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This week we’re going to discuss a real estate sector which has long been of interest to us, the so-called “build-to-rent single family rental (“BTR-SFR”) sector. In fact, in one of our CEO’s most recent newsletters, we alluded to an investment opportunity which we have been studying in such a sector.
Now is the time to tell you more about why investment into the BTR-SFR is so compelling, so kindly read on….
Some background to our interest in the build-to-rent single family rental sector
Some eight months ago, our CSO wrote a newsletter about the BTR-SFR asset class, a sector of the real estate market which has significant appeal and which we have been carefully monitoring for some time. Indeed, it’s not just us, as we have seen large institutional investors such as Blackstone invest in or acquire BTR-SFR projects over the last few years.
There is one particular project which we have identified which we are still critically examining. However, we wanted to share with our current and potential future investors some of the reasons why we believe investment in the BTR-SFR sector is right at this time.
At this point, it’s worth restating that we are not only a firm which invests in multi-family assets, nor are we limited to investing in one asset class—it really depends on where the best returns can be achieved and where we are at in the real estate cycle. So, we need to be always actively looking at new opportunities across the real estate spectrum, yet still adhering to our core investment strategy,
Build-to-rent real estate investment
BTR as an asset class
BTR refers to purpose-built housing designed and operated for rent rather than for sale. It can comprise multi-family accommodation or single family rental residences (“SFR”). Such projects usually offer agreements and are invariably professionally managed by the primary investor or operator. In many cases such operators provide a wider range of occupier based series or amenities than just renting space.
Build-to-rent single family rentals is an already proven concept
BTR-SFR is well beyond its initial concept phases, with the business model having been successfully operating for a number of years. Whilst the model didn’t originate due to the pandemic, this was one catalyst which brought build to rent into more focus and caused demand to increase dramatically.
Being a well-established real estate investment sector, detailed operational data is readily available, enabling investors to make more qualified decisions.
Key demand drivers are positive
There are several key reasons for the surge in demand for built-to-rent properties. One important one of which was that restrictions associated with the pandemic boosted demand for better, larger space for remote working and/or learning. BTR-SFR communities fitted the bill well and offered far more flexible and affordable options compared to buying a new home.
As a result there was significant migration away from dense urban cores to smaller cities and suburbs where single family residences are more likely to be found.
Having said this, it’s really been national, longer-term, demographic shifts which have been the key driver.
Firstly, there is ongoing from demand from millennials (comprising over some 72 million people)—people who either through a lifestyle choice prefer to rent (able to be nearer city or urban areas without the expense of owing, or flexibility in case they travel with their jobs or have no fixed employment base—ie “digital nomads”); or simply cannot afford to buy as are still carrying heavy student or credit card debt and/or don’t have enough savings for a home purchase deposit or yet earn enough to make mortgage repayments.
It’s important to note that people aged 25 to 44 comprise about 48% of renters in the build to rent sector, and earn an average of about $100,000 in annual income.
Add to this, the huge growth in demand for BTR-SFR from retirees (the “silver tsunami”), people who have cashed out from their own homes, have cash to spend, and want to enjoy their retirement by being able to travel without the burdens of home ownership.
Popularity of renting has been increasing
Over the last 15 years, the percentage of renters has been rising in the United States. For reasons outlined above, many millennials are not financially ready for homeownership.
The BTR-SFR market is, therefore, likely to remain popular amongst millennials, ageing baby boomers and remote workers over the foreseeable future, with such strong demand drivers. Add to this an overall undersupply of rental homes and it means that there is a clear gap which build to rent can successfully fill.
Rising interest rates increase cost of ownership
As interest rates continue to creep higher, meaning that the costs of mortgage repayments increase, this will slow single-family sales and keep would-be buyers priced out of the single-family market. They will have to stay in the renter pool, thereby supporting demand
Until recently, it was fair to say that many BTR-SFR customers were renters by choice, but now it is often by necessity. The average monthly 30-year fixed mortgage payment for a newly constructed home was up 82% from $1,382 in February 2020 to $2,514 in April 2022. More than ever, therefore, these high costs are material in the rental decision. given also that renting such property provides a tenant with most of the pros of being a homeowner without the illiquidity and high costs.
Falling home ownership rates
Whilst many millennials aspire to own a home at some point in their lives (some estimates say nearly 90%) but, with median home prices currently at all-time highs and high student debt, homeownership is a major challenge. After falling to an all-time low of 62.9% in the US in 2016, this percentage recovered to 65.5%% in 2021, but is still below the 69.2% recorded in 2004.
Market growth potential
Overall, there is still plenty of room for the BTR-SFR sector to grow and it is expected that such homes will form a double-digit share of new construction by 2024, compared to only 6% in 2022.
Turnover of tenants is often lower
As many build to rent properties are located in favoured neighbourhoods or in new communities, with good access to nearby amenities (good schools, shopping, places of business, entertainment, public parks, etc), many residents stay for the long-term and renew their leases multiple times over the years, especially when the property has good quality property management.
