InterFace Panel: Site Costs, Entitlements Processes Contribute to Build-to-Rent Projects’ Unique Risk Profile
ATLANTA — The build-to-rent (BTR) space boasts a scintillating story of short-term success, driven by demand from households that rent by choice and want the feel and privacy of owning a home without dealing with maintenance and paying property taxes.
Building to rent involves developing residential properties with the explicit, predetermined purpose of renting them. This differs from single-family rental (SFR), a more established practice of buying existing single-family homes and renting them out that has its roots in mom-and-pop investments but is now being adopted by larger companies.
The rapid growth of the BTR space has brought challenges that are markedly different from those of building and operating traditional multifamily and student housing properties. A panel of experts outlined some of these commonplace hurdles at the 12th annual InterFace Multifamily Southeast conference on Thursday, Dec 2. About 350 industry professionals attended the event, which took place at the Westin Buckhead hotel in Atlanta.
For starters, the space can be tough one to break into. Developers undertake different strategies for launching their BTR platforms and divisions, frequently partnering with single-family homebuilders or leveraging existing relationships with third-party general contractors. This is largely because these developers lack the in-house construction experience and expertise that these projects require.
“Historically, in terms of vertical construction, multifamily developers haven’t built many three- and four-bedroom townhomes and detached residences,” said panelist Chase Davidson, manager of the SFR division at Atlanta-based RangeWater Real Estate. “On top of that, owners in the BTR space have to combine the land acquisition and development pieces with the operations side, which has a lot of nuances relative to traditional multifamily.”
As BTR developers grapple with learning curves and growing pains — as well as natural barriers to entry — some of the biggest headaches they encounter tend to come in the early stages of projects. Specifically, these challenges include accurately forecasting land acquisition costs and modeling rent growth, both of which are key metrics for potential investors that need to understand the risk-reward proposition.
Because the BTR space is relatively new, with minimal performance data surrounding it, models for rent growth are somewhat unproven. This complicates the efforts of lenders and developers to accurately underwrite risk in new projects. Further, SFR developers cannot rely on comparable multifamily deals for a given market or project size when creating risk profiles, partially because the unit-to-land ratio between the two differs tremendously.
“Site costs are a huge part of the cost structure in this space, starting with everything you’d see in a traditional apartment project, like soil conditions, wetlands issues or need for more roads and utilities,” said panelist Blair Sweeney, managing director of the BTR division at student housing developer Landmark Properties. “But with BTR, you’re developing six to eight units per acre instead of 30 units per acre in a regular multifamily deal. So any issue with the site is magnified because there are fewer units over which to spread the cost.”
Developers of BTR product also tend to have longer lag times between when they identify and acquire a site and the start of vertical construction. Davidson of RangeWater explained some of the typical pitfalls that these developers face in these regards.
“A lot of the deals we do require some sort of rezoning; in a lot of cases the zoning for this property type doesn’t exist,” he said, adding that many of his firm’s projects that are currently in development won’t actually have homes on site until 2023. “The entitlement process is also different in every jurisdiction. The situation is fraught with risk as municipalities work to understand this property type and take different views of it.”
Part of SFR developers’ jobs involves educating the municipalities in which they want to build on the appeal of the product type. Often this occurs in advance of the entitlement process, noted panelist Eddy O’Brien, managing partner and co-founder of Blaze Capital Partners, a multifamily development and investment firm based in Charleston, S.C.
“You do a lot more upfront due diligence before you even get into the entitlement phase, just to vet what a certain municipality will require or what box you can check,” he said. “That lends itself to flexibility of design and owning your own product. But partnering with other homebuilders that know where their product fits within that market is key.”
Homebuilder Help, Harm
Moderator Walker Harris, area vice president and director of operations at Walker & Dunlop’s Atlanta office, pointed out that the BTR developers face another unique challenge and risk component: They compete with pure-play, single-family homebuilders and also have to partner with them at times.
“A lot of publicly traded [single-family] homebuilders are converting portions of their pipelines to build-to-rent as well,” Harris said. “In a world in which capital isn’t scarce but lot inventory is, and in which [Miami-based homebuilder] Lennar can snap its fingers and add 10,000 lots to their pipeline in a day, what’s your competitive advantage?”
O’Brien addressed this conundrum first, saying that his firm shied away from directly competing with top-dog homebuilders, preferring to collaborate with them instead. He added that this approach helped Blaze Capital Partners minimize some of the entitlement risk on its first couple projects — an advantage that ultimately proved to be short-lived.
“On our first three deals, we worked with a homebuilder, went through their lot inventory and found that the economics would be similar if they flipped us some finished lots and we brought them in as a builder,” he said. “That helped us tap into that pipeline [of lots] and work around some of the entitlement risk. That window of opportunity lasted six months, as homebuilders realized they had something and decided to go compete on their own.”
“The mid-sized and smaller homebuilders that are likely to partner with us are starting to better understand the space and the capital markets within it,” O’Brien continued. “So it’s going to be interesting to see how the dynamic plays out in the next couple years as a lot of these early-inning deals start monetizing.”
Other panelists chimed in to share their experiences of working with single-family homebuilders, highlighting the differences in how each side approaches site acquisition, structuring of fees with partners and customization of product. The group concurred that as demand for SFR properties grows, the relationships between the two sides will also evolve, often straddling the line between harmonious and contentious.
“A lot of it depends on the homeowner and whether they’re trying to move into an area in which they don’t have relationships or scale,” said panelist Stephen Furr, vice president of development at Atlanta-based PeakMade Real Estate. “Having [BTR developers] as equity partners and sources give homebuilders a chance to have a multi-development partnership that gives them access to relationships and inventory that they can produce at very low risk. So there are relationships here that can be built and expanded upon.”
— Taylor Williams