Build-To-Rent Housing: The Demographic and Economic Drivers of Building Horizontal Communities
November 18, 2021
By Joseph Rubin
Booming Demand for Rental Homes
The build-to-rent phenomenon (sometimes called ‘built-for-rent’ and referred to in this analysis as “BTR”), the latest reflection of increased demand for single family rental homes, results from the convergence of the demographic, social, and economic trends determining where and how Americans live. Since the inception of the pandemic, most Americans have spent more time in their homes, whether owned or rented. According to Unison’s 2021 State of the American Homeowner survey, 64% of respondents said their home is more important to them now than ever before. The survey also found that 78% of Millennials feel emotionally attached to their homes, the highest percentage of all generational cohorts. If so many are so attached to their homes, the question becomes whether they prefer to rent or to buy.
Owning a home has been considered part of the American Dream, and the creation of equity in a home has often resulted in building wealth and the ability to pass assets onto the next generation. However, during the Great Financial Crisis (GFC) a dozen years ago many homeowners lost their homes, turning that dream into a nightmare. After the crisis, the homeownership rate fell from a peak of 69.2% in 2004 to 65.4% at the end of the third quarter 2021.1 Beyond the housing crisis, the drop in homeownership has been driven by changing preferences across generations as well as the soaring prices of homes, which has significant reduced affordability despite record low mortgage rates. According to the recent ULI study on Low Density Housing in America, the median home price in the U.S. is now 5.6 times the median income, compared with 4 times the median income during the generation from 1985 to 2000. The recent economic volatility caused by the pandemic and the potential for rising interest rates put ownership further out of reach for many Americans.
Since the GFC, demand for rental homes has grown. Developers responded by building millions of additional multifamily units. With some variability over the years, demand has absorbed those new units, and migration during the pandemic gave demand an additional push. RealPage reports that in the third quarter of 2021 over 250,000 new units were absorbed, a record. But part of that growth in demand has been met by the newest asset class in the real estate sector: single family rentals (SFR). Renting houses has always been a significant component of the rental business, but it had been a mom-and-pop affair. During the GFC, large institutional players started buying thousands of units out of foreclosure to fix up and rent rather than sell. At the time it was unclear if a portfolio of rentals could be efficiently managed over a dispersed geographic region; however, the last decade has proven the success of the strategy. Since the start of the pandemic, SFR has outperformed traditional multifamily in both rental growth and occupancy.
The Growth of SFR: Real Estate’s Newest Asset Class
A driver of SFR demand has been the combination of high home prices and the increasing size and preferences of renting households. Importantly, as the Millennial generation moves into their peak child-bearing years, the number of families renting homes has increased. The Census found that families with children make up 29% of renting households but just 26% of owning households. ULI’s Family Rental Housing Study in 2020 noted that traditional rental units were not designed for families and average unit sizes have shrunk during the past 20 years. The study also found that families want suburban living with good schools and community amenities. The Harvard Joint Center for Housing Studies – Rental Housing Report 2020 found that the profile of renting has changed, with more married, college educated, and higher income households in the rental pool. Larger households want more bedrooms and living areas than typical multifamily communities provide, as well as a garage, basement, and back yard. All these trends have led to increasing demand for SFR housing, and SFR homes now account for about a third of all rental units in America.
The largest issue for the SFR industry is continued scalability. At its inception, large players such as Invitation Homes and American Homes 4 Rent rapidly bought homes in large numbers from banks to amass their portfolios. Today, accumulating homes one at a time is highly inefficient. The answer is to build a community of homes specifically for rent. This analysis will further explore the growing demand for rental homes, the characteristics of purpose-built horizontal communities, and the attractiveness and risk considerations of build-to-rent to both developers/investors and the residents.
Demographic Catalysts of Single Family Rentals
Traditionally, the greatest source of renter demand is from younger people between college graduation and forming larger households. Today, demand has been emerging across generational cohorts. In recent years much of the growth in rental demand was from Millennials, despite their proclivity to live in their parent’s homes as long as possible. Many of the Millennials have grown up now, the oldest reaching the age of 40, so one could speculate that rental demand would start to decline. However, affordability is keeping many Millennials and generational cohorts in rental units. A study by The Amherst Group found that 85% of SFR renters cannot qualify for a mortgage.
