293: Build to Rent Phenomenon with SFRHub's Michael Finch

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It's my pleasure to welcome Michael Finch. He is a principal at SVN and SFR Hub Advisors. Michael, welcome. How are you?

I'm doing very well, thank you.

Good, good to have you. And you're coming from Phoenix, is that correct?

We are headquartered in Phoenix, yes.

Good stuff. So build to Rent. This is a somewhat new, I mean, you know, it's always been happening throughout history I guess, but it's really catching on. The BFR model where you know, people are basically developing homes, single family homes many times or residential communities of townhomes for rental, not an apartment building. Little different. Tell us about the model and why it's attractive.

Well, it's attractive for many reasons. You know, one, we've got a shortage of supply across the country of rental product. Whether it's, you know, more affordable rental product or just rental products in general. You've got 40% of the country today that rents. Of that 40%, roughly, I think it's like 37% prefer to rent single family detached homes. So you know, when you've got nearly 18 plus minus million people renting detached single family homes and the population is growing more and more with both millennials, Gen Xers and baby boomers all preferring to rent or choosing to rent and or even if they're not choosing to rent, they can't afford to buy. 54% of the country can't buy. So it's all spurring the growth of the build for rent model.

I mean it's not just the fact that they are in a position where they either want to or need to rent. It's because they want to. But they don't want to live in an apartment complex, right?

Oh, exactly. I mean you can't. Most of the apartments that are being built, you know, are all, you know, 70 plus percent one bedrooms and efficiency units and then the balance being two bedrooms. So you know, there's very few outside of, you know, the older apartment buildings that were built in the 80s that even have three bedrooms anymore. So you know, if you're a young millennial. If your boyfriend, girlfriend, you got a dog, maybe you're having your first kid or getting married, you typically want to live in a three bedroom home. If you're a married couple with children, you have to have at least a three or a four bedroom home. And maybe you need an extra room for an office or you're a baby boomer downsizing from, you know, a three or four thousand square foot home and all the kids are gone and you still wouldn't want to move into a two bedroom apartment. You want to have a yard and a backyard and the privacy of single family living. So it just makes a lot of sense for a lot of people.

What kind of deals do you think are ideal in the bfr, the build for rent model? What's the style of home? What's the price of the home? What metro area? How much rent do you command for sort of the stereotypical deal, if you will.

I would say the stereotypical deals are really happening in the sunshine smile of the country though. We are starting to see some build for rent happening in the Midwest as well, but predominantly in the sunshine smile of the country. Country.

And, and so what that really does just, just so not everybody knows what that means. You know, if you looked at the map of the US and you put a smile, the, you know, a smiling mouth across it, that's the kind of the shape that he's talking about, correct?

Correct. So I mean you're, you're really anywhere from California all the way to Virginia kind of that smile that encompasses, you know, Arizona through Texas into Florida, Georgia, you know, up to the Carolinas. That kind of covers the spiral of the country. And by and large, the ideal build for rent home is very similar to a typical entry level, first time buyer home. So very likely under 250,000. They certainly can be more than 250,000 if they're located in the right sub market. And the rents make sense. And you have an affluent population that's also choosing to rent, which we're seeing in large numbers. One of the biggest rent growth populations today is an affluent market that makes over $100,000 a year. So we see it all from those that are willing to pay 1350 to, you know, 17, 1800amonth for a nice, you know, single family home, all the way up to, you know, those that are willing to pay, you know, 2,500 to 3,000 that could easily afford to buy a home, but they just choose to rent. It's a unique product.

So if they're paying 13 to $1,700 a month. How much are you paying to acquire that house?

Well, again, it's also market specific, but if you were looking, you know, in that, I would say 15 to 1700amonth range, you know, you're going to be in the low twos to maybe mid twos.

Yeah.

And.

Yeah, yeah, yeah. I got to tell you, I mean, that rent to value ratio is not super exciting for the investor, is it? You got some appreciation built in there and.

