850 a month. And I think consumers are telling us that.”
Single-Family BTR Challenges
There’s also a small, but important, distinction to remember when talking about single-family BTR homes versus so-called horizontal apartments. While single-family BTR homes and neighborhoods basically look and feel the same as for-sale products, horizontal apartments are more akin to stand-alone cottages and duplexes where there may be shared interior walls, but no second floors, or upstairs neighbors.
And while single-family built-to-rent is typically zoned and platted the same as for-sale communities with individual lots, horizontal apartments are typically on a single plat.
“The biggest difference is the in-tracks, and the way you set up what’s underground, your electricity, sewer, and everything else,” says Sullivan. “It’s much more akin to a multifamily product than it is single-family because it’s higher density. So, you know, some builders haven’t had that experience yet, but I think the secret’s out that that’s one of the biggest challenges.”
Challenges also can be found in terms of zoning and entitlement, and the NIMBYism that’s encountered in trying to push any development through in some communities, where there can often be more pushback against rental homes than those that are built for sale.
“Sometimes, developers get cute and try to tell the municipality they’re building townhomes with individual tax IDs, but then choose to rent them,” says Brett Forman, executive managing director in the Palm Beach, Florida, office of private commercial mortgage lender Trez Capital, which has underwritten several BTR projects. “And when a lender such as ourselves goes to seek a zoning opinion from the municipality that they don’t mind that it’s a rental, all of a sudden the local board says, ‘Wait a minute, we didn’t think you were going to rent product, we thought you were going to sell.’ At that point, you’ve got three sides to the story.”
In terms of financing, the options are also multilayered, and can work the same as a typical for-sale development, but may also include more multifamily components as well.
“The capital stack is all over the place,” says Sullivan. “There’s debt and equity that are paying attention to this. On the debt side, it’s often a commercial bank that’s local, and from the equity side, there are basically investment banks or private equity that are circling the space. But they typically want to be part of the operating company. They just don’t want to be just part of the financial team.”
A Durable Product
In terms of what goes into the product, builders and developers say it’s all about designing these homes for the long haul, with finishes that require little or no maintenance.
“The design of the houses themselves isn’t noticeably different from for-sale homes, but the better BTR homes are built with long-term maintenance in mind,” says Jacobi. “Our homes have no carpet, we use luxury vinyl tile flooring instead. In the kitchens, we use laminate-wrapped cabinets instead of the typical painted or stained wood cabinets that are in most for-sale homes. It is more expensive to install, but it will cost us less in the long run.”
Getting it right on the front end—and keeping costs low by putting in the same finishes in all units to gain efficiencies of scale—will also influence how a community pencils out down the line.
“If you take someone that has built single-family tract homes, and all of a sudden they’re trying to convert that experience into single-family build-to-rent, there are challenges because you’re not building a single-family home to sell,” says Forman. “For the rental, you really have to keep your costs in line.”
Landry says the details and finishes are really what set BTR single-family homes apart from those for sale.
“We put composite decks on the back of our homes,” says Landry, as an example of the types of materials American Homes 4 Rent chooses in its new product. “We always ask ourselves, ‘Is it desirable, is it durable, and is it efficient?’ It has to be all three, because we’re not building these homes for anybody else. We’re building them for ourselves, and the plan is to operate them for 10 to 15 years or more.”
Of course, for traditional for-sale single-family home builders, making those kinds of tweaks to designs and finish materials in markets where it makes sense is a relatively easy pivot. And when they do, they’re currently seeing a huge market to pump out entire communities of BTR homes, known as dedicated rental communities, with willing buyers, much as D.R. Horton outlined on its earnings call.
“One reason we see the dedicated rental community space growing is not only the substantial demand for the rental home, but because home builders view it as another sales channel,” says Sudha Reddy, founder of El Segundo, California–based Haven Realty Capital, which recently announced a $133.7 million acquisition of six dedicated rental communities in the Atlanta area from ResiBuilt. “Groups like Haven are able to offer competitive prices to builders who are able to sell in one transaction to an investor instead of selling individually to homeowners, which takes longer and carries more risk. Home builders build more projects than they normally would in a given submarket without cannibalizing potential for-sale buyers. It’s a win-win.”
The Choice: Build For Sale or For Rent?
Of course, many home builders pivoted to that eager, easy sales channel when buyers became relatively scarce going into late 2018. But now, with demand overheating in many markets, driving home prices back up to where builders can make good margins again, selling a high volume of homes at cheaper prices isn’t as desirable today.
“Conceptually, the builders get it, and they like the idea,” Sullivan says. “But right now, supply chains are jagged because of COVID, which is impacting the capability of bringing homes to the market. So, if you have homes that are about to be released, that’s platinum, and the builders are less likely to release those to the single-family investment community because they can optimize the sale.”
For that reason, it’s really in the land arena that for-sale builders and BTR community developers are most likely to run into each other, at least for the time being.
“It’s going to be fascinating to watch this space in the post-COVID time frame because of the upward pressure in rents, home prices, and land prices,” Sullivan says. “It will be increasingly difficult for all home builders, land developers, and the people in the BTR space to make deals pencil. And it’ll be fascinating to see how the creative minds deal with that going forward.”
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