Housing: Interest Continues to Rise for Build-to-Rent vs Build-to-Sell
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Dan Oppenheim , CFA
June 4th, 2019
Interest Continues to Rise for Build-to-Rent vs Build-to-Sell
- Single family rental (SFR) conference discussions focused on build-to-rent homes. We attended a single-family rental industry conference, where the focus shifted even further to homes to be built as rentals. While single-family home sales to owner-occupants have slowed as of late, there remains plenty of enthusiasm for and capital available to the build-to-rent segment of the market. We remain Neutral on the single-family rental sector based on the improving affordability in the for-sale market (primarily driven by falling mortgage rates), which could in time driver higher move-outs to buy, especially as this is occurring at a time of worsening affordability in the for-rent market (increasing rents). We prefer Invitation Homes (INVH) to American Homes 4 Rent (AMH) based on INVH’s focus on markets where the for-sale market is less affordable, which should lead to lower turnover and higher rent growth over time.
- Strong demand from residents has led to ample financing for build-to-rent homes. The healthy occupancy in the SFR – AMH and INVH announced same-store occupancy of 95.8% and 96.6%, respectively in April/May 2019 – has led to greater willingness/eagerness to commit capital to the sector, with lenders typically offering 90% loan-to-cost construction loans, with permanent financing upon completion of the home at 75% loan-to-value (LTV). This availability of financing will likely lead to an increasing share of single-family construction focused on the rental market, but unlikely to leading to overbuilding of single-family homes.
- More homebuilders in attendance, recognizing the opportunity in build-to-rent. Despite great similarity in the homes, we’d previously seen little overlap in attendance at SFR conferences by homebuilders and vice versa. However, we saw senior representatives from many of the large homebuilding companies, especially those with success building homes for first-time buyers. We think the scale and experience of these homebuilders provides a significant advantage relative to new entrants trying their hand at single-family construction.
- Yield compression for stabilized portfolios leading SFR owners to build-to-rent strategy. As capital has continued to flow into the SFR sector and has led to lower yields and higher SFR values, we’ve seen more SFR owners consider build-to-rent programs, as the build-to-rent strategy offers the potential for greater yield. Many in the SFR sector view stabilized yields on acquisitions of 5.5% to be the standard, with these owners hoping to achieve a 100-200 basis point premium via build-to-rent, capturing profitability in both development and lease-up. We believe SFR owners who attempt to build homes, but with limited scale will face both cost impediments and operational challenges. SFR owners who plan to purchase homes upon completion from homebuilders may forgo some potential/theoretical profit from construction, but will fare better by utilizing the experience and scale of large homebuilders.
- Other themes: automated valuation models, overpaying for homes, affordability. SFR owners expressed concern about buyers utilizing automated valuation models, believing that many of these buyers were overpaying. A related concern was of worries about the heated market for portfolios of SFR properties. On the operations side, some owners emphasized their awareness of the higher rate of rent growth than wage growth in recent years, worrying that this gap may become unsustainable and cause affordability challenges if rent growth continues to outpace wage growth.
Interest Continues to Rise for Build-to-Rent vs Build-to-Sell
|Exhibit 1: SSR’s Preferences Among Housing-Related Sectors|
|Source: SSR analysis|
Positive outlook toward housing sector given sensitivity to interest/mortgage rates. We expect the improving affordability to drive greater home sales, home improvement, and home price appreciation. Among stocks, we see the greatest opportunity in: MAS (building products); DHI, MTH, and TOL (homebuilders); LOW (home centers); and AVB, EQR, and INVH (REITs).
Preference for INVH over AMH, as INVH’s market exposure limits competition with for-sale.
