Aug142015

Is single-family build-to-rent homes a viable business model?

American homebuilders never before built new homes in volume specifically to rent. Is this a passing opportunity or a new persistent business model?

Prior to 2010, no companies existed that bought, owned, and managed single-family detached homes. The millions of foreclosures that followed the millions of mortgage defaults in the housing bust provided a unique opportunity to acquire large numbers of homes at prices that provided favorable cash returns.

If you are looking for apartments for rent in hoboken nj, you need to consider if the REO-to-rental model works, money will flow into this model until resale prices rise too high to justify the cost of capital. In cities where resale prices haven’t recoverd reflated, rental yields exceed 6%, a far higher return than apartment investors obtain. The flow of money into these markets is looking for a high volume of homes they can obtain at or below a threshold price.

Prior to the housing bust, hedge funds didn’t have the patience to accumulate portfolios of 25,000+ homes because it would have taken too much time and effort to assemble. Further, since prior to the bust house prices were very high, it didn’t make sense financially to attempt to assemble a large number of houses: they cost too much. Therefore, the single family homes market historically was composed of millions of individual, non-professional investors.PREFAB-ABANDONED

The housing bust made the REO-to-rental model possible, but only time will tell if it remains viable. I believe it will because it’s the same model as apartments, albeit with a higher management cost, but it’s basically the same model as one that’s endured through time.

If the REO-to-rental model works, money will flow into this model until resale prices rise too high to justify the cost of capital. In cities where resale prices haven’t recovered reflated, rental yields exceed 6%, a far higher return than apartment investors obtain. The flow of money into these markets is looking for a high volume of homes they can obtain at or below a threshold price.

For example, let’s say some suburb of Orlando has houses that rent for $1,500 that cost $200,000. An REO-to-rental management company could pay up to $250,000 per house and still make their yield. They would demand a high volume at $200,000  to meet rental demand, but their request for housing would fall to zero at $250,000. Thus we have a high volume demand, but only at a low, fixed price.

In markets where builders could provide volume at a fixed price, it would be profitable for an REO-to-rental company to pay a builder to construct new homes specifically to provide rental stock. This has never been done before, and it may evolve into a sustained business model where demand exists for rentals but house prices are still low.

A New Opportunity to Build Detached Homes for Rent

by John Burns August 4, 2015

10% of Housing Demand

Builders and developers will now start building more detached homes for rent. A source from here reveals that their mobile-home sales are through the roof. For years, home builders have ignored 10% of housing demand, allowing resale homes to fill the demand. As shown below, 12.7 million of today’s 120 million households rent a detached home.

Housing-Block-Chart-JBREC

29% of Rental Demand
44.3 million US rental households occupy:

  • 15.5 million individually owned rentals
    • 12.7 million detached homes (29%)
    • 2.8 million condominiums and townhomes
  • 26.8 apartment buildings
    • 13.2 million units in small apartment buildings (less than 10 units)
    • 13.6 million units in larger apartment buildings (10+ units)
  • 2.0 million mobile homes, boats, etc.

Rental-House-Demand_JBREC

Detached rental homes is a large segment of the market, much higher than I realized. These are mostly investment homes owned by individuals, often an entry-level home the owners chose to keep rather than sell to “liberate” the equity for a move up.

Historically a Mom and Pop Business

The 12.7 million detached home renters have largely been ignored by builders and developers for years as both supply and demand steadily grew over many decades. The vast majority of the growth of individually owned rental homes has historically come from households who lived in the home before relocating and decided to continue owning and renting the home rather than selling it. Approximately 54% of the landlords of single-family rental homes own only one home, per RentRange.

Property-Pie-Chart_JBREC

Owning only one rental home is a clear sign of a mom and pop business.

Detached Rentals in Masterplans

We have noted that even actively selling masterplans, despite not building single-family homes for rent, have a significant number of single-family renters. Just go into Zillow and look for yourself.

The large number new home rentals in Irvine is testament to the number of foreign investors buying new homes as rentals.lowly_renter

The proactive developers are now looking to develop these neighborhoods and homes themselves, rather than letting others meet the demand.

Our research, which we confirmed with the CEOs of several of the institutional investors, shows that these renters live in detached homes primarily because that is the preferred lifestyle. Most of them did not even consider renting an apartment. They prefer to live in a detached home and are renting either because of:

  1. Necessity. They do not have the ability to qualify for a mortgage.
  2. Flexibility. They choose to rent to maintain the flexibility to move.
  3. Choice. They would rather spend what they earn today than save for a down payment. …

Here come the home builders, seizing the opportunity to build single-family detached homes to be sold to professional investors or to manage themselves. Consider the following:

  • Starwood Waypoint, an owner of 16,000+/- rental homes, has worked with 12 builders to buy homes from them. While they have often bought the slowest selling floor plan or the last few homes in a community, they are now actively pursuing new subdivisions in areas where they currently operate. Their CEO recently told me that their business has shifted dramatically in the last few years, with only 25%+/- of their tenants now having gone through foreclosure, versus 50%+ a few years ago.

Interesting shift in the renter profile. I wonder if these are Millennials choosing renting as a lifestyle over owning.rent_not_for_losers

  • The CEO of American Residential Properties shared at our recent client conference that their tenant profile has shifted as well, with new leases typically to young families with more than enough income to buy but who are choosing to rent primarily to have the flexibility to move.
  • Masterplan developers have taken notice. Bob Sharpe, the owner of Rancho Sahuarita in Tucson, surveyed his 5,500 home community and found that renters occupy 22% of the individually-owned homes. With 4,000 homes left to sell, why not build and rent homes to this group, many of whom will buy homes in the future?

Typically, an owner-occupant will pay more than an investor, so builders don’t cater to them, but if he’s exhausted the owner demand, and rents are still high, he can build out his project, make a few bucks, and move on.rented_room

  • Lennar has been a pioneer in detached subdivisions for rent with their Frontera community in a suburb of Reno Nevada. Rents for 1,210- to 2,182-square-foot homes range from $1499 to $1999 per month, or $0.92 to $1.20 per square foot, per apartmentguide.com. While Lennar also runs an apartment company, they acknowledged that the management complexities are very different. Lennar’s CEO recently noted that “it’s a pretty exciting opportunity for our company…and we’re probably going to launch another one or two as part of our evaluation as we go forward.”

Drop the Stigma
There remains a stigma that renters are not as good for the neighborhood as owners. From personal experience in my own neighborhood, as well as Census data, I can testify that they certainly move more often—and that they have always been great neighbors and their homes have been very well maintained.

There are good renters and there are bad renters. Because renters generally move around more often, they often won’t make much effort to meet the neighbors or get involved in their communities, but many do. Even those that don’t get involved generally lead quiet lives and don’t disturb the neighbors.

For as difficult as it is to have bad renters in the neighborhood, I sold a property in Las Vegas because it was difficult to rent, a difficulty created by the “owners” across the street that held wild parties and harassed the tenants if they complained to the police. What do you do when you live in a neighborhood where the owners cause problems?rent-vs-own

Conclusion
Last year, approximately 25,000 detached homes were built for rent. We believe that number will increase significantly over the next several years. We expect detached homes for rent to become an important segmentation opportunity for the top masterplans in the country, who will no longer ignore 10% of housing demand.

I think he’s right, and this will become a viable business model as long as prices are low and rental demand continues to outstrip resale demand. Perhaps when the homeownership rates stops declining, owner-occupant demand will push prices back up to where the build-to-rent model doesn’t make sense financially, but since I believe the REO-to=rental model will endure, this new build-to-rent model will exist to serve it.

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