Will the Build-to-Rent Suffer Set Back Soon?
Originally Published by: The Builders Daily Capital — June 29, 2022
SBCA appreciates your input; please email us if you have any comments or corrections to this article.
Only when the tide goes out do you discover who's been swimming naked." – Warren Buffett
When a saying rings true intermittently – but reliably – it rings all the smarter. The condition "only when" means that at all other times, skinny dippers get to look like everybody else.
Survivors of the 2005-to-2009 housing crash practically shudder to remember the skinny dippers they got exposed to back then, what seems like a lifetime ago. It was not a pretty sight.
Now, as the spigot of money supply tightens and cost-of-living pressures squeeze household payment power for housing, what seemed to be an endless incoming tide has begun to ebb.
Mark Twain was wrong when it comes to the housing market," one homebuilding and real estate we've talked to for more than 15 years reflected on current, rapidly slowing conditions. "History does repeat itself, and it rhymes. We've definitely entered a turbulent time, and it's churning to the negative faster than most of us predicted it would."
Single-family for-sale builders – in a widening gyre of markets and submarkets – were first to see momentum slacken and then simply evaporate. Their pivot to a full repertoire of tactics ranging from incentives, to price pull-backs, to product re-engineering will be the equivalent of turning a mega ocean liner around in a harbor – a slow-motion process at a time every moment counts.
Operating priorities, revenue versus margin assumptions, and reforecast contingencies reflect an array of conditions that are decidedly more bumpy. From the vantage point of historic challenges on the affordability front against a backdrop of already tricky dynamics on the input cost front – all minus the Fed and Treasury enzymes that made nearly everybody and everything a financial winner in the wake of the economic shock of COVID in Winter 2020 – residential real estate and construction's shiny newest toy – single-family built-to-rent looks for all the world like higher ground. It may be.
Wall Street Journal staffers Will Parker and Nicole Friedman report:
Prospective home buyers face affordability issues that are likely to get worse before they get better. Existing-home sale prices reached a record median of $407,600 in May, while sales slid for the fourth consecutive month. Mortgage rates have nearly doubled since January, helping to boost the median mortgage payment for new loans by $513 a month, according to the Mortgage Bankers Association.
With this trend poised to continue—the Federal Reserve has signaled it will continue lifting short-term rates to combat inflation—single-family landlords say they are well-positioned as more would-be home buyers have little choice but to rent.
And this is exactly why?
Is it because it always goes so well when a business believes it can force its customers to ante up on the largest outlay of their monthly household budget and make the business sustainably profitable because they have no other choice but to do so?
Still, other than crypto, non-fungible tokens and fake burgers, few Wall Street investment binges carried so potent a "have-fun-staying-poor" clout in pulling investors all-in on the BTR sure bet blitz over the past 30 months or so. The 212 capital, the white paper, the $300 million or so raise, the contract deal and partial entitlement on a piece of dirt anywhere and everywhere would be a winner.
Just say anywhere and everywhere in residential real estate and the trouble starts.
With apologies to Dr. John [Malcolm J. Rebennack], there's only a few things that can go haywire in a strategy like the one that triggers $45 billion or $60 billion in new investment plans for the residential single-family rental marketplace in the past few years:
- The right place at the wrong time
- The right time in the wrong place
- The right place and time, but the wrong line [product, plan, process]
- The right place and time, but the wrong dime [capital pro forma]
A lot of the deals we saw from peripheral players that didn't know how to get the product, or the location, or the price points, or the operations up, or the land plan, ... they're all starting to flow back in to the market again," says our informed executive confidante. "The debt-fueled expansion of BTR is for all intents and purposes over, as the cost of debt now is greater than Cap Rates. "
Our source notes that, since the lion's share of these deals never reached the stage of vertical construction, the impact of the failed investment remains relatively insulated as the land parcel reverts back into available either raw or developed lot pipelines.
The next question – of worry now to at least some investors – is whether 100% of those projects that have gone vertical in the past 12- to 18 months will make their pro forma business model.
WSJ's Will Parker and Nicole Friedman include this qualification:
Most analysts also say that the current pace of rent growth isn’t sustainable. Renter finances are being pushed to their limits in more cities, according to a new report from Moody’s Analytics. Since late 2019, the percentage of U.S. metropolitan areas where the typical earner would have to spend more than 30% of their income on apartment rent has ballooned, rising to 23% from 8%, Moody’s found.
If rents are pushed too much higher, it could lead to people choosing to double-up in apartments and houses, leading to higher vacancy rates and potentially lower rent growth, said John Pawlowski, an analyst at real-estate analytics firm Green Street.
Pawlowski and other analysts – in light of a decade of underbuilding and the peak home and family formation years of the Millennial cohort – don't see rents heading downward.
There's just one more thing many of those analysts may underappreciate, well articulated here by Housing Wire economics reporter Logan Mohtashami:
It’s not just home price inflation either; shelter rental inflation has also taken off. When supply is low and demographics equal demand, don’t make it complicated, folks. People always need somewhere to live. If they’re employed, they’re either buying a home or renting.
Zero in on the "if" in Mohtashami's assertion.
People are starting to think differently about that "if" now, versus six or 10 or 18 months ago.
Get ready to shield your eyes if you don't want to see BTR's skinny dippers over the next few months.