Well, you got to keep in mind that these run much more efficiently than a typical apartment. You know, when you have single family detached homes, the resident is paying the water, the sewer, the trash, the electric, you know, the cable, the WI fi, your operating expenses are significantly reduced.

Yeah, okay.

You know, typical, typical apartment building is running around, you know, 40% of gross, where a typical bill for rent, really depending on the location, you know, that is taxes and insurance, you know, can be anywhere from, you know, 27% operating expenses up to usually 35 on the higher end.

Well, and the other thing you didn't mention is that the turnover is lower, right?

Turnover is drastically lower. The residents that rent in a single family build for rent subdivision, you know, on average are saying, you know, much closer to four to five years. There's almost a pride of ownership that happens when you, when you move into a new home to rent and you're typically moving there's, you know, because of nearby jobs and the school districts, you know, so it's not economical to pack up in a year or two, you know, a three, four bedroom home, and then try to find another home within the same zip code or school district or near the job. So the 10 year is drastically longer than the typical apartment dweller, which is about on average 14 months.

Good. Okay. What else do you want people to know about this? And you know, just the whole build for rent thing, I mean, you do have to pay a bit of a premium. You know, you used to be able to get the 1% rule right. It's just the market has just appreciated significantly. So you just can't command those types of rent to value ratios anymore, which, you know, makes a lot of investors wish for the good old days. But you know, in a few years we'll be thinking this is the good old days. So.

Yeah, maybe, but you certainly have to be a bit more sophisticated than investors were in what you call the good old days, which is when, you know, things were, you know, 50 cents on the dollar. Yeah, that's not where we're at today. But There's a lot of savings both for the builder and for the buyer. So let's take this as an example and say a builder was going to build 100 single family homes for 250,000. That's what he would be selling to the retail consumer. You know, if he was going to sell one by one by one to homeowner, that may take that builder three and a half years, you know, to get out of that community, to sell, you know, from start to finish to start selling the first home to get out and sell the last home in a build for rent where we're bringing investors to the table sooner, much sooner into the development where the builder can deliver, you know, say 10 homes a month to a buyer. Well now that builder, instead of selling the homes for 250, maybe they're selling them for 235, but they're out of that community in say 10 or 11 months. So that's a significant reduction in their builder warranty expense and their land carry costs. They may be able to bring down the finishes and oftentimes they do to where they're not building to a for sale product, but you know, a nice durable, almost like a class A apartment building build, you know, putting in finishes for rent instead. So there's a lot of cost savings that they can bring down and actually make more money and maybe do two projects in the same amount of time as doing one. But those cost savings also get passed on to the buyer. So if the buyer is buying, you know, what would have been a $250,000 home and they're getting it for 235,000, for example, well, you know, they're starting off with equity in the home and they're probably, you know, depending on the location, which, it's all a factor of rents, but you know, $235,000 home, you know, should be renting at 17, 1750, 1800 and that's not a bad return. And keep in mind you've got no capex, you've got very little turnover, very long term tenants, very low operating expenses compared to, you know, either new construction apartments and certainly older vintage apartments. The stabilized cap rate would typically be probably a six and a half percent, may be better, but you can't buy a C class apartment building in today's market at a six and a half cap rate in most sub markets. So you've got new construction with very little to no maintenance, no capex, very affluent or even if not affluent, but higher quality tenants.

I agree, you don't have to Convince me. I agree. Single family is just a better market. Yeah.

And in the long term, you've got greater liquidity and greater, greater appreciation, most likely. So if the housing market appreciates now, you've got a hundred homes that if you wanted, you could sell one by one or in smaller chunks to smaller investors.

Or you can sell them, you can sell them to an emotional buyer who wants a home rather than an investor. So it's a whole different animal. Do you have any special financing for people who want to buy portfolios like this? You know, are you working with, you know, some of the typical companies out there or. Just talk to us about the financing side. You know, someone wants to buy 10 properties at a time or they want to buy 100 properties at a time. How do they do the financing?

