Why build-for-rent might be the right investment in a market downturn

November 10, 20223 min read
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The housing market in today’s economy is characterized by scarce stock, high interest rates, and record-high home prices. This makes homeownership a dim prospect for most, especially millennials who are the largest emerging group of prospective homebuyers.

Against the backdrop of high stock market volatility, build-for-rent (BFR) developments — real estate designed to rent as opposed to long-term home ownership — are proving to be a great alternative.

What is build for rent (BFR)?

With low housing supply and surging demand for rentals, the massive influx of capital into build-for-rent communities today is hardly a surprise. But BFR owes its popularity to another type of investment: the single family home. In 2012, Warren Buffet told CNBC that if he could find single-family homes concentrated in particular metropolitan statistical areas, he’d “buy up a couple hundred thousand.”

Within two months of Buffet’s statement, Blackstone spent $100 million a month on single-family homes, amassing an enormous portfolio. Following in the footsteps of Buffet and Blackstone, other investment groups also began to target single-family homes with a level of enthusiasm typically reserved for multifamily complexes. This gave rise to a new kind of real estate asset — the single family — which boasted a higher yield-on-cost than multifamily units, larger space and afforded more privacy for residents, making them even more attractive to younger individuals.

But limited housing stock and tight market competition capped the growth of single family rental portfolios, driving investors to look for alternatives. Enter firms like Haven Realty Capital, one of the first developers to start acquiring single family homes with the intention to rent. The logic behind the strategy of developers like Haven Realty and others was simple: acquiring land and building homes would potentially lead to higher returns than buying individual for-sale homes via a broker or the MLS, since there’s no premium expense to beat other buyers in the market. Over time, BFR communities also began to take on a similar look and feel to comparable for-sale homes in the area, while offering additional perks like club houses and sports and recreation facilities, making them even more attractive to renters. 

What can BFR investments offer in times of a market downturn? 

About 36% of renting households (roughly 16 million people) swapped out their multi-unit apartment complex for a single-family rental during the pandemic, with the uptick expected to continue.

There are a few macroeconomic forces that contribute to the popularity of BFR homes in today’s market downturn.

A staggering 60% of Americans can’t afford to buy a home because of rising prices and mortgage rates, which is driving more people to the rental market.

At the same time, housing demand continues to surge as people look for more space but  supply shortages run more severe every year. For example, the past 20 years called for roughly 1.3 million homes to be built per year to meet homebuyers demand, but only 947,400 were built annually. This means that the rental market will continue to expand, with more homebuyers opting to rent long term.

Moreover, when the economy tightens — for example during a recession — fewer people buy houses, resulting in higher rental occupancy and longer-term tenancy. Higher unemployment also leads to more single-family renter household formations, as families burdened by rising prices can typically rent for less than monthly mortgage repayment on an equivalent home. 

BFR investments can also help investors to hedge against inflation. For one thing, management’s ability to reset leases on an annual basis allows them to match current market conditions. In addition, when built-for-rent communities are sold, they are sold in one transaction, typically to an institutional buyer. This means they also trade at a cap rate like other commercial properties, as opposed to trading on a per-unit basis. 

Moreover, the cap rate premium associated with the community at exit may result in a per unit price above what an individual buyer would pay, creating a potential arbitrage opportunity for investors — once again, providing and opportunity to circumventing inflationary pressures.