Build to rent has been receiving a lot of press lately, but what is the build-to-rent business model?
Build to Rent is a real estate investing strategy where developers build single-family houses with the intention of renting them out rather than selling them.
The build to rent model is different than the buy and hold model and the multifamily developmennt model. While there are similarities to multifamily, the product is dramatically different than multifamily buildings. There are advantages and disadvantages to build to rent. Lets start with the advantages.
Build To Rent Advantages
Predictable Maintainance and Capex Costs
Typically, new constructed homes have lower maintainance costs than existing housing stock. It is also much easier to project maintainance costs on new builds than older homes.
For instance, a HVAC system might last between 10-20 years. If you are purchasing a property with an 8 year old HVAC system, you should have resurves for almost the entire replacement cost because it could happen any time now.
With a new build, the depreciation on everything is in sync and just starting. So you do not have to start with as large capital reserves and by retaining monthly amounts towards this account it is easier to stay on top of large repairs as they come.
If your strategy is to hold for 5 years, it is likely that you will not have any neede capital expenditures during your hold. Only maintainance and repairs.
Huge Demand for New Construction
Everyone wants to rent a house with new, clean fixtures. In a new construction home, everything is new.
Everything being new isn't where the benefits of new construction single family ends. Homes built now can more closely reflect current trends and demands than homes built in the past. Examples of this are open concept floorplans and laundry on the same floor as the bedrooms.
The lack of new housing in the American market compared to what the demand was for the last decade has created a demand for new housing that will take quite some time to fully fill. This drives appreciation opportunities in the new housing market.
Comparable Rent Ratios
You can still achieve rent ratios similar to other asset classes such as multifamily and existing SFR's. Once you adjust capital requirements of existing housing stock to account for larger reserves that will be required for upcoming capital expenditures, it starts to become clear why build to rent can compete against buying existing housing stock to rent out.
Single family has a lower turnover than multi family in general. However, there is even less turnover in new construction single family. This can be attributed to lower competition as a majority of the rental inventory out there is not housing stock.
Build to rent is a scalable investment. You could build a single family residence on a single infil lot, or develop an entire subdivision for build to rent.
Because most of the demand for land is by developers looking to sell the property off once the project is complete, there are usually opportunities to acquire properties that do not quite meet the needs of other developers but will work quite well for the build to rent model.
Large Scale vs. Small Scale
There are opportunities for investors to buy infill land in a community to build one or two homes to rent out. Where the strategy really has a differentiation, though, and provides investors with great returns is in the larger communities.
These large-scale build-to-rent communities can have all the amenities of a gated community or large luxury apartment complex. Amenities such as pools, community centers, dog parks, walking trails, and professional management.
The value proposition to the customer is that they can simply rent a home in these communities rather than purchasing one, dealing with maintenance, paying an HOA, and paying the mortgage. The tenant also has the ability to keep to a one-year lease, so they have the flexibility to move if they need to for a job or other reasons.
Comparison to Other Forms of Development
When evaluating land for development, there are a few strategies that could be used. Sometimes, a mix of these strategies can be used when doing commercial real estate development.
- Mobile-Home Park
- Single Family to Sell
The difference between all these forms of development is either in the exit strategy of renting vs. selling or in the type of product.
On the type of product front, the decision-maker for the build to rent single-family vs. a multi-family development or mobile-home park would be the density and surrounding demographics.
There is more to weigh when deciding between build to rent and condos, townhomes, or single-family properties to sell. Some locations offer better returns to sell the property immediately. Places where the margin is tighter might make more sense to get rental income.
There are grants and incentives to providing low-income housing with the build-to-rent strategy. Navigating all the grants available from HUD and other housing agencies is not for the novice investor. That being said, there are plenty of opportunities to provide affordable housing and get subsidies from the government for doing so.
How to Estimate Costs
The cost of building this year has been volatile, with lumber adding so much to the cost of construction.
On your first pass of estimating the rehab costs, you will likely use ballpark numbers to see if a particular site makes any sense to do at all. You will check with zoning to determine what density is permitted.
Your first hard costs are planning and permitting costs. This will likely run you somewhere between $5,000 and $10,000 per house. Land development can range from $5,000 to $50,000+ per lot, depending on if it is infill with existing infrastructure or you are building a subdivision. Then the cost of construction will range from $125-$200/sqft depending on what product you are building and what part of the country it is in.
- Planning $5,000-$10,000 per lot
- Land Development $5,000-50,000+ per lot
- Home Construction $125-$200 per square foot
How Long Will it Take?
The build-to-rent strategy is not a quick fix and flip strategy. It is a longer-term project. There will need to be approvals from zoning, engineering surveys, land development, and construction,
To fully execute the build-to-rent strategy, it will take one to two years.
There are outliers if you are doing a build to rent infill development and already have plans ready. Perhaps you can build it in 6 months and have it pre-leased once it is completed.
What is the process of the build-to-rent strategy?
The build-to-rent strategy has 5 stages: Financing, land development, construction, lease-up, and permanent financing.
There are several ways you can finance the development of build-to-rent properties. If you are building one or a couple of homes, traditional residential mortgages are a possible route to take.
Types of Build to Rent Financing
- Commercial Bank Loans
- Hard Money
- Private Equity
- Specialty Build to Rent Loan Products
The specialty build-to-rent loan programs are somewhere in between commercial bank loans and hard money as far as terms and underwriting are concerned. If your project meets the qualifications of their loan program, they are able to offer better rates than a hard money lender will usually offer.
2. Land Development
Getting the property ready to build on is twofold. First, you have to do the entitlement and permitting phase. This is where everything is planned out, presented to the city, and permitted.
Once the permitting is completed, it is time to move on to site development. This stage includes grading, clearing, utilities, and building the streets.
The construction process of a build-to-rent community is also a cross between large-scale commercial development and single-family homes.
If you were to build a community of single-family homes to sell, there is an incentive to build a variety of floorplans, styles, and finishes. When building a community for the build-to-rent strategy, most of these choices will be the same. Likely with superficial differences of styles and a couple of different floorplans.
The similarities to multi-family allow you to do construction more streamlined than single-family homes, which often tend to move towards being at least semi-custom as banks require a certain number of units to be pre-sold before releasing funds.
This is the phase of the investment where you will see the market's reality compared to your underwriting. If you did a good job in underwriting and a good job building a desirable product, then you will start to see the results when leasing up.
During this phase, you will either be relying on a professional property management company or doing the property management in-house.
A nice attribute of BTR vs. multi-family properties is that in BTR, construction completion is more staggered than multi-family. In order to have a successful launch, though, you should perform pre-marketing and have a waitlist before you are ready to rent your first units. Then once a model unit is ready, you can turbocharge these efforts.
5. Permanent Financing
Once the property is stabilized, it is time to exit from the development phase of the project. The two common exit strategies are to sell to a long-term investor or to refinance into permanent financing.
Because the development process has significantly more risk than holding a portfolio of SFR's with signed annual leases, you can expect to pay a significantly lower interest rate when moving to permanent financing. In many cases, it will be a couple of points lower.
Crowdfunding and Syndication
If you really like the benefits offered by the build-to-rent asset class but are not ready to take on the whole project by yourself, there are other options to get into this asset class. You could become an investor in build to rent properties through crowdfunding or syndication deals.
Crowdfunding Platforms Offering Build to Rent
Wrapping it Up
The build-to-rent strategy can be a great way to create passive income and wealth. It is a strategy that can scale up to very large developments while still working on the scale of a single home. There are also ways to get into a fractional investment of a build-to-rent project through crowdfunding.