October 2020 | Insights From Our Home Building Practice – One of the most remarkable developments in the home building industry today is the fast-growing Single-Family Build-for-Rent (SFR/BFR) segment. Although data is somewhat limited because the vertical is still relatively new, there’s already plenty of evidence to indicate that the SFR/BFR business has become, in the words of Metrostudy, “residential real estate’s hottest trend among investors, developers, and builders.”
SFR/BFR, which started to build momentum less than a decade ago, has gained traction due to ongoing challenges in housing affordability, changes in traditional household structures and priorities, and shifting consumer demands. This emerging asset class can provide home builders an opportunity to diversify their product offering for an evolving customer base, broaden their market focus, and establish additional revenue streams to potentially hedge against future declines in traditional, new construction single-family home sales.
The SFR/BFR business includes not only the construction of homes but also post-construction management of these properties, which represents a fundamental shift in focus and necessitates a different approach. To succeed, builders must implement new strategies, operating models, and leading practices in order to address these new requirements.
Build-For-Rent
Build-for-Rent is an extension of the single-family rental market which grew out of the Great Recession of 2008. During this period, investors (mostly individuals and small companies) began buying hundreds of thousands of distressed, existing single-family homes and unsold, new inventory from home builders for conversion to rental properties.
Since then, demand for this type of housing has been continuously increasing. While certain consumers simply haven’t been able to afford traditional home purchase and ownership, others who have the financial resources have eschewed the opportunity buy and own, often due to changes in life priorities and perceptions of value. These factors have led to long periods of declining homeownership, which in 2016 sank to a post-recession low of around 62 percent. Meanwhile, in recent years, more than 5 million existing homes nationwide have been reclassed to the single-family rental sector, which today tops an estimated 13 million homes.
Building single-family homes for rent began solidifying as a credible business model around 2012 as existing housing inventory available for large-scale acquisition and SFR conversion began to dwindle. With consumer and investor interest remaining strong, demand quickly started to outstrip supply. As the model has continued to mature, a few sizeable cohorts have been driving the market forward and encouraging builders (the “sleeping giants”) to awaken and focus efforts on expanding the scale of BFR product delivery. While these consumers represent a variety of demographics, they share an important common characteristic that differentiates them from traditional multi-family renters: they don’t want to live in apartments or own single-family homes, but still seek communities that offer multi-family-type amenities, such as pools, tennis court, parks, etc. These consumer groups include:
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Millennials raising young families who can’t yet afford down payments, mortgages, and ongoing overhead;
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Previous single-family homeowners who are experiencing life transitions such as marriage, divorce, or death of a significant other;
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Empty nesters, particularly Baby Boomers, who are downsizing but want comparable quality of life and the convenience of a “lock-and-leave” lifestyle; and
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Consumers of all ages who can afford to buy and own but do not prioritize homeownership for any number of reasons, including reluctance to tie up their assets in a single-family house purchase.
The COVID-19 pandemic may shape up to be another driver. In early Spring 2020, RealFoundations observed a significant spike in cancellations for new home contracts among its home builder clients. Many buyers appeared to be increasingly uncertain about the future and were understandably hesitant to make long-term financial commitments in the foreseeable future. However, these potential buyers still wanted the benefits of living in a single-family home. Additionally, multifamily renters may seek lower-density SFR properties with better “social distancing” characteristics, causing them to gravitate to new BFR communities with the types of amenities to which they are accustomed. In the months since the pandemic started, we’ve witnessed a surprisingly strong and accelerated recovery of both sales and closing metrics for many national builders in a very short period of time; however, we still expect the demand for BFR products to continue its upward trend as well as the pandemic crisis continues to subside.
As the product offering continues to mature, the statistics show that BFR is on an upward trajectory. According to the National Association of Home Builders, in 2017, 37,000 homes were built as rentals, with another 43,000 constructed in 2018, or nearly 5 percent of total single-family housing starts. However, these numbers appear to be conservative, as they represent only homes built for rent and held for operation by the builders and do not reflect homes produced by merchant builders that then are sold to investors. The actual figures are almost certainly higher, which would indicate a faster rate of growth.
To date, BFR activity has primarily focused on U.S. non-coastal regions where land is generally cheaper and in greater supply. For example, in 2019, almost one-quarter of SFR/BFR homes were built in Texas, Oklahoma, Arkansas and Louisiana. We expect the geographic footprint to expand over time as the product becomes better understood and the economics become more competitive when compared to build-for-sale activity in areas where land is at a premium.
Expanding Business Models
Several large traditional home builders now are expanding their business models to include the production of homes that are purpose-built for rent. It’s an opportunity to figure out how this new line of business can provide an ancillary income stream and potential partial hedge against future declines in the conventional build-for-sale segment, while still controlling risk. As the market has expanded, we’re seeing the formation of new companies as well as creative structures and partnerships between entities that want to participate in the growing BFR segment. They include:
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Home builders that vertically integrate or establish third-party partnerships to handle all aspects of the BFR model, including land acquisition, product development, construction, leasing and property management. This includes pre-fab/modular builders that have lower building costs and faster delivery-to-market advantages;
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Single-family for-sale home builders that invest in BFR builders/operators but aren’t involved in decision-making related to land and product;
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Dedicated “merchant builders” that hand off products/portfolios at build completion to operating entities for ownership and property management; and
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Existing SFR investors and property managers are now broadening their portfolios to include ground-up BFR development.