We prefer INVH to AMH as INVH that it generates over 40% of its net operating income from the western U.S., where for-sale affordability is less attainable. This advantage from its market exposure was evident in INVH’s renewal lease growth of 6.8% in its Western region in 1Q19, significantly above the 5.2% for its overall portfolio. Renewal growth was more modest in Florida (up 4.7%), the Southeast (up 4.2%), Texas (up 3.6%), and the Midwest (up 2.4%). In contrast, AMH generates just over 10% of its NOI from the western U.S. (primarily Phoenix, Las Vegas, and Denver), with AMH’s largest markets being more affordable markets in Texas (Dallas, Houston, and San Antonio), the Southeast (Atlanta, Charlotte, Nashville, Jacksonville, Tampa, Raleigh), and the Midwest (Indianapolis, Cincinnati, Chicago, and Columbus). We believe AMH’s greater concentration in more affordable markets and often at relatively higher price points within those markets will result in greater turnover and reduced pricing power over time.
Build-to-rent represents a small share of new construction. We estimate that only 5% of single-family starts are build-to-rent homes, with this representing approximately 45,000 of single-family homes out of the 876,000 total single-family homes started in 2018. In addition, large SFR owners represent only a small portion of the overall build-to-rent market, with each individual SFR owner building a maximum of a few thousand homes per year. In contrast, the largest homebuilders build over 50,000 homes annually, leading to significant efficiencies. Homebuilders often construct a few homes in each of their communities as rentals, typically those homes with the least favorable location within the community. However, homebuilders are also looking at the opportunity to build full communities of homes for SFR owners as build-to-rent homes. This would help the homebuilders via increased volume, and we also see benefit to SFR owners (the buyers of these communities) based on the scale of the homebuilders, the ability to complete construction on schedule, and the understanding of land development. However, we see the risk outweighing the benefits for SFR owners that attempt develop communities on their own through in-house construction division.
Will too many homes be built as SFRs? Not a risk of oversupply, given overall level of construction. Excess capital flowing into a particular real estate segment can often lead to oversupply. However, even as construction of build-to-rent homes is increasing, we do not think this will lead to an oversupply of single-family homes. The key issue is that while there may be too many homes built as rentals, the overall level of construction of single-family homes is still at a low level. Construction of single-family homes (876,000 started in 2018) has increased from the lows of the housing downturn (431,000 single-family homes started in 2011), but are still far below the peak level (1.716 million started in 2005) and a normalized level of approximately 1.1 million annually. As a result, if there is a shift in the consumer demand and greater desire for ownership, these homes built as rentals can be sold, rather than rented. In most cases, the finishes chosen for SFRs emphasize durability and cost, but are not so different than traditional entry-level homes and should appeal to first-time buyers.
Focus on decreasing construction costs due to continued escalation of labor costs. Homebuilders cite the need for further standardization of homes and panelized building systems to reduce construction costs. Several small SFR owners also mentioned their efforts to reduce construction costs, but we do not believe SFR owners have sufficient scale or experience to build homes at a similar cost to large homebuilders.
Concern from SFR owners that buyers using AVMs are overpaying for homes and overall concern about acquisitions. We heard owners of SFR portfolios express their surprise at prices paid by buyers utilizing automated valuation models (AVMs) to assess pricing of SFRs.Our view is that the comments reflected both frustration at their own inability to acquire homes as those buyers using AVM models were willing to pay higher prices, along with slight concern that the market was getting overheated. SFR buyers noted the challenges in finding attractive acquisitions of both individual homes and larger portfolios.
Potential for the SFR industry’s strength to go too far via affordability challenges. TheSFRindustry has succeeded in creating attractive homes for residents, leading to high occupancy rates and rental rate growth in recent years. Unfortunately for residents, this annual rental rate growth of 4-5% has exceeded more modest wage growth that has been closer to 2% for most SFR residents. Those SFR owners with experience in rental housing were both aware of and worried by the faster pace of rent growth and the risk of affordability challenges for residents in future years. In addition to the rising cost of renting as a result if the steadily increasing rents (INVH noted that it achieved 5.6% year/year new lease growth in April and 5.0% year/year new lease growth in May), the cost of owning has been decreasing as a result of slowing home price appreciation and falling mortgage rates. We continue to believe that this divergence (rising cost of renting at a time of a declining cost of owning) will lead to an inflection point in turnover, which has been at exceptionally low levels (31% 12-month turnover for INVH in 1Q19 was a record low for INVH).
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