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.”
Renter-occupied households account for 35% of single-family homes, according to the National Multifamily Housing Council. And the majority of those renters, 51%, are made up of those under 30.
“This is a seller’s market so what I’m finding is that anything that is put on the market that is reasonably priced and in reasonably good condition is selling, and rentals are no exception,” Caballero said. “When you’re in a good market, everything is moving quickly.”
The number of renter households increased by 9 million between 2005 and 2015, marking the largest increase over any 10-year period on record, according to the Harvard Joint Center for Housing Studies. This high demand for rental housing from Millennials is leading builders to construct entire neighborhoods just for rental housing, according to an article in the Wall Street Journal.
In the article, one expert explained how the growing appeal of renting reflects a new mindset about homeownership.
“It used to be that if you were an adult and didn’t own your own home, you were kind of a bum,” said George Casey, a former homebuilder and chief executive of Stockbridge Associates, an industry consulting firm. That stigma has now “been blown into a million pieces,” Casey said.
But not only is there a new mindset when it comes to renting, more families were forced into rental homes after the foreclosure crisis.
“The entire rental market has been very hot for several years,” Caballero explained. “What’s contributed to that is there’s been a lot of foreclosures for a number of years. There’s a lot of people out there that can’t qualify for a new home, they’ve been living in a home, they want to continue living in a home but they can’t buy one.”
With the rental market going so well, it makes sense that builders wish to capitalize on the market.
“I can tell you that the rental market is good and it’s probably even better in some areas than the sale market, and I suspect that that’s part of the information that’s considered by these builders,” Caballero said.
He explained that while major investment hedge funds capitalized on this rising demand in the past, builders are beginning to recognize the opportunity for themselves.
And in fact, who better to keep up with these rentals than the very builders who constructed them in the first place and have resources at their disposal for the upkeep of the homes?
“They can buy the home at a good rate and then put it in their investment portfolio,” Caballero said. “And then in other cases builders are doing this as just additional business.”
In total, about 5% of all new single-family construction was built for rent in 2016, up from a historical average of less than 3%. And experts say the trend will only increase over the next few years as home affordability decreases and as more and more older Americans consider downsizing.
The build-to-rent trend, however, does have a downside. Housing inventory is hitting new lows, lingering at a supply of just 3.6 months at the current rate of sales, according to a report from the National Association of Realtors, and building to rent will only strain that supply further. Rand explained that homebuyers are facing a whole new realm of competitors for the few homes that are available.
“Actually, another way to look at it is that homebuyers are competing with home renters, and because of the large number of home renters, they’re technically competing with home investors,” he said. “Homebuyers are competing with investors, but homeownership is competing with rentership.”
And investors tend to have deeper pockets than a single homeowner.
“If you’re in Dallas, Texas, and you’re looking to buy a $175,000 single-family home that’s really nice, there’s a very good chance that you’re competing with an investor to buy that property,” Rand explained. “When there’s new demand, and there is new demand on the investor side, new demand is going to create a shortage of inventory.”
But increased competition isn’t the only downside of the build-to-rent trend. brings.
As it turns out, some builders refuse to sell their homes to investors who intend to rent out the property.
“Years ago there was one entire subdivision that was build out for rent – it didn’t turn out to be a very nice subdivision because you had an entire subdivision of homes that are rental,” Caballero said. “There’s a percentage level of rentals that will, in their opinion, negatively affect the saleability of the subdivision.”
In order to protect their future sales profits, some builders are resisting the build-to-rent trend in order to keep the home values high in the subdivision they are working in.
Even so, build-to-rent provides an attractive option for builders and investors with an appetite for growth in a constrained market. For them, and a growing pool of renters, that new-home smell is more tantalizing than ever.