Economists Share What's Different About Build-to-Rent
Originally published by: Builder Online — March 2, 2021
by Ali Wolf, Zonda chief economist
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Zonda chief economist Ali Wolf consults colleague Tim Sullivan about the growing popularity of the residential build-to-rent market
There will continue to be demand for rental communities even as millennials age into prime home-buying years and the homeownership rate rises. These communities can range from highly amenitized and institutionally managed to single-family homes. Mom and pop investors have known the value of single-family rental homes for decades, but the build-to-rent (BTR) asset class is one of the fastest growing in residential real estate. I recently sat down with Tim Sullivan, Zonda’s senior managing principal, to discuss the growing popularity of the space.
BUILDER: Can you talk us through the evolution of this product type?
Sullivan: The first stake in the sand came from the REITs in the wake of the Great Recession. Government officials were looking for a solution to the foreclosure crisis and decided to try incentivizing investors. The plan worked, and investors shelled out billions to buy homes below replacement cost to then rent to consumers. But maintenance was inefficient because the homes were rarely clustered together, so the companies got smart and realized by building new in one location, they could get economies of scale while still supplying a single-family rental product.
BUILDER: Did the product stay the same along the way?
Sullivan: Yes and no. There are two main types of BTR products, and one is a traditional single-family home. An important factor for BTR is how the homes are mapped; the single-family homes are fee simple in platted lot subdivisions. This product type gives flexibility to the owners because some or all of the units can be sold, if desired, at a later time. These homes typically offer three to four bedrooms and outside space in a lower-density configuration. But the institutions realized not everyone needs that much space. Enter: horizontal apartments. For institutional investors, this product type is relatable because it’s basically just an apartment pulled apart. These apartments are on one common map and can’t be sold separately. The earlier mentioned economies of scale also apply here. Horizontal apartments act as an apartment replacement by offering renters primarily one- and two-bedroom options with small yards in a relatively dense environment. These apartments are also accidental COVID hedges as they’re not stacked.
BUILDER: What do we know about BTR renters?
Sullivan: Not everyone wants to own and not everyone is in the financial position to own, but many people like the lifestyle that corresponds with single-family homes. There are individuals in nearly every demographic cohort across different life stages and income levels that can be satisfied by BTR product. The platted single-family homes tend to cater more toward families, while singles and couples, especially millennials and empty nesters, make up a big share of renters in horizontal apartments. Our research shows the incomes of renters in horizontal apartments are typically higher than for traditional institutional quality apartments by 20% or more. One reason is that many people use BTR apartments as a transitional residence to test-drive a location—a trend only exaggerated by COVID-19.
BUILDER: Has anything surprised you with BTR?
Sullivan: I wouldn’t say this surprised me because of the parallels to how active this cohort is in the for-sale market, but our research found that single women are drawn to horizontal apartments. The gated communities offer security, complemented by a low-maintenance lifestyle with the look and feel of a master plan. We’re seeing many master plans embrace both BTR product types.
BUILDER: For those not in existing master plans, though, what amenities are typically offered?
Sullivan: One could argue that’s the trade-off. For the horizontal apartments, renters generally get a detached home with privacy and a small, private backyard without the elevated level of resort amenities you’d find at a traditional institutional quality apartment community. What’s most common is a gated community with open space, a pool, a place to barbecue, and a gazebo. You may even get a small clubhouse, but it is not going to be a world-class resort.
BUILDER: Do you think that will remain the norm?
Sullivan: We are already seeing some developers pushing the envelope. A simple example is that we are just now assessing high-quality gyms being added to the horizontal apartment amenity set. Moving forward, some BTR communities will evolve more toward resort-style amenities with a richer array of offerings, but it will also require higher rents to justify.
BUILDER: OK. So let’s say I’m a builder. Should I look to enter this space?
Sullivan: Every builder should think about it, especially as a way to diversify their product offerings. One of the things we’ve seen in the past six months is that the bloom has come off the rose a little bit though. Builders are not looking at the BTR space as much because the for-sale market is so strong. The rapid home price appreciation has actually made it easier for some for-sale communities to financially pencil above the rental side now. We are also seeing many of the BTR operators have more trouble finding land opportunities than they did one and two years ago as the for-sale housing has exploded.
BUILDER: What are some markets where you’ve seen BTR product work well?
Sullivan: BTR generally works well in areas with lower land costs. From our advisory studies, we’ve seen this product do well in places like Orlando, Florida; Charleston, South Carolina; Phoenix; and Charlotte, North Carolina, but there are many more.
BUILDER: Can you name some markets where it doesn’t work well?
BUILDER: What should we expect from the BTR space throughout 2021?
Sullivan: I’d first step back and say every builder should think about this space, especially as a way to diversify their product offerings. BTR generally works well in areas with lower land costs, but there are times where it financially pencils in higher-cost areas as well. Besides that, I expect: 1. more competition; 2. more amenities; and 3. more attention from capital.