Amount of new development of BTR-SFR properties is relatively small
Many developers see build to rent as an opportunity to capitalise on the strong fundamentals, reliability and performance of traditional single-family rentals, yet BTR SFRs currently make up only about every one in ten of planned new builds.
According to recent data, a record 7,724 build to rent units were completed in 2021, with another 13,981 expected in 2022 for a total of some 45,800 units built since 2000. In all there are estimated to be only around 90,000 existing single-family homes specifically designed for renting in the US in nearly 720 communities.
Given that there are estimated to be over 72 million millennials, a high proportion of whom will not be able to afford to buy a home, as well as thousands of retirees joining the rental market every year, the new supply figures are not major.
In fact, the housing shortage, as well as the long-term demographic drivers mentioned above are expected to continue to push demand and rents higher, estimated at 4% to 8% in 2022 alone.
In summary, there’s little doubt that build to rent is one of the fastest-growing sectors of the housing market and a trending topic in real estate. Indeed, according to a recent survey of 3,300 renters, some 78% of respondents said they were interested in living in a community of single-family homes.
BTR-SFR are a favoured rental option
For many tenants, BTR-SFR type properties have become a favoured option. Apart from the reasons outlined above, many really prefer this type of product which has been described as both “the new starter home in the suburbs” or as “changing the American Dream”. Many couples already with children and a desire to live in the suburbs are just some of the top factors driving the trend in popular locations such as Dallas, Phoenix or Columbus.
In addition, the BTR-SFR model has steadily gained popularity in Sunbelt markets which tend to be more affordable.
Designs can be optimised for renters and also developers
For renters: SFR offers the best of space and privacy, a single-family lifestyle most close to that of a homeownership experience. Generally, properties are well sized and attract both downsizing empty-nesters and families with children.
There are, typically, two distinct product types currently dominating the market, and the demographics to which they appeal. First there is the smaller, 1-storey homes on a single property, being more like a traditional apartment community and appealing more to younger millennials and downsizing retirees.
On the other hand, there are larger, 2-storey homes which can be built on individual lots like a typical subdivision, will attract more of a home buyer demographic, particularly families as many consumers have a strong desire to move beyond apartment living and have separate walls and no one living above or below them; even a yard is a huge driving factor.
For many developers, having both product types allows them to cover both types of customers but can also supplement their home sales business with many renters becoming buyers over time.
In terms of key amenities, just as with a traditional single-family home buyer, renters are looking for space, flexibility and desire to be part of a community, but also a degree of fit-and-finish that goes beyond the basics of a starter home.
This will include smart-home technology, stainless steel appliances, upgraded cabinets, quartz countertops, and attractive fixtures as well as modern colour palettes and exterior architectural styles
For developers/investors: the BTR-SFR product is still evolving and developers and investors are getting smarter about demand trends. There is an apparent shift in development to master planned mixed communities with a variety of rental (and also buy) options and not just single stand-alone projects.
BTR-SFR is an alternative way to diversify a portfolio for both passive and institutional investors, but not necessarily a replacement for other forms of master planned communities (“MPC”). However, one key advantage for developers is that lot size is a bigger issue for buyers than renters. Developers can provide greater density in build to rent projects and gain better returns on land acquisition costs without a detrimental effect on marketing and sales.
Any extra land can be used for amenities such as swimming pools, walking trails, recreational centres and more, all making the community more valuable to residents and justifying higher rents.
Furthermore, developers can expect that many tenants of BTR-SFR projects eventually move on to purchase houses of their own and, therefore, a good mix of different assets within projects can help provide future revenue opportunities with anticipatory planning.
Apart from the aforementioned advantages, there are other key factors which need to be discussed, and some of these are as follows:
Build to rent is a “Resilient Asset Class”
Over the years, BTR-SFR has proven to be a so-called “Resilient Asset Class”: This means that it is one of those asset classes within real estate which maintain strong end-user demand even in times of economic downturns or market volatility.
Such resilient assets are favoured by investors as they may help reduce risk and keep the income from an investment relatively stable, by weathering down markets yet still achieving steady long-term growth. Multi-family real estate is another example of a resilient asset class.
Despite economic uncertainties as a result of the pandemic multi-family rents and occupancy levels have generally remained steady or increased, whereas the performance of other asset classes, such as offices or shopping centres, have seen decreases in cashflows and some volatility.
Obviously, people still need somewhere to live and the BTR-SFR sector has been a major beneficiary of strong renter demand. Yet, this resilience goes back further than the recent pandemic
BTR-SFR resilience during the Great Recession
Whilst it’s not possible to predict with certainty how investments in BTR-SFR will perform should there be another recession in the future, it is possible to review the performance of the asset class during the Great Recession of 2008-2010.
Even though, for decades, single-family residence rental properties have existed alongside owner-occupied homes, major institutional investors have largely ignored the asset class. It was previously seen as inefficient and presenting certain logistical challenges, with investors preferring to focus on assets such as high-rise residential buildings and garden-style apartments.
