Rental operators building new rental homes at 6%-8% cap rates as existing supply shrinks

March 27, 2016

Original Story: http://www.jwbrealestatecapital.com/rental-operators-building-new-rental-homes-at-6-8-cap-rates-as-existing-supply-shrinks/?utm_campaign=shareaholic&utm_medium=email_this&utm_source=email

A shrinking supply of existing homes is driving small single family rental home operators such as Kinloch Partners in Atlanta and JWB Real Estate in Jacksonville, Florida, to build new rental homes, according to executives with the companies.

Kinloch and JWB say they are building new rental homes at cap rates ranging from 6% to 8% — in many cases exceeding the yields achieved by larger operators that are exclusively buying existing homes, according to the executives, a single family rental industry analyst and public filings by large SFR operators.

Those larger institutional and public SFR operators say they are still finding a sufficient supply of existing homes, and as such don’t need to build-to-rent just yet. On average, those large players are achieving cap rates ranging from 4.7% -6.5% on existing homes they purchase, renovate and rent, according to the analyst and information published by the companies.

But a build-to-rent model appears to be in the cards for every SFR operator, eventually. American Homes 4 Rent has not yet built to rent, but will at some point, said CEO David Singelyn at an IMN SFR conference in Boca Raton,Florida, two weeks ago. Singelyn said new home construction is not keeping up with demand.

Buying existing homes for use as rentals, “is not going to be, in the future, an effective way to buy at any scale,” said Bruce McNeilage, co-founder of Kinloch Partners. Rising home prices will eventually necessitate building, in many cases, as cap rates on purchased existing homes won’t meet most companies’ yield targets, said the analyst.

According to McNeilage and Alex Sifakis, president of JWB, some of those bigger operators are already building to rent, albeit not directly. Both companies build, rent and then sell homes to large institutional SFR operators, as well as retaining some of the new rental homes for their own portfolios.

They aren’t alone. Speaking at the IMN conference, Phillip Carter, president of Texas Cash Cow Investments said his company has been building to rent for 18

months due to a supply shortage of existing homes. His problem now is finding lots.

On a separate panel, Curt Schade, COO of Pretium Partners and Progress Residential, a private SFR REIT, said that his company has built about 400 of its 8,500-home rental portfolio. However, he suggested the tactic only works in some markets where land prices remain low — mostly in the Southeast.

Some new rentals go to big players

Both McNeilage and Sifakis declined to specify which institutional operators are buying their newly built rentals. But the process appears to work like a mortgage conduit in many cases, where ownership transfers from Kinloch or JWB to the large institution as soon as a lease is signed — assuming other parameters laid down by the buyer are met.

According to the SFR analyst, who also covers home-builders, 20%-25% of a home’s cost is in real estate. Land prices have doubled or tripled over the past year, from USD 4,000-USD 5,000 per lot in middle-class Atlanta neighborhoods a year ago to USD 10,000-USD 15,000 now, according to McNeilage. Kinloch started buying land a year ago, tying up several hundred lots in anticipation of building rental homes, he added.

Construction averages about USD 50 per sq ft — including non-livable space such as garages. By that metric, a 2,000 sq ft home costs USD 100,000 to build, and a 2,500 sq ft home costs USD 125,000. Including land costs, that puts Kinloch’s total cost for a new home in the USD 120,000-USD 160,000 range, McNeilage said.

Rents average USD 1,300-USD 1,500 per month, but Kinloch can get USD 50-USD 100 more per month in rent on a new home, he said. That gels with an estimate provided by Michael Breese, CEO of Homestar Property Solutions, who said at the IMN conference that new homes in Atlanta command an additional USD 100 in monthly rent.

Kinloch averages a net yield of about 8% on new rental homes, McNeilage said. In comparison, the company can buy, renovate and lease existing homes at about a 9% net yield.

Buying existing no longer a no-brainer

The comparison seems a no-brainer, absent consideration that it can take as much time to find, buy, renovate and lease two existing homes as it does to build 10-15 new ones, McNeilage said. Given that disparity, it increasingly makes more sense to build rentals than to compete for a shrinking supply of existing homes, he said.

835919_700 In Jacksonville, lots retail for USD 5,000 in less desirable locations, and up to USD 50,000-USD 80,000 in the toniest, Sifakis said. JWB focuses on the middle of that range, looking for instance to buy USD 20,000-USD 25,000 lots in bulk that could retail for as much as USD 30,000 on a retail, one-off basis. In one recent case, the company purchased 120 unfinished lots for USD 5,000 each, Sifakis said. The company will finish them — adding infrastructure such as electric and plumbing — for an additional USD 12,000 per lot, and then build 2,000 sq ft homes at a cost of USD 45 per sq ft, or about USD 90,000. At that point, JWB will have invested USD 117,000 in each home. They’ll rent for USD 1,200-USD 1,300 per month, which translates to a cap rate of about 7.2%, Sifakis said.

The goal, he said, is to build and rent at a 7.2% cap rate, and sell to an institutional investor such as Invitation Homes at a 5% cap rate. JWB also has its own fund that owns 160 rentals and 140 lots. Those homes will

be sold to a larger investor at some point, Sifakis said. To date, neither Sifakis nor McNeilage have seen much build-to-rent competition from the big SFR operators. But that is inevitable, they say.