The Baby Boomers (ages 57-75) are retiring in large numbers and beginning to downsize their homes. They remain active consumers but are looking to cut costs. For many the answer is selling their homes in an up market, investing the proceeds for income, and renting a home often in a warm climate or near their children and grandchildren. The pandemic accelerated this trend. Generation X (ages 41-56) are in prime homeownership years, but some have been priced out of the market.
As mentioned above, Millennials (ages 25-40) have an emotional attachment to their home. Older Millennials are clearly seeking the additional space that a home provides and have a desire to own. According to a 2019 study by Apartment List, 90% of Millennials want to own their home. In fact, CoreLogic data indicates that Millennials represent 67% of first time home buyers, and they are buying in more affordable regions or where technology jobs are plentiful. Yet many still struggle to afford a house. They often have not accumulated the savings required to cover the down payment, and some are still paying off student debt. The Unison survey also found that Millennials are cautious about buying given the pandemic’s impact on economic and employment volatility (recall this is the generation that came of age during the GFS). Younger Millennials are not yet at prime home buying age. The result is that many in this largest generation of 72 million will be renting homes by necessity if not by choice, particularly in higher cost markets.
The older cohort of Generation Z (ages 9-24) is just entering the workforce. These are the classic years for multifamily rentals. But this generation of 67 million has new preferences. A study by the National Apartment Association found that 43% of GenZ wants to live in suburban houses after college graduation. The move away from urban multifamily is being supported by a desire to work from a comfortable home rather than have to come to the office. While it is certainly unclear how that trend will play out over the next few years, GenZ could also be a surprising demand generator for SFR.
Characteristics of Horizontal Communities: Multifamily Disguised as Single Family
For all the reasons described the supply of SFR product, particularly new product, has struggled to meet demand. One answer is purpose-built rental homes. The sector has attracted the attention of leading home builders, SFR aggregators, and boutique companies focused solely on BTR. The biggest players such as DR Horton and Lennar are getting in the game. LGI Homes has created rental home sections within its broader homeowner communities. And new partnerships are being formed between larger builders and the boutique firms to respond to market opportunities. Examples include the joint venture between Toll Brothers and BB Living that controls about 4,000 home sites and has 20 communities in the pipeline, typically in higher priced markets with larger-than-standard SFR homes. Taylor Morrison and Christopher Todd Communities have already developed more than 2,000 units.
As expected, new capital is also pouring into the sector. NexMetro, which builds under the Avilla brand, recently received a $400 million capital infusion. The company has a pipeline of 60 projects with 6,500 homes completed or under construction. Invesco invested in the Hunt Companies’ Avanta Residential’s pipeline of 20 BTR communities. Capstone Communities recently secured a programmatic private equity capital partner to fund its development pipeline. And JP Morgan has formed a $625 million joint venture with American Homes 4 Rent.
The communities these companies are building come in a variety of flavors. The ULI Low Density Housing study divides the BTR world into three categories:
- Horizontal multifamily: densely populated (9-14 units per acre) communities with similar unit sizes, types and amenities as suburban multifamily communities but lacking stacked units; homes are typically one story or townhomes in configuration, typically without an attached garage; the community generally offers between 100 and 150 units
- BFR single family attached: somewhat less dense than horizontal multifamily, units are not stacked but contain at least one shared vertical wall; units are typically larger than multifamily units and have attached garages; the community could offer between 70 and 200 units
- BFR single family detached: the largest homes most similar to SFR offerings with lower density (3-7 units per acre), larger unit sizes with three or more bedrooms, attached garages and more spacious yards; the communities range from 85 to 175 homes
In all configurations the units are built with more durable materials than standard home building to reflect the transient nature of the residents. Depending on unit price points and land availability, BTR communities may include the standard suburban multifamily common area amenities: club house, pool, fitness centers, and a dog run or walking trails.
The Scales Are Tipping to BTR
Many real estate developers and investors have recognized the growth and profitability of the sector and are rushing into the BTR space. However, building horizontal communities is not without risk. The following tables summarize the pros and cons from the point of view of households demanding rental homes as well as the point of view of BTR builder/managers that supply those homes.
