There’s no lack of intrigue when it comes to one of the housing industry’s hottest sectors—build-to-rent (BTR). There’s an appetite for information and data that can help builders better understand the space. Zonda senior managing principal Tim Sullivan interviewed three of the industry’s leading voices at PCBC in Anaheim, California, in late May. The following is an edited transcript of their conversation.
Tim Sullivan: We are here to share some insights, and you’re going to hear diverse takes on different operators’ approaches to BTR, because one size does not fit all.
This BTR space came from the Great Recession, because there were some very intrepid investors out there that realized, “We could buy a whole bunch of products at replacement cost.”
Then they got smart and realized that we don’t have to buy just one by one, we can buy a whole bunch of ones. There were some institutions that were created from it, and it became a smart way to invest, particularly when we were in a Great Recession.
Then suddenly, the intrepid investor said, “Wait a minute, we can go straight to the builders, and we can buy at a discount. We don’t have to use a Realtor.”
That would work until it didn’t because home prices went up.
When you think about why—why are we doing this?
One: There’s a housing shortage.
Two: There’s a shortage of housing that is associated with incomes.
Last year builders were saying, “I’ve got too much supply. I’ll rent it.” And then suddenly, the market improved at the latter part of last year and the first part of this year, and they didn’t want to rent anymore because the market is back.
Now keep in mind, this is still a fragment of the housing stock. We have 335 million people here. We have 170 million households. Looking at those numbers, we’re adding 100,000 units a year. It’s a drop in the bucket. So, when you ever hear that BTR has taken over the world, just know that it’s still a very small portion.
Tell us about the product you’re doing.
Donald Povieng, co-president, Empire Communities: We’re a bit unique in that we’re a Toronto-based home builder with a 30-year track record of building everything from single-family detached houses to 50-story high-rise towers in Toronto.
We expanded into the U.S about 10 years ago with master-planned communities, and we were just selling land off to builders.
In the process of trying to sell them, we realized it’d be easier if we could just build our own houses. So, we set up our own builder out of Houston and acquired builders out of Austin, Texas; Atlanta; and Charlotte, North Carolina. In the process of acquiring different builders, we ended up acquiring the ability to build a lot of different product types.
That has really guided us and has allowed us to really build everything from single-family detached homes, duplexes, townhomes, horizontal apartments, as well as traditional multifamily product.
And the way we think about it is the same product doesn’t always work in each of these markets. We really need to adapt to what our renters look for, and zoning allows for, and that allows us really to be able to underwrite deals from four or five different perspectives.
If the deal doesn’t underwrite as multifamily, will it work as a BTR townhome? Will it work as a horizontal apartment deal? And that’s been able to salvage quite a few deals for us where the original underwriting didn’t work. We just headed to a different product type.
Sullivan: That’s another thing to consider if you’re in this space. The fact that you need marketing and you need to understand the local market, you must figure out how to build things. And if you’re trying to build that on the fly, don’t do it.
Rachael Kish, director of strategic initiatives, Christopher Todd Communities: I love this space because of the niche that it serves. Our residents are a specific demographic with a specific way to live. As we move nationally, we’re able to take that offering, localize it, and serve a very particular demographic in an exciting way.
Sullivan: So, I would argue that Rachael’s side perfected a product and process. They find the right locations for that. Donald finds the right location based on a certain set of metrics and adapts the product. Thomas, you guys are probably one of the big original players in this space. Talk about how you got into it and what you focus on.
Thomas Fichman, senior vice president investments, Tricon Residential: In addition to our core business of buying and renovating existing homes, we’re also building a significant pipeline of BTR communities, with 25 communities comprising approximately 3,200 homes currently under development. Tricon has a resident-first strategy. We strive to deliver superior service and drive long-term resident satisfaction and financial stability, which we believe is good for our residents, good for business, and for the sector overall.
Sullivan: Go back to the element of you guys having a resident-first approach. This sounds like just a tagline, but it’s not. Tell me what it means.
Fichman: I think the brand is really important. We believe in our brand, and it’s defined by our commitment to provide quality housing in good markets and provide superior service to our residents. It’s really driven by our brand awareness and ultimately has contributed to our strong corporate reporting. We have an industry global low turnover rate of less than 17%—that means our residents stay with us for about five years, which is not that far off for what a homeowner spends in their house.
Sullivan: Tell us how that contrasts that with apartment turnover.
Fichman: Much higher, so you’re probably looking at closer to 50% in that case. If you look at our fundamental resident, it’s American families looking for quality housing, quality rental housing, and in good markets. We’ve tended to focus on what we define as the middle market, and our residents will typically have around $100,000 household income. And we find that those tend to be longer-term renters that ultimately helps drive our operating performance.
Sullivan: Talk to us about how you guys have evolved.
Fichman: Brand is something that is important to us with our real estate developers who care deeply about that resident experience. When we came into the space, we really pioneered smart-home technology. Now everyone is doing smart-home technology. But at the time, that was just an example of how we were going to let the brand live in people’s lives to create convenience.
Now we’re thinking of other ways to innovate beyond technology, so concierge and health care coming right to your doorstep. So, when we talk about the brand, it really boils down to the experience, and when there’s wonderful positive experiences in the life of residents, they will be very motivated to stay where they are. And that’s the whole point.
Sullivan: Donald, I mentioned there’s been a snapback for some rental coming back to for-sale. Do you have any concerns in any market about oversupply?
