Within US real estate circles, all eyes are on the build-to-rent sector. Capital is pouring in, media buzz is growing—and things are just getting started. What key dynamics are driving the build-to-rent market, and why is it such a compelling investment? We’ll explore the answers here and look at ways individuals can access and evaluate investment opportunities.
WHAT ARE BUILD-TO-RENT HOMES?
Build-to-rent (BTR) homes are single-family homes developed specifically to be rented. Such homes are part of cohesive, planned communities with on-site management, leasing, and maintenance services. Generally consisting of 50 to 200 homes, many BTR communities are located in areas with good school districts and proximity to business centers.
BTR homes often offer more space and amenities than typical apartment complexes—many renters consider them a welcome, modern upgrade. Residents may enjoy private fenced patios or individual backyards, fitness or business centers, and other outdoor features, such as grilling areas, playgrounds, or dog parks. BTR communities are tailored to appeal to specific target audiences, such as older millennials searching for space to suit their growing families, retirees looking to downsize, or households in transitional life stages.
The BTR market encompasses a broad spectrum of community configurations, unit types, and home sizes. The Urban Land Institute describes three subcategories of BTR communities
Horizontal multifamily communities are fairly similar to apartments but are not stacked.
Single-family attached communities feature duplexes and townhomes. They typically provide attached garages and larger unit sizes than horizontal multifamily communities.
Single-family detached communities offer the largest homes of the three subcategories, often with three or more bedrooms.
WHAT’S DRIVING THE BUILD-TO-RENT MARKET?
Positive momentum in the BTR market is directly related to dynamic forces in the overall single-family rental asset class, where demand is booming and institutional owners are looking to grow their portfolios.
Demographic tailwinds, affordability challenges, and lifestyle preferences fuel demand for single-family rentals
As they age into their mid-30s, millions of millennials are entering their prime single-family living years. Millennial household formation rates are expected to accelerate as marriage rates climb and incomes stabilize. Some millennials will seek homeownership—but affordability will likely be a major challenge.
As home prices and mortgage rates surge, the affordability gap between owning and renting is widening. In Q1 2022, the difference between an average monthly mortgage payment and a rent obligation grew 45% compared to the prior year. As such, renting is seen as the lower-cost option in today’s market.
Lifestyle-related reasons also underpin the choice to rent, including the desire to avoid maintenance and maintain the flexibility to move. Single-family renters also say they don’t want the financial responsibilities of homeownership. These reasons often resonate with baby boomers and retirees—another important source of demand in the single-family rental market.
Institutional players seek scale
Approximately 98% of single-family rental homes are owned by small-scale investors, typically mom-and-pop operators who own three or fewer rental properties. Institutional investors—attracted to the strong underlying fundamentals of the single-family rental sector—are a small but growing part of the market.
To grow their presence in the single-family rental market, institutional players can acquire existing portfolios of homes from smaller operators and/or aggregate individual “scattered site” assets. Given the current housing market—characterized by low inventory levels and soaring prices—institutional participants are increasingly opting to grow their rental portfolios by building communities from the ground up.
|As demand for single-family rental homes surges and institutional players seek to scale their single-family rental portfolios, the build-to-rent sector is rapidly expanding.|
Build-to-rent by the numbers: Red-hot growth and ample room to run
Operators are embracing BTR to grow their portfolios
A Q4 2021 survey of single-family rental operators showed that 26% of portfolio growth came from new homes purchased from builders or new self-constructed homes, rising from 11% in Q4 2020 and up sharply from just 3% in Q3 2019.
BTR starts and market share poised to accelerate
In the next ten years, experts predict single-family housing construction will increase and a larger share of single-family starts will be BTR. Currently, an estimated 5% of new single-family housing stock is BTR. Looking forward, the proportion is expected to increase toward 7.5%. This acceleration would boost the number of new BTR homes from roughly 50,000 per year to between 100,000 and 150,000 annually.
The structural housing shortage is (still) enormous
Following decades of undersupply, the cumulative US housing inventory gap between 2001 and 2020 is estimated to total more than 5.5 million units. To fill this gap over the next decade, building would need to accelerate to a pace that is well above the current trend, increasing by more than 700,000 units per year, or 60% relative to the pace of housing construction in 2020. Said differently, even if building were to continue at the current pace—the most rapid pace in more than a decade—it would still take more than 20 years to close the 5.5-million-unit housing gap.
BTR communities are delivering much-needed supply to the market—and the runway for growth is ample, given the severity of the national housing shortage.
What makes BTR a compelling investment opportunity?
Investors poured an estimated $30 billion in debt and equity into the BTR sector in 2021, an initial surge that is expected to gain momentum in 2022 and beyond. Behind the massive inflow is a thirst for compelling risk-adjusted returns, which the BTR segment is positioned to deliver.
Several characteristics enable BTR investments to generate attractive risk-adjusted returns. First, BTR communities can be carefully crafted to deliver premium yield and margins. Projects can be reverse engineered using assumptions like market rents, tenant preferences, and demand trends, with a close focus on return drivers like cash flow and debt service. Taken together, these factors tend to produce higher net investor returns than traditional single-family rentals.