Benefits and Consideration for SFR Renters
- BTR homes provide more space than traditional multifamily housing, including more bedrooms, living area, garages, and yards.
- The management company handles internal repairs and outside maintenance.
- Renting is more affordable than owning, and may become more so if mortgage rates start to rise; renters avoid down payments and property tax.
- The period of residency is flexible.
- Renting prevents the household from building equity as market prices improve
- Rents are rising rapidly and could create an affordability issue; mortgage payments can be fixed for the long-term.
- Renters can’t customize their homes to meet their specific tastes and needs.
- Local suburban governments and school districts do not always listen to the concerns of renting households, which are often considered transient.
Benefits and Considerations for Developers of BTR Communities
- Demographics and housing affordability issues are creating a surge in sustainable demand.
- SFR rents are typically at a premium to multifamily; increasing rental rates has not mitigated unit absorption.
- Data suggests SFR tenants stay longer than in traditional multifamily units, reducing marketing costs.
- Management is more efficient in a contained community than among geographically scattered homes.
- Construction and permanent debt is now widely available, including from Fannie Mae and Freddie Mac.
- Capital can be recovered by selling all or a portion of the community.
- Parcels of land of the right size and in the right locations are increasingly difficult to find and more expensive.
- Some local jurisdictions require rezoning from single family to multifamily, the entitlement process takes time.
- Communities may oppose multifamily units in traditionally single family neighborhoods, particularly in desirable infill locations.
- The rapid rise in SFR rental rates, and their premium over traditional multifamily units may force households to revert to traditional multifamily.
To highlight a few points from this analysis, the affordability issues of the home ownership sector is spilling over into both traditional multifamily and SFR. The most recent CoreLogic Single Family Rent Index report indicates that rents increased 9.3% year-over-year in August 2021, with more expensive detached homes rising 11.7%. Although the rate of growth has tapered in the last two months, these rapid increases have the potential to push renters from SFR to multifamily living. As noted, the biggest obstacle for BTR community developers is finding available land. BTR builders want to position themselves in the path of population, employment, and economic growth – and landowners have figured out they can raise lot prices to meet demand. According to a recent survey by the National Association of Home Builders, 76% of respondents believed the supply of developed lots were either “very low” or “low,” the highest percentage in the thirty-year history of the survey. Unless horizontal community builder-operators can team up with major home builders that already have inventory, the quest to build rental homes could be curtailed.
Despite these costs, the returns are very attractive. In fact, a recent analysis by Green Street put BTR at the top of the list of all real estate asset classes for risk-adjusted returns, indicating an 8.0% return for BTR as compared to a 5.9% return for multifamily. The latest trend is developing and then selling horizontal communities to operators, with many deals trading at capitalization rates of 4.0% to 4.5%, per a Northmarq report that estimates sales volumes will double in 2021 over last year. Builders are pre-selling lots, selling upon certificate of occupancy, or holding through stabilization, depending on how quickly they want to recycle capital. The opportunity is bringing new players and new capital into BTR. Zelman & Associates projects an infusion of $49 billion of capital in 2021.
According to Hunter Housing Economics, only 6% of all homes built in the United States are for rental units. Per the Census Bureau, there were about 50,000 completed BTR units in each of 2019 and 2020. Hunter projects the development of 100,000 units this year, growing to 180,000 units by 2025. That growth will in part be fueled by a maturing SFR debt market. Lending is starting to be competitive, with higher leverage offered by Fannie Mae, Freddie Mac, and private debt funds. The loans are also being securitized. Trepp indicates that the year-to-date 2021 volume of SFR commercial mortgage-backed securitization issuance is just over $14 billion. Despite the rapid growth, the bonds are performing well with a delinquency rate in October of just 0.26% compared to 1.7% for CMBS multifamily loans.
Fueled by the convergence of demographic demand and an increasing inability to afford to home ownership, the number of American households choosing to rent homes over apartments will likely grow for the foreseeable future. BTR developers and operators are rushing in to grab market share, despite the challenges of land availability, supply chain issues, and the increasing cost of building materials. This small segment of the rental market is poised to grow with institutional players – builders, managers, and capital providers – stepping in to grab their share and earn outsized returns.