Povieng: There is a concern of oversupply in some markets. I think Arizona is a concern. There’s so much of the same product, but as you go across the country and look at other geographic areas, we’re not as concerned. There are some markets that we are hypersensitive to in terms of oversupply, and we’re constantly watching those numbers. But generally, if you look at how much market percentage of both threats and similarly where rental has been, we still fall under 5% of the overall market. We’re not concerned with the oversupply.
Fichman: I think what Donald’s saying it’s completely right. If you look at recent data, it seems to show that supply, at least in the markets Tricon operates in, it’s reverting to pre-pandemic levels. And it also appears to be stabilizing.
It’s generally accepted that the U.S. housing industry is about 4 million homes undersupplied. When you combine that with homeownership affordability challenges, as well as what I view to be favorable demographic shifts to millennials as they continue to shift their household formation years, the demand and supply fundamentals of single-family rental remains very strong.
Sullivan: Let me do a true/false question, and it has to do with schools: “Schools don’t matter in my space.”
Povieng: False.
Kish: True.
Sullivan: Why don’t schools matter, Rachael?
Kish: I would say from a transaction and resale standpoint, of course, schools matter. Buyers always put that box on their list. From an operating standpoint, our product offering is primarily one- and two-bedroom homes.
So, we work with a recent college grad, maybe an older 20-year-old, no children, and then also a retiring demographic where there are no children in the home. They’re just chasing their children and grandchildren across the United States.
We actually don’t have a lot of demand for grade schools from our particular demographic. That’s been a really positive story that we can sell in the municipalities because we can go in and say, “Hey, do you want to work with us? We don’t create an overburden on your school system.”
Sullivan: And so, over to Donald, because now we’re talking about, at least on the three- to four-bedroom product, backyard, family.
Povieng: I think Rachael summed it up well. Schools matter depending on what product type you’re building. So, if you’re one with studios, ones-, and twos-, schools don’t really matter as much, but once you get into the three- and four-bedroom range, schools are huge.
Sullivan: We’ve got an issue with financing. The banking industry is in dire straits right now. Our small regional banks are frozen. There’s a fear out there. How are you guys negotiating the capital stack?
Povieng: The narrative of this industry was that rentals are a great inflation hedge. Well, it’s a great place if there’s permanent financing in place, because in the absence of that it’s a struggle. A year and a half ago, we were turning down pension fund money because we had other relationships. We had other money, buckets of capital that we’re working through, and several different debt providers, we really had our pick. You take a project out, we’d have 10 term sheets, and we just negotiated with any lender we wanted.
I would say nine months ago things started changing. You started to see term sheets being pulled, you started to see some concerns with some of the lenders. And you know, I think fast-forward to the fourth quarter last year, you know a lot of the deals that we had on the table were pulled or they were pencils down until next year and we’ll see what happens.
In the first quarter this year, things have been starting to open up a little bit. There are some groups still that are saying, “No, we’re still pencils down until Q3 of this year.” But we’ve got two multifamily deals that we’re putting the capital stack together on right now. Pretty good interest overall. But it’s not 10 term sheets anymore. We’re working with three term sheets, and frankly we’re takers of some of the fees and structures that are part of it.
A lot of brokers love that we have that track record, and you can stand by what we’re doing. A lot of lenders have said we’re one to five groups that they’re willing to lend to right now. So, we’re fortunate enough, but it’s very difficult.
Sullivan: Right now is probably the single most difficult time if you decide to start a BTR company. My suggestion is wait two years, just because of capital availability.
Kish: Capital’s an ongoing conversation It seems like initially when our CEO set out, built around this, the sector didn’t even have a name. It was just these little cottage things. That’s how we refer to them. He couldn’t get a bank to talk to save his life. Eventually, he knocked on enough doors and developed a great relationship with a regional bank, and that’s how he was able to develop his first seven.
Now we’ve got the track record. He’s proved his point, so that’s helpful. He has a substantial balance sheet. So many of the deals that we’re looking to build right now we could just build them for cash. While that’s not necessarily ideal, it’s an option.
Sullivan: Thomas, what metrics are you watching?
Fichman: I think the two most prescient metrics in history, but particularly over the last 12 months, have really been interest rates and months of housing supply. I mean those really told the tale as we worked through the more challenging conditions in the second half of last year. So those are those are two metrics that we always have.
Sullivan: And as you guys probably know, existing-home month’s supply has gone like this in every single market. We are horribly undersupplied, pushing prices up again. And we are in place I’ve never seen in my four decades of market research. If you knew everything we know now, would you still get into the BTR space today?
Fichman: The answer is yes. Assuming I have the three key ingredients to be successful, or at least have a chance to be successful, in this space, which is first, available equity and debt capital. No. 2, an established operating platform, and No. 3, local established support.
Kish: Oh, absolutely. There’s so much intrigue around BTR, and the demographics have changed so much that the housing offerings need to keep up with that new demand.
Povieng: I would say yes, as well. When we started our platform, COVID wasn’t a thing. Inflation and high interest rates weren’t a thing. The banking crisis wasn’t a thing. And so, as you start to go back and think through what’s happened in the last three or four years, all of our growth strategies and business plans basically have to be rewritten every three months.
This space is so new. I remember attending a conference five years ago, and I sat next to this lady. I asked, “So, what do you do?” She said, “I’m a dentist. I purchased five buildings, and I’m trying to figure out what do with the space.”
And now as you as you go through the recent years, you’ll start to see folks from D.R. Horton and Lennar and others get into the space, and so it’s constantly evolving. We’re really early in terms of the stages of how this industry and this product segment will evolve.
I think we’re going to start to see some interesting consolidation as you start to have distressed properties or deals with distressed operators. I think you’re going to have these land holdings, but they can’t get financing. I think you’re going to see some aggregation there.