Over time, as BFR becomes a more proven business model and the returns become more measurable, some of these approaches likely will emerge as more repeatable. This could result in the establishment of leading practices, lowering barriers to entry and streamlining the path to profitability. As more participants enter the market, the stage may then be set for consolidation, similar to what has happened historically in traditional homebuilding.
Builders also are using a range of planning strategies to increase exposure to this type of product while still managing risk. While some builders are developing entire purpose-built SFR/BFR communities that utilize uniform product design to simplify construction and maintenance, others are allocating specific tracts or lots for this type of product within new community plans, taking a hybrid approach to forward planning. In many cases and where possible, builders are also including commercial and retail components to create a complete “lifestyle” product more aligned with a master-planned community or multifamily offering.
Challenges Ahead
Home builders entering the SFR/BFR space must be cognizant of the potential challenges they will face. As such, several key components are foundational for successful execution:
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Operating Model While home builders are experts in developing and constructing new single-family homes and communities, they lack experience in, and their operating models don’t support, fundamental aspects of leasing and property management including marketing, property maintenance, rent collection, performance measurement, and reporting. Also, many standard build-for-sale practices will require adaptation for SFR/BFR ventures, including key activities such as land due diligence, gross margin analyses against long-term rental cash flows, product strategies, design, parking, amenities, and geographies.
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Technology While software solutions are commercially available that cater to both conventional home building and multifamily property management, none is specifically designed to support the unique needs of SFR/BFR portfolios. Existing multifamily solutions have been built and are tailored for multifamily assets, so a lot of the core functionality, data models, analytics and standard reporting features aren’t appropriate for BFR. While these solutions can be customized to address the unique needs of this vertical, the work can be significant to avoid workarounds or concessions on critical functionality. As the BFR segment continues to mature, it is highly likely that a purpose-built and BFR-focused solution will be developed that will be more effective in addressing all requirements.
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Perception and Acceptance Over time, financial markets and analysts have continued to embrace SFR and BFR as business models and financial returns have become more predictable. However, there’s still a substantial negative predisposition toward rental properties and renters in general. This includes a lingering belief that renters often don’t apply the same standard of care for properties as traditional owners, which is problematic when BFR lots or tracts are included within conventional master-planned communities. Moreover, there has been widespread discussion in the media that large-scale SFR acquisitions can drive down the long-term value of communities and neighborhoods. Finally, many builders worry that widening their portfolios to include a BFR offering, which generally features basic to mid-range finishes, could dilute their brand value without very clear delineation in the product.
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New Partnerships As each builder begins to establish its preferred approach for moving into the BFR arena, new partnerships are materializing to address key requirements of the business model. These include but are not limited to capital partnerships, land acquisition and construction agreements, and deals for long-term property management.
How RealFoundations Can Help
Home builders and investors alike are looking to define and capitalize on business strategies for achieving success in the dynamic single-family rental sector. Their prospects are bright if they develop and implement solid strategies, operating models and critical processes, and leverage effective technologies to manage, monitor, report and evaluate performance. Success requires understanding not only the macro dynamics, trends and outlook for the space but also how companies should augment their operating, functional and sourcing models to address the unique requirements of the BFR space. Key questions include:
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How will the enterprise conduct the new business? Who is leading which parts of the effort?
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How will critical business functions be sourced? What is the process for identifying and building relationships with strategic partners to handle those functions?
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What software applications are needed to support daily operations, reporting and growth?
RealFoundations has extensive, relevant experience and expertise as a result of working for decades with large traditional home builders, leaders in the single-family rental and multifamily sectors and, more recently, companies in the growing build-for-rent segment. We can help clients as they move into the SFR/BFR business by:
Connect with Us
To learn more, contact RealFoundations’ Enterprise Managing Consultant Dylan Rhea by email or +1 949 258 4040.
About the Author
Dylan Rhea is an Enterprise Managing Consultant with RealFoundations. He brings over 20 years of both domestic and international real estate industry experience to RealFoundations in both the public and private sectors, working with clients to deliver key projects in the areas of business transformation, target operating model development, long-term technology strategy, mergers and acquisitions, and enterprise platform implementations.
Across the span of his career, Dylan has focused on homebuilding, construction/development, owner/operator, corporate service provider, and real estate investment market segments. He has forged trusted relationships with global clients such as Morgan Stanley, Jones Lang LaSalle, Simon Property Group, AMP Capital Investors, Developers Diversified Realty, and Boston Properties, as well as Top 20 public builders KB Home, Lennar Corporation, Toll Brothers and Ryland Homes.
About RealFoundations
RealFoundations (RF) is the world’s foremost professional services firm focused solely on the real estate industry. Through our delivery of Management Consulting and Managed Services, we help companies that develop, own, operate, service or invest in real estate make better, more profitable decisions. We are proud partners to over 500 real estate companies around the globe, providing accelerated solutions that solve some of real estate’s most complex challenges. We Make Real Estate Run Better.
