US: BTR safe-haven for capital with long-term upside benefits

Wolfson Development Co’s CEO provides insights into US Build to Rent trends, with the sector a safe-haven for capital with long-term, upside benefits.

Adam Wolfson, CEO at Wolfson Developments Co | BTR News
Adam Wolfson, CEO at Wolfson Developments Co.

To describe US property markets as choppy or turbulent over the past year would be a vast understatement. As the CEO of a relatively sizeable US-based Build to Rent development company, I can tell you first-hand that property markets here changed more abruptly in that period than at any point in my career.

By Adam Wolfson, CEO & CIO at Wolfson Development Co

All the major ’food groups’ took severe hits as liquidity, both in debt and equity markets, either dried up or became prohibitively expensive. As the broader economy found itself grappling with a fundamental paradigm shift with respect to cost of capital, investors in all real estate asset classes dropped or re-traded deals as fears over levered cash flows and relative value elsewhere won the day (or year) and kicked off a period of price discovery unseen since the cycle began.

It stands to reason that, broadly speaking, asset values should change given a near 500 basis point raise in the Fed Funds Rate in a 12-month period, the fastest-paced climb in decades. One should expect pullback as investors, both institutional and otherwise, game the outcomes trying to determine whether this is the new normal or if more pain is to come. A wide retreat in the RE markets most certainly took place and the Build to Rent markets were not spared.

Prior to this time, the Build to Rent markets enjoyed a healthy pre-sale market in which institutional investors would fight each other for the privilege of committing to purchasing communities upon unit completions, taking lease-up risk away from the developer in exchange for a 25-50 basis point discount over stabilized cap rates. This market evaporated in the latter half of 2022 as these investors questioned what stabilised debt would feel like and, relatedly, what values would be three to five years out.

But all asset classes are not created equal and while certain segments (office, industrial and retail for example) might be deserving of a (severe) re-pricing, there is a real and credible case to be made that Build to Rent does not deserve be thrown out with the proverbial bathwater. It makes sense that an investor might not want to take an office deal into investment committee as there is an enormous and secular shift toward work-from-home (WFH), smaller offices and a more remote lifestyle. In addition, as recession fears continue, cyclical questions of employment levels are real and unanswerable. Though the Industrial segment has secular support in fundamentals, cyclically there are questions given the same potential deeper recession driven by job loss. It makes sense that with companies like Amazon looking to reduce their footprints investors might take pause, at least for the moment. But Build to Rent doesn’t suffer from these same ills.

In fact, the case for Build to Rent is as strong as it has ever been (maybe stronger) driven by glacial secular tailwinds, cyclical tidal waves and myriad built-in arbitrages vs other asset classes and investors should be running to Build to Rent as a safe harbor, hedged against both rate increases and decreases and set to outperform the broader RE market.  

The following are the major themes that should drive Build to Rent in the current macro environment:

Significant secular trends

  1. A current shortage of nearly 5.5 million attainably priced homes across the US.
  2. Millennials are aging out of apartments as household formation stays relatively strong (though a bit delayed, per RCLCO study).
  3. Declining ownership rate across most generations. 
  4. Covid relics (WFH and desire for more privacy) allow people to flee colder, tax-heavy climates and urban settings in favour of suburban areas in tax friendly, warmer environments, with the Southeast US and Florida among the leading beneficiaries.

Compounding cyclical trends

  1. A higher interest rate environment has pushed the monthly cost to own substantially higher than the cost to rent and has pushed nearly 47% of would-be homebuyers into the rental market.
  2. Higher credit standards and low savings make down-payments and mortgages very difficult.
  3. Homebuilders impacted by the high-rate environment are starting fewer homes which both further exacerbates the secular standing supply issue and allows current Build to Rent projects to deliver into a period with even more constrained supply. 
  4. Forecasted cyclical discounts on land, purchase price, and construction costs as the economy grinds slower.

Significant Internal Arbitrage

  1. Build to Rent traditionally has 10-20% lower cost to build  than apartments.
  2. There’s a premium (30%) for single-family home look-and-feel, with more private living experience, attached garages and yards (also vs apartments).
  3. Higher yields and nearly identical exit cap rates to apartments.
  4. Generally, a ’stickier’ tenant base with +/-20% turnover vs +/-50% in multifamily, translating to lower R&M, turnover, staffing and marketing costs.

In addition to the above, many believe it is inevitable that significant consolidation will occur in the given only 3% institutional ownership in the broader SFR markets while Wall Street believes this shoots to 40% over the next six years.

While it seems clear given the above that Build to Rent enjoys secular and cyclical drivers that other asset classes do not currently have, Build to Rent is a safer bet for yet more reasons. Perhaps most compelling is the unique hedge that it has on the wider interest rate and housing trade in general. To be sure, Build to Rent seems uniquely positioned on both sides as it stands to reason that if rates stay high or increase, renter demand should increase with housing unattainable.

On the other hand, when rates eventually drop (and though some may return to the home-buying market), prices of underlying assets increase as cap rates drop in line with less expensive debt and increased market liquidity. To be clear, a widespread and deeper recession fueled by job losses, if it were to occur, will no doubt destroy demand in Build to Rent just as in other asset classes yet the buoying effect of the above drivers should allow Build to Rent to, at minimum, outperform the other asset classes and, at maximum, have significant upside.

Investors should take note.