In spite of the economic challenges brought on by the COVID-19 pandemic, rental housing remains a coveted asset class among investors, with demand running high in many U.S. metro areas. The need for shelter exists in any economy, making real estate investing a virtually recession-proof endeavor. Specifically, the build-to-rent (BTR) segment of the real estate sector has emerged as one of the strongest since the pandemic started in early 2020. But what exactly is the build-to-rent sector and where can investors benefit the most from this burgeoning asset class?
Even before the coronavirus impacted every facet of society, the BTR trend tapped into a unique housing need wherein renters started searching for more family-friendly neighborhoods with more outdoor living space and more square footage inside their homes. BTR properties arguably flourished during the pandemic as more Americans left their small apartment units and condos in densely populated urban centers for safer, socially-distant properties in more sparsely populated suburban locations.
According to Forbes, while multifamily housing has been the standard for renters, new data indicates a trend toward families moving to the suburbs seeking single-family residences to rent. In fact, John Burns Real Estate Consulting found in its Single-Family Rental Analysis and Forecast that as of September 2020, rent growth increased 3.8 percent for new leases. It’s clear that demand for BTR properties is here to stay.
Defining the Build-to-Rent (BTR) sector
Build-to-rent is a purpose-built development of residential property designed to be used as rental homes instead of for-sale homes. Similarly, in commercial real estate, BTS or build-to-suit, describes a purpose-built property that a commercial tenant, such as an office user, develops for that office user’s specific needs. The office building tenant then leases the space from the BTS developer.
In short, a development partner purchases land and provides a BTS facility specific to the consumer. The end user rarely owns the property, but they maintain it while they rent, paying all the bills, taxes and other expenses related to the property. Typically, the tenant pays a premium for having a facility that meets their standards and needs.
Build-to-rent follows a similar model as BTS, but the BTR community generally markets to a specific lifestyle type. Renters with families, perhaps overqualified for government-sponsored financing like FHA loans, but unable to amass the hefty down payment required by most banks, are turning to BTR to find homes in neighborhoods that offer an appealing lifestyle with upscale amenities.
Master-planned BTR communities appeal to a wide range of renters, depending on geographic location. For example, many communities in Arizona, where single-family rentals are up nearly 7 percent in Phoenix, according to JBREC, cater to active adult lifestyles to entice retirees. Other BTR communities boast excellent school districts or well-appointed amenity centers with swimming pools, tennis courts and other perks.
What factors should be considered when investing in a BTR property?
Location, lifestyle, and community are the biggest factors when considering a successful BTR portfolio. Location is rated as the top factor influencing rents in a recent John Burns poll, and these factors should be taken into consideration 20 years into the future from an underwriting perspective. Additionally, savvy BTR investors develop property that appeals to the millennial demographic. The Census Bureau estimates that 65 percent of Americans under the age of 35 rent their homes, instead of own them.
According to a study on millennial homeownership by the Urban Institute, the homeownership rate of those aged 25 to 34 is only 37 percent, which is 8 percent lower than the homeownership rates of Gen Xers and Baby Boomers at the same age. Many millennials still have college debt, are tired of living in an apartment, but still want access to a vibrant community and the amenities that they provide, so a BTR property is the perfect solution. These data points demonstrate that demand for renting newly constructed single-family homes, or BTR units, will remain strong for years to come.
The benefits of living in BTR vs. existing SFR
For many decades, the single-family rental market has been dominated by owners who were unable to sell their homes. Homeowners, after frustratingly long days on the market, become weary of continued maintenance costs and fearful of an unoccupied home. Those homeowners often decide to turn their homes into rentals. As the demand for single-family rentals (SFR) increases, homeowners are finding strong rentals in their areas, leading some to turn their homes into income properties.
According to many news sources, demand remains strong for BTR homes, even when the rental cannot "check all the boxes." In addition, many metro markets are experiencing unprecedented shortages in single-family inventory. According to Westword, bidding wars have ensued in markets all over the U.S., with some dubbing the demand as panic-buying real estate. Those wishing to enter the single-family home market as investors are finding market entry extremely cost-prohibitive, and the returns are negligible.
In terms of features, BTR homes tend to focus on smart space, not necessarily more space. In addition, the COVID-19 pandemic has shifted renters away from seeking shared spaces, like garages and hallways, so finding a single-family rental that checks all the boxes has become possible. No longer is availability dominated by whatever leftover homes are in the area. Instead, renters can, and are, driving demand for the single-family market.
BTR appeals to institutional investors, making the asset class more valuable
Resort-style multifamily properties were popular among renters in the early 2000s, before the Great Recession and subprime mortgage crisis. Build-for-rent properties are rapidly replacing high-end multifamily units in terms of popularity among renters today. The same applies to BTR investors. Cap rates for BTR assets have tightened as institutional investors continue to identify the vast potential for growth of this sector. BTR is the buzzword these days and everyone wants a piece of the pie. Pricing for these assets has become more accurate as investors understand how much capital is required to develop these communities. Furthermore, low interest rates aid the sector, making it easy for investors to acquire debt financing.
The Southwest is poised to benefit from new rental homes
Based on research conducted by Atlas Real Estate, the Southwest is a hotbed for BTR construction, with Phoenix being the epicenter for all BTR communities. Salt Lake City, Boise, Idaho and Reno, Nev. also feature demographics that appeal to many institutional and private BTR investors alike. The high cost of living in places like Seattle, San Francisco and Los Angeles has prompted suburban flight to these less-expensive cities where people have more living space, backyard/outdoor areas and feel like they belong to a community, which is almost always part of a new BTR development.
Savvy investors should avoid developing BTR product in metro areas where home prices are affordable. For instance, smaller towns where people do not rent much are not good candidates for BTR developments.
Economic forces make now an opportune time for BTR investing
While the data is persuasive that build-to-rent communities are growing opportunities, many investors wonder just how their dollars go further with BTR than the traditional single-family rental margin. In short, BTR builds value on the front-end versus waiting for the real estate to appreciate and sell later. Investing in BTR communities means that developers and contractors can readily source materials and subcontractors, giving them pricing power, which is passed on to investors.
Although the pandemic has impacted the economy and investment activity, real estate remains a smart investment option, especially for build-to-rent properties. As the second quarter approaches, investing in promising BTR investment opportunities in growing metro areas of the U.S., such as the Southwest, is a good place to start.
Vincent Deorio serves as vice president of corporate development at Atlas Real Estate, a full-service real estate company specializing in investment brokerage, property management and institutional acquisition.