Second, BTR assets benefit from operational efficiencies and economies of scale. By concentrating a large number of holdings in fewer locations, operators can more efficiently deliver services like property management, maintenance, and leasing. Developers can create additional operational efficiencies by choosing durable finishes that require less maintenance over the long run. Building a bulk of similarly constructed homes also allows developers to achieve economies of scale with materials, appliances, and other costs that can be spread across an entire project.
Third, BTR communities can be completed in phases and pre-leased, which boosts occupancy rates and reduces the risk profile of the overall development. Lastly, BTR projects offer greater marketability for an exit than scattered-site homes.
|Build-to-rent investments can deliver compelling risk-adjusted returns driven by operational efficiencies, economies of scale, and strategic project planning—all underpinned by the strong fundamentals of the single-family rental sector.|
How can high-net-worth investors access and evaluate BTR investment opportunities?
The BTR market can be a challenging space for high-net-worth investors to access, given the intense
interest from deep-pocketed institutions positioned to quickly scoop up opportunities. That said, individuals seeking to passively invest in the BTR space have four primary options:
Crowdfunding platforms – BTR sponsors can use online crowdfunding platforms to find and engage individual investors. However, BTR deals are typically few and far between on these platforms. When they do appear, they’re often oversubscribed quickly. Plus, these investments typically represent concentrated bets on a specific BTR community and come with an additional layer of platform fees.
- Developer offerings – Individuals may be able to become limited partners in developer-led deals. These investments are often hard for individuals to access, as sourcing them is heavily dependent on relationships. Again, these investments typically represent concentrated exposure in a limited number of assets.
- Publicly traded pooled vehicles – Pooled vehicles, such as REITs, typically offer exposure to multiple BTR communities. As a result, they can offer greater diversification potential than an investment in a single BTR project, which can reduce volatility and help mitigate losses.Publicly traded pooled vehicles offer low-cost, liquid access to BTR exposure—however, because they are publicly traded, these investments typically have a high correlation to the broader equity market, meaning they may be affected by market downturns and lose value even though the underlying assets are not materially impacted.In addition, publicly traded pooled investments are often managed by large corporations, so a portion of an investor’s dollars will likely be directed toward supporting the corporate structure. Furthermore, the investment’s return profile will reflect not only the performance of the underlying BTR assets, but also the performance of the larger corporate entity.
- Private pooled vehicles – These investments offer all the potential diversification benefits of pooled vehicles but with a meaningfully lower correlation to the broader equity market thanks to their non-public status. Private pooled vehicles also have smaller corporate overhead than their large, publicly traded counterparts. As such, many individuals find that private pooled vehicles are an ideal way to invest in the BTR market.Traditionally, sourcing and access to private pooled vehicles have depended on prior relationships. However, some innovative BTR sponsors—including The Peak Group—actively seek out high-net-worth individuals as investors in their private pooled vehicles.
Evaluating BTR sponsors
The BTR market is competitive and rapidly evolving. As more players enter the space and various strategies and products go live, it becomes increasingly important for individuals to complete thorough due diligence before investing. When evaluating sponsors in the BTR space, investors would be well served to establish clear answers to the following questions:
- What is the strategy? This speaks directly to understanding the risk-return profile of the investment and sets the stage for evaluating the sponsor’s relevant experience. For example, a strategy that blends exposure to BTR communities with exposure to existing, scattered-site single-family rentals will demand unique operational dexterity and likely have a lower risk profile and higher current income than a strategy purely focused on a single BTR community. It’s also important to understand if the sponsor is developing new BTR communities itself, partnering with a home builder, or doing “bulk takedown” purchases of completed BTR homes. Each variation has its own risk-return profile.
- Does the sponsor have specialized development experience? Ideally, the sponsor has extensive experience and a consistently positive track record owning and operating single-family rental properties. If the sponsor is playing a role in development, experience in this arena is also critical, as is experience in the geographic market(s) in which the strategy is focused.
- Does the sponsor have skin in the game? Passive investors should ensure their partners’ interests are aligned with their own. Sponsor co-investment of at least 5% to 10% of each deal’s equity is considered industry standard.
1 “Low-Density Rental Housing in America,” Urban Land Institute, 2021
2Marcus & Millichap Research Services, RealPage, Inc., Freddie Mac, National Association of Realtors, April 2022. Mortgage payments based on quarterly median home price for a 30-year fixed rate mortgage, 90% LTV, taxes, insurance, and PMI.
3New Home Trends Institute by John Burns Real Estate Consulting, survey data 1Q21, published June 2021
4“Low-Density Rental Housing in America,” Urban Land Institute, 2021
5John Burns Real Estate Consulting and the National Rental Home Council, 4Q21 Single-Family Rental Market Index
6Moody’s Analytics, US Census Bureau, Harvard University Joint Center for Housing, RCLCO; as cited by RCLCO in “Build-to-Rent: The Single-Family Rental Boom”
7Rosen Consulting Group, “Housing is Critical Infrastructure: Social and Economic Benefits of Building More Housing,” June 2021; Census Bureau survey of construction, 2020
8Hunter Housing Economics, as cited by Will Parker, “Building and Renting Single-Family Homes Is Top-Performing Investment,” Wall Street Journal, November 9, 2021
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