During the Great Recession, however, a number of investors took note of the price dislocation caused by a wave of foreclosures in the single-family housing market. A number of pioneering institutional SFR investors began purchasing these such properties to initially rent them, intending to sell them at increased capital values once the economy recovered.
For some investors, the strength of the SFR market was greater than expected. Indeed, as the recession forced many families to have to vacate their homes due to foreclosures, many of those same families rented SFRs as they had to transition from being homeowners to being renters. Partly as a result of this, values of single-family rental units grew by a significant 36% from 2005 to 2017, much higher than the 4.7% growth rate of owner-occupied, single-family homes..
Furthermore, the overall vacancy rate for SFRs remained stable during the Great Recession, being lower than the vacancy rate for all rental types during such time. In Q1 2006, the SFR vacancy rate was just under 10%, and it stayed that way until 2009.
BTR-SFR performance during the pandemic
The sector continued to perform well even during the toughest days of the pandemic..
There were a number of factors which contributed to such strength and these include:
- many people sought more space for remote working and/or learning and working and BTR-SFR communities offered more flexibility and affordable options compared to buying a new home;
- people wanted more privacy for social distancing;
- there was a large migration away from dense urban cores to smaller cities and suburbs where BTR-SFRs were more likely to be found.
As a result, BTR-SFR occupancy maintained an average of 95.3% in Q2 2021, the same as in Q2 2020 when the pandemic was spreading around the country. This level of occupancy is a generational high as occupancy of the BTR-SFR was under 91% in early 2010.
In addition, from May 2020 to April 2021, annualised rental growth averaged 8.1% for newly let SFR units, more than double the historical average of 3.3%. Annualised rent growth for lease renewals also saw a record high being 5.2% in April.
BTR-SFRs are well positioned for continued growth, helping the multi-family space continue its track record of resiliency throughout uncertain times.
BTR-SFR growth vs multi-family growth
Since early 2017, BTR-SFR properties have outperformed multi-family assets with the blended rent growth of such properties averaging 4.1% from 2017 to 2019. During the same period, multi-family properties showed 3.2% rent growth.
In terms of occupancy, seasonally adjusted BTR-SFR occupancy was 98% for Q3 2021, up over 210 basis points from Q3 2019. Multi-family occupancy was also a strong 96.2% for the same period—the highest occupancy in recent history for the asset class.
The narrowest gap in return between the asset sub-classes came in Q3 2021 as the multi-family market rebounded from the pandemic and showed 8.2% blended rent growth during the quarter, while BTR product rents grew 8.6%. The widest gap between BTR and multifamily was during Q4 2020,
Even though the gap narrowed in Q3 2021 this does not mean that multi-family rental growth is catching up as it ignores the cumulative effect since the onset of the pandemic. When returns are indexed, single-family rents are up 9% or some 2% higher than the pre-pandemic figures. Conversely, even with the most recent surge in multi-family lease rates, blended rents are only 3% higher than in Q4 2019 and are actually 2% lower than pre-pandemic levels.
More institutional investors investing in the BTR-SFR sector
Over the last few years, more institutional and other major investors who have clearly studied the changing demographics and the long-term prospects of the sector in detail, have been looking to gain a greater foothold in the BTR-SFR space. This has been either through joint venture (“JV”) partnerships for new developments or buying stabilised assets.
Demand for BTR-SFR assets is likely to remain strong for the foreseeable future, and given its track record of resiliency throughout turbulent and uncertain times, institutional investment capital has many reasons to invest in this asset class.
Indeed, since the beginning of 2021, major investors have announced commitments of more than $10 billion toward development and acquisitions in the build to rent space. Such demand also is evident in sales activity and pricing trends, with some $2.3 billion of assets changing hands in the same year, more than double 2020.
In 2022, several properties are actively being marketed for sale and are expected to transact in the coming quarters.
Some developers are contemplating adjusting sales strategies
In view of a growing slowdown in sales, some traditional, for-sale home builders are looking to profitably pivot into the build to rent market, using the asset class as a “backstop” as consumer demand on the sales side slows.
One key advantage to consumers, which in turn should help sustain demand, is that BTR-SFR is a value- and service-driven component and not just a retail sales component of new projects.
The next steps
All-in-all, CPI Capital believes that now is the time to invest in the BTR-SFR sector.
We will continue to do our due diligence on the investment opportunity which we are now studying. For those investors who have worked with us previously, they will know that we are thorough but also cautious. For new potential investors you may wish to know that we constantly look at market conditions, supply demand and economic factors to support our decisions.
Even though there may be some form of economic slowdown looming, there are tremendous opportunities to make profits in these sorts of environments, and we are so confident about this opportunity that CPI as the General Partner is planning to invest 10% of the equity into the project.
Shortly, we will be providing further information about our exciting, new BTR-SFR project, as well as details about how to invest. We will also announce the time and dates for two webinars we plan to hold.
The first one will be with our leadership team discussing the case for investment into the asset and the other with the builder to discuss the development schedule costs.
For anyone wanting additional information at this stage, please feel free to contact us now.
CEO, Co-Founder CPI Capital