“We’re talking to some guys who want us to do it for them,” Sifakis said.

Source: http://www.Debtwire.com

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Meeting the Needs of Consumers, Developers and Investors By Bruce McNeilage In early 2022 I made a prediction. The three-bedroom house would die a slow death. What was once a staple of American construction and homeownership has become as outdated as ‘70s floral couches and wood-paneled living rooms. Consumer demand is pushing builders to create more four- and five-bedroom homes. In addition, existing business conditions make four- and five-bedroom homes the best option for developers and investors. As 2022 played out, my prediction came to fruition. Of the more than 1 million homes constructed in 2022, more than half were four bedrooms or more. That is up from just 25% in 1973. Given current demographics, mortgage rates and work-from-home trends, we expect this trend to continue in the foreseeable future. Older Renters, Work from Home, Drives Need for More Spacious SFR Homes From the consumer standpoint, more bedrooms in a Single-Family Rental (SFR) home makes sense. Most families are clamoring for more space. Millennials, the largest demographic cohort, are entering peak child-rearing years and more space is a necessity. Of course, the global pandemic has played a role in shaping housing trends, as well. More people are working from home and need extra space for one, even two, home offices. More than one-third (35%) of workers with jobs that can be done remotely are working from home all the time, according to a new Pew Research Center survey. This is down from 43% in January 2022 and 55% in October 2020 — but up from only 7% before the pandemic. That’s a five-fold increase in people who need – or likely want – more home office space. While many companies are still hoping to bring workers back to the office, the trend seems to have leveled out. Work from home, in one form or another, is now an entrenched part of the working world and it will continue to impact housing decisions for consumers, builders and investors, alike. Even for a family with only two children, a three-bedroom home no longer has the utility needed for the typical family. Many families are caregivers for an aging parent. In fact, according to Pew Research, 23% of US adults are now part of the sandwich generation — people taking care of an aging parent and a child under the age of 18. These people simply want – and need — more bedrooms, whether they are owners or renters. More families are opting to rent today, as well. The typical age to buy a first home has jumped from 33 years old in 2021 to 36 years old today. It is the oldest ever on record for first time buyers, according to the National Association of Realtors. The rising age is a sign that high housing costs and mortgage rates are pushing homeownership out of reach for younger Americans. Mortgage rates have shot up so rapidly that the average monthly payment on a 30-year fixed-rate loan rose by more than $600 in one year, according to the Consumer Financial Protection Bureau. The CFPB says the average payment for a home purchase loan surged more than 46% — from $1,400 per month to $2,045 — over the 12 months ending December 2022. Likewise, the median total of costs and fees for such mortgages spiked almost 22% to nearly $6,000 in the same period. And with mortgage rates rising to decades-old highs this week, the average monthly payment has almost certainly grown in 2023. This is pushing more people to rentals . Additional Bedrooms Drive up Rental Income, Profits for Builders, Institutional Investors From a business perspective, there is almost no reason for a builder or investor to construct or invest in new three-bedroom homes. If a builder has invested in a lot for $100,000, that is a fixed cost. It is not going to change no matter what they build. A 2,200-square-foot house can be configured with three-, four- or five-bedroom options, so why not go for the configuration that brings a higher profit margin? Won’t an extra bedroom cost more, you ask? Not really. In a 2,200-square-foot house, adding an extra bedroom is a minimal investment up front (approximately $1,000) and will continue to pay for itself over time. Each bedroom can bring an additional $150 per month in rent. That means opting for a four- or five-bedroom house adds $150 to $300 in rent per house per month directly to the bottom line. For builders putting together a Build-to-Rent subdivision, those numbers multiply quickly. A 30-home rental development with five-bedroom homes will yield an additional $100,000 in rent per year. It is as simple as creating a layout that includes five bedrooms. Four- and Five-Bedroom SFR Homes Yield High Occupancy, Positive Cash Flow I have seen this strategy work first-hand. In two of our most recent Build-to-Rent subdivisions, we have opted exclusively for four- and five-bedroom 2,200-square-foot homes in up-and-coming communities. The confluence of demographics (older renters with young families) along with higher home and mortgage costs are pushing more people into high-end rental homes. One key to success is finding cities with growing populations and desirable amenities. Like any real estate transaction, good schools, youth programs, restaurants and entertainment options are important factors. Once you check those boxes, occupancy falls into place. Our occupancy rates are close to 100%, creating positive cash flow, from a demographic of affluent renters with high credit scores. Finally, we anticipate our five-bedroom rentals will add value significantly faster than three-bedroom homes. Whether we hold these assets for one, five or 10 years, the return on our initial investment will be significantly higher with a five-bedroom SFR rental strategy. While no real estate investment strategy is fool-proof, four- and five-bedroom homes show great promise over the next several years. As for the three-bedroom home: You are more likely to see one in the Smithsonian someday. Bruce McNeilage Bruce McNeilage is co-founder and CEO of Kinloch Partners. He has been in the real estate investment business for 33 years, is a national speaker and guest lecturer on the topic of single-family “Built to Rent” (BTR) housing and started his own BTR business in 2005. Kinloch currently owns assets in the MSAs of: Nashville, Tennessee; Atlanta and Augusta, Georgia; and Aiken, Greenville-Spartanburg, and Columbia, South Carolina. Learn more at KinlochPartners.net.