Are You Ready to Compete with Built-for-Rent?

9

Say again?

That’s right.  Home builders are going into the single family rental business one nail at a time.  They building new homes from scratch and either selling them to investors or renting them out and managing them through a subsidiary.

With inventories of foreclosures and short sales at multi-year lows, their timing is perfect.  Single family vacancy rates are down and rents are up.  Now investors find themselves competing for tenants with apartments, hundreds of homes owned by hedge funds, investment properties owned by other small investors and homes designed to be rentals and managed by the builders who built them.

There’s nothing terribly new about building single family homes to be rented out and for years builders rented out a handful of homes they had a hard time selling.  However, the single family rental market, initially a way to create demand for foreclosures and provide needed rental housing, has become the fastest growing rental category.  Some 27 percent of renters now live in single family homes and the number continues to grow. Building homes for rent is growing too.

Five Percent of New Home Construction

In 2011, when foreclosures were plentiful and home builders were hurting for work, homes built-for-rent accounted for 5.35 percent of new home construction.  According to data from the Census Bureau’s Quarterly Starts and Completions by Purpose and Design, the market share of single-family homes built for rent, as measured on a one-year moving average, stands at 5.1 percent for the third quarter of 2012. This is only slightly lower than the recent peak of 5.35 percent set at the beginning of 2011, and is considerably higher than the 20-year average of 2.7 percent.

In 2011, however, heads turned when Beazer Homes formed a REIT to buy and then rent single-family homes. The Atlanta-based company joined with buyout firm Kohlberg Kravis Roberts & Co. to form the REIT, which eventually plans to go public.

“It’s not a short term, opportunistic thing,” Allan Merrill, Beazer Homes’ chief executive, told the Wall Street Journal. “It’s not buy as many as you can, lever it up as far you can, and flip them as soon as you can. It’s building a durable rental stream.”

As of last May, Beazer already had accumulated 192 single-family homes in the Phoenix and Las Vegas areas—more than 10 percent of them houses the company built and sold in the first place. Most were purchased at steep discounts from their original prices through foreclosure auctions, short-sales or other distressed home-buying strategies.

Those homes will go into the new company, dubbed Beazer Pre-Owned Rental Homes Inc., which hopes to expand beyond Phoenix and Las Vegas to at least one other, as-yet unidentified market. Within two years, Beazer said the number of rental homes under the new REIT’s control could number in the thousands.

In for the Long Haul

“You walk into these homes and it has the feel, smell and look of a reconditioned home,” said Patrick Whelan, the new company’s chief executive, a veteran of the rental-apartment business. “We’re delivering the message of, ‘you don’t need to worry about the stability of the landlord and of the property you want to rent for the next three years.’ ”

Another entrant in the built-for-rent market is Jacksonville Wealth Builders, which had been buying foreclosed homes to sell to investors. So many investors are pursuing bank-owned homes to operate as rentals that it’s pushed prices as high as it would cost to build them, so the company began building from scratch.

With demand for single-family rentals on the rise, Jacksonville Wealth Builders has turned its attention to buying foreclosed residential lots, building rental homes to sell to investors, renting the homes and providing property management services.

“We’re starting to see prices go much higher [on foreclosed homes],” said Greg Cohen, Jacksonville Wealth Builders managing partner told the Jacksonville Business Journal. “We’ve basically bought 95 percent of our properties through [the Multiple Listing Service]and the connections we have, but those opportunities aren’t there as much.”

The Rent-to-own Option

One option that turns renters into owners is rent-to-own programs that reduce carrying costs on unsold inventory and helps convert more homes to sales.  Some builders have a separate division to handle the rental side of their business, while others prefer to work with customers on a case-by-case basis. T&M Building Co. of Torrington, Conn., and Classic Communities Corp. of Harrisburg, Pa., are two examples.

Renters sign a use-and-occupancy agreement that allows them to live in the home until they can refinance it and take T&M out of the equation. In most cases, customers are able to purchase their home after renting for one year. Occasionally it takes two years. Customers can also elect to sign a conventional lease, but they always have the option to buy.
Photo: ArmchairBuilder.com

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About Author

Steve Cook is the editor of Real Estate Economy Watch and writes for a several leading outlets in addition to BiggerPockets, including Equifax and Total Mortgage. He also provides communications consulting services to leading real estate companies. Previously he was vice president of public affairs for the National Association of Realtors.

