Why Build-to-Rent Continues to Take Commercial Real Estate by Storm

Pictured is CityHouse Ashburn Station, a 200-unit build-to-rent community in Virginia. American Real Estate Partners, in partnership with Rithm Capital, acquired the property earlier this year for $120 million. The partnership cited the above-average unit size, aesthetic appeal and proximity to Northern Virginia employment hubs as key reasons for the purchase and as attributes that appeal to renters.

REBUSINESS

By Mark Taylor, managing director, residential, American Real Estate Partners

For young families across the country, the dream of homeownership has been delayed due to high mortgage rates, low supply and rising build costs. Many millennials, particularly those with growing families, are ready to move into their first homes but cannot afford either the down payment or the increased mortgage payment.

According to Pew Research Center, 65 percent of Americans under the age of 35 still rent, as opposed to a market average of around 33 percent. That’s why build-to-rent (BTR) homes are booming; they offer residents the space and privacy of a house with a lower price tag, alongside the extensive amenities and institutional property management services of rental apartment living.

For most people, rent is by far their largest monthly expense. Ideally, they want to live somewhere that is safe, stylish and comfortable — all things that BTR homes offer. Here are  some of the reasons BTR is taking the real estate industry by storm.

The Economics

BTR appeals to investors as well as residents. Whether townhouses or single-family, BTR homes are typically larger than traditional apartment units and generally include an attached garage.

The trunk rent, or monthly rental cost, is higher but markedly cheaper on a rent per-square-foot basis. From an investment perspective, BTR homes have higher efficiency and lower operating costs than apartments.

The efficiency of a typical apartment building is around 85 percent. This is because shared spaces like hallways, clubrooms, fitness centers and other amenity areas contribute to the achievable rent but often have an opaque cost/benefit.

With BTR, efficiency approaches 100 percent, because as a house or townhome, there are no common areas like hallways, translating into more for the customers money. And with construction completed in eight- to 10-unit phases, owners can lease residences at an accelerated pace. This significantly reduces capitalized interest costs that accompany a larger traditional apartment building with a protracted  unit turnover.

BTR also fits well into the business model for production builders, many of whom have been forced to lay off workers as demand remains 20 percent below its five-year average.

Production homebuilders hold significant purchasing power, a lower production cost structure and offer scalability. This combination means lower build costs compared to a typical general contractor building a one-off project with a more expensive overhead structure. All of this frees up capital to put properties on more desirable land.

Additionally, BTR products are typically built as townhome strips, allowing owners to modify development programming based on customer demand as construction progresses through a community. But there are nuances to consider. While a for-sale builder focuses on delivering the lowest initial cost product, the owner/investor costs are higher upfront for a number of reasons, including:

• A lower-level fire protection specification raises the insurance premium for the owner but lowers the initial build cost.
• For-sale homes don’t come with move-in ready features such as drapes and appliances while BTR homes do.
• As a rental home, smart locks are required for BTR properties, as well as locks on mechanical closets.

It’s also worth noting that the capture rate, or the percentage of prospects going to lease, for BTR properties is lower than that of apartments. Apartments have a 20 percent capture rate with two tours max to get there. BTR homes have a 10 percent capture rate typically requiring more than two tours.

But the slower pace is worth it, as BTR homes tend to be “stickier” with residents, meaning they don’t move as often, reducing turnover costs. According to Green Street Research, BTRs are one of the best risk-adjusted returns available in the public market.

Path of Growth      

Thus far, the South and Midwest have led the way for BTR communities. Meanwhile, the Washington, D.C. market and other high-cost markets have lagged — though this is changing as a result of high-wage job growth and corresponding submarket inflation pressures.

For example, in Northern Virginia, Amazon HQ2 and Inova Hospital are hiring in large numbers, but the housing inventory is generally dated and unappealing. In Loudoun County, one of  America’s fastest-growing counties, more than 60,000 new housing units are needed by 2040, according to a study commissioned by the county.

This creates a massive opportunity for BTR. A mid-market townhome in Northern Virginia — circa the fourth quarter of 2023 — costs about $800,000, requires upwards of  $60,000 down payment and works out to a mortgage payment of about $7,000 per month with MIP, taxes and insurance. Well-executed BTR properties have a much lower monthly cost, don’t require a massive down payment and offer an enviable list of amenities, from green spaces and common areas to basketball and pickleball courts.

While many production builders are buying down mortgage rates to stimulate sales, and playing into the belief that these rates will come down, the reality is that today’s rates are in the range they have been historically, and not the “free money” period we have recently exited.

The Bottom Line

Rental demand has been high since the Great Recession and is likely to remain so. Young families and professionals that would previously have become move-up buyers are increasingly shut out of a market driven by higher costs and interest rates sitting at a two-decade high.

BTR, as a product and an asset class, is rapidly growing in popularity. Given the desirable lifestyle amenities and high-growth locations, the demographic that would have been move-up buyers is becoming move-up renters by necessity as well as choice, instead.

Add to this the challenging underwriting metrics for traditional rental product, and it’s clear why BTR fills an important gap in the real estate market and is an attractive investment option offering opportunistic returns with reduced risk given the execution parameters.

Headquartered in Northern Virginia, American Real Estate Partners (AREP) is an institutional fund manager and operating partner focused on office, industrial, data center and residential/mixed-use repositioning and development throughout the East Coast.

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