Build to Rent
The newest trend in SFR presents a big opportunity for builders and investors
Ah, that new-house smell. Fresh paint, flawless floors and brand-new appliances just waiting for homebuyers to do their final walk through. Except that the first occupants of some new homes aren’t owners at all — they’re renters. And they already know their landlord since he’s the builder.
The glory days for investors where they could cheaply buy a home in foreclosure and fix it up are at their end. From 2008 to 2012 foreclosures hit record levels, but now that the foreclosure crisis is over, investors must find a new way to adapt to the evolving market.
That market includes soaring home prices according to a recent study by the National Association of Realtors, which shows that many metropolitan areas hit new highs in 2016. These conditions can make it difficult for investors to find profitable areas to invest in.
A growing trend within the real estate market, build-to-rent, seems to offer a clever solution. While this phenomena has been growing quietly for several years, it wasn’t until recently that it started to pick up steam.
One expert, HomesUSA.com President Ben Caballero, explained that he had never heard of builders renting out their inventory, but noticed the shift in the past year.
Some builders even left the sales market entirely, focusing solely on constructing rentals, said Caballero, whose company assists builders in marketing their sales and rental listings to Realtors through the Multiple Listing System.
Build-to-rent allows investors to buy newly built homes and rent them out instead of selling them. Because the homes are new,investors are able to charge higher rent prices and tenants often stay in the home for longer periods of time.
“In the SFR business, our clients are building large portfolios of rental properties,” said Greg Rand, CEO of OwnAmerica, a single-family rental investment brokerage. “And as it pertains to new home sales, one of the things that has arisen in the past two years is the build-to-rent trend, builders that are building single-family homes intentionally to create rentals out of them.”
Building homes to rent them out used to be thought of as just a niche, Rand explained. Now, however, it is being thought of as a substantial market segment.
And Caballero explained why builders could be choosing to rent out their new homes rather than sell them.
“I think it’s probably just the philosophy of taking advantage of the market escalation,” he said. “It might be a situation where they have inventory that they wanted to get off the market, and they might be able to lease something better than they can sell it.”
But the question remains: Why would builders move into the rental market during a time when homes are selling quickly and at higher prices than any time in the past decade? Rand said he understands why more builders are investing in build-to-rent.
“Builders — their life is a treadmill. They do a subdivision, they buy the land, they get the approvals, they build the properties, they sell the properties and when they’re done they’re out,” he said. “They’ve made their profit, if things go well they made a lot of profit, but they’re out and they have to go back on the treadmill and find another project.”
Really good builders have a pipeline of projects they are always lining up, however it is a never-ending process where if the builders can’t find something else to construct, it creates a problem — their employees and capital are still tied up in their business.
“Creating continuity for a builder is very hard, so a lot of them are getting excited about the idea of building and holding, which I had never heard of before except for in commercial real estate,” Rand explained. “Build a subdivision or buy a bunch of lots in a scattering of subdivisions and instead of building houses on them and selling them to homebuyers, they’re building houses on them and renting them to tenants and keeping them, which gives them the ability to create longer-lasting shareholder value by building a mountain of cash flow over time as opposed to just holding until they can equal the gap. That trend is really taking hold.”
But that’s not the only way builders are profiting from the growing build-to-rent trend. Rand said that all his clients looking at portfolios of rentals want to buy new if they can. This means that builders who construct a 25-unit subdivision are often able to sell the entire division to just one buyer, eliminating the cost and time of searching for multiple buyers.
“If they build and they want to hold, they could create the shareholder value over time,” Rand said. “If they build and they want to sell, they could sell the entire neighborhood in one transaction. It’s a very interesting twist.”
But why would investors want to rent out new properties instead of older ones? One real estate investment company, JWB Real Estate Capital, gives these reasons:
A house that is freshly built has a lot of money-saving advantages for investors. The property insurance is often less expense each year due to condition of the home. More insurance companies are offering lower annual costs for homeowner’s insurance to owners of new properties versus older homes.
Because many older homes have aged appliances, replacements will likely be necessary for a new investor. These costs are now always figured into the future goals of investors and can decrease passive income. A home that was recently constructed can often demand a higher rent price because of the age and location. Being the first investor on the market to own a home before it is deteriorated could secure a buy-and-hold future.
JWB also explained that the age of a home is a significant factor in whether renters will sign a long-term lease agreement. Because older homes experience faster rates of deterioration, renters grow tired of continuous issues, issues that would not be present in a new home.
And finally, JWB points out that the land value of a property increases over time, which means investors might have to pay more for an existing home. This would then lengthen the time required to earn back the money put in for the initial investment.
But despite these seemingly obvious upsides to renting out new homes instead of existing homes, rental prices for these new homes are still affordable, perhaps emphasizing their attractiveness.
“It’s surprisingly to me, the rents are not really that significantly different,” Caballero said. “I think that their rentals are really quite competitive. I’m not sure that they’re not leaving money on the table to be honest with you.”