9 Comments

  1. This article reminds me of the days leading up to the bubble bursting, only this time it is going to be in the rental market. I don’t know how an investor is going to fix his rentals going bad except maybe to sell to homeowners?

    Exactly what you are describing is happening in Philadelphia, in the middle and upper income market. There is a frenzy of construction on apartment units and new homes, all the while the existing newer (5-10 year old) condo homes are not selling most are becoming rentals.

    I believe Philadelphia is still net losing population each year, so eventually one has to figure there is going to be a glut of units at some time in the future.

    • Dennis.

      Thanks for your comment.

      The data on Phlidelphia is not good. Through December year-over-year list ptices were down 6.35 percent in the New Jersey suburbs and 2.24 percent in the metro. Unlike the rest of the nation, inventories were down only slightly down, 2-3 percent year-over-year, according to the latest data from Realtor.com.

      Through the third quarter, foreclosure activity in the Philadelphia was up 34 percent over 2011 and 9 percent over Q2, according to RealtyTrac. Philly’s foreclosure problem isn’t going away soon; Pennsylvania is a judicial state and a backlog is piling up.

      Looks like a great market for investors.

      Steve

      • Steve,

        That is kind of my point, the market is acting like none of the bad in the market is happening while the good (spending on building) rushes forward. In Philly we have these boom and bust cycles every 7-10 years, only this time the next one is starting too soon.
        What most don’t comprehend is the hidden backlog of foreclosures, for example my sister recently lost her house to foreclosure, the original lender allowed her to get about $200k underwater.

        Instead of the process moving fast she was able to with the use of a lawyer keep the lender tied up for 4 years. That’s right 4 years no payments and she did not pay the taxes either, in the end the lender paid her $3500 for the keys.

        During the process the lender agreed to allowed her to stay in the house so as the vacant property would not be vandalized, until a buyer could be found. None was found, and the property is now listed for 50% of her original note. The lender was not interested in any offer of a short sale from me, I think this is because they really did not loose a dime in the transaction due to the TARP money the received compliments of the US taxpayer.

        In PA who knows there could be an avalanche of homes waiting to hit the market.

  2. I see good and bad things when the big boys start playing in the SFR field.
    Pros
    -large interest in protecting landlords, ie more lobbying for better local laws
    -They will run a better business and have less flexibility for poor tenants and subsequently train them to be better tenants.
    -Their lack of flexibility may turn into boon for smaller investors down the road, although you won’t see fire sales. They won’t be desperate to sell like many unexpected landlords.
    -The larger the player, the larger effect they may have on a market. If investors watch them, they may be able to time markets better.

    Cons
    -They may turn SFR into apartment style rents (perks, move in packages, lower rents) Smaller investors will have no choice but to compete.
    -If their practices become draconian in the eyes of the public in some areas (picture evicting a single mother before Christmas, a story from Grand Junction CO), I can see local municipalities making rules tougher.
    -If they become big enough they may push laws to make it tougher on smaller investors to afford. (think big car makers and the regulations they push which prevent new startups)
    -They can quickly saturate the rental market
    -Preowned rental homes may have a stigma like short sales or REO’s do with the retail investor.

    I imagine many things will change in the rental field in the next ten years. There are way to many high dollar interests for there to be negligible impact. The one benefit for the smaller investors is flexibility.

    Steve thanks for the update. I appreciate you keeping us informed on the trends in our industry.

  3. Steve,

    Thanks for noticing this important trend.

    I’ve been land banking in a Denver inner-ring suburb for 10 years in order to build new rental homes. The profit margin is still pretty thin, if you have to borrow 80% of the money to build, you can just barely break even.

    Now that resale values have begun to increase, there will be eventual profit when it’s time to sell.

  4. Steve – great article! We’re actually about to start doing this very thing in Atlanta. With prices of distressed properties climbing as quickly as they are, the prospect of renting a new construction property becomes more and more attractive.

  5. I am not sure if this follows the thread correctly but as an investor how can we leverage a new construction thru a lender to put a tenant in place after completion. Most times the building costs plus the builders margin minus your 20% is not enough to generate much cash flow. Is it even possible to do that?

  6. Jenna Ashford on

    Every nine years, its going to continue to perpetuate the same cycle since the new companies like Jacksonville Wealth Buyers are young, fresh out of college and they like learning the hard way. They are unaware they are in a dangerous game and there are a lot of lifelong residence that have vested interest in the community. And they discriminate by zip codes on public forum. They need to know the law or consider retaining a lobbyist.

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