Well, we work very closely with Walker Dunlap. We've been working with some of them on the build for rent, purposely in that they're putting together bridge loans. And there are other groups that do this to Corvus, who we work with Lima Capital, you know, five Archer. There's a lot of groups that we've worked with finance the sfr, okay. That play in the SFR space. But in particular we've been developing, and Walker Dunlap developed a program for developers and builders to do construction and vertical financing and then for the buyer bringing in bridge loan financing. You know, if the buyer is going to buy 100 homes in tranches, so say 10 homes a month, you know, so then they can work to, you know, lease those homes up and close, you know, on a bridge loan per tranche. And then once the community is finished, you can roll it into permanent debt. That's a lot more attractive. The same type of debt structure you can get on an apartment building.

Yeah, Very really interesting. So it's one blanket loan for all of the single family homes. Right.

It would be multiple bridge loans and then you roll it into permanent debt.

Yeah, got it. Good stuff. Okay. What else do you want people to know?

I would like people to know that this is really just in its infancy. You know, this is a brand new commercial asset class. And I honestly think it's going to be one of the biggest asset classes moving forward. People have been doing build for rent, you know, kind of small local builders and, you know, markets across countries for a long time, but not to the scale that it's approaching now, where buyers, especially large, you know, institutional type buyers, you know, the multinational, you know, asset type buyers and family office private equity groups, I mean, they, they're Looking at this and they want to see fully amenitized communities because the demand is there. But it works, it works equally as well if you've got a 20 lot subdivision to build for rent. So, you know, it can be small subdivisions, medium, large. You know, typically we see Once you're over 120 units and build for rent, you know, you're going to want some amenities, probably a clubhouse and a pool, fairly similar to apartment buildings. But if you're under that number, you probably don't need those amenities and then that helps, you know, just drive your operating costs down even further.

Yeah, really interesting. Something you were talking about earlier was how the builders can exit their developments a lot faster. And this really has to be just turning the home building industry on its head. They are not used to this type of thing at all now. They're sort of needing to act if they want to take advantage of this opportunity. More like an apartment developer versus, you know, and before they used to stay. Well, they still do, obviously, but you know, stage things out in phases and build attractive homes rather slowly, frankly, you know, over about maybe three, four years. But now if you've got investors who can just gobble them up as they come online. But in the past, builders were very reluctant to have a bunch of investors in their communities. They don't want to see a bunch of for rent signs. They think it's scare off the homeowners. So is it kind of an all or nothing proposition where you got to go to the builder and say, look, we're going to sell everything to an investor or is it we'll sell some of your units to investors. And then they're thinking, well, we don't want too many investors in here. How does that dynamic play out?

It is not an all or nothing anymore. And so I'll first address, I think the opportunity and the reason that a lot of the public regional builders are looking and now doing build for rent one because it'll be the first time in history if there is a market slowdown or correction or I know some people are hoping for a big recession just to buy cheaply again, but if there is, it'll be the first time that builders can continue building. They don't have to stop production. If people are losing homes, they're going to want to wrap homes so a builder can just keep building and investors can buy the homes and rent them. That's unique in and of itself because the demand is there today. And if there's a market correction, there's just going to be greater Demand because people will have lost their homes. And it's already happening today where, and has been for quite some time, a number of years where builders have been selling portions of the community, maybe the last 10% or the first 10% or just some scattered homes, you know, to investors in those communities already. The stigma of a renter just isn't what it used to be and it's becoming less and less what it used to be. Just given the huge number of Americans that are choosing Trent today.

Oh, yeah, no, no, I don't deny that. That's definitely a new trend and it's, I think it's a good one. I think that's actually healthy.

I think it's a great.

I'm not in favor of this high homeownership rate. I think that's a bogus idea.

Well, I don't think the government is either because they seem to be passing more legislation that tax favorable to homeowners.

Well, if you're in one of the high salt states, yes, you're right. Why people are leaving California, New York.

The Tax Cut and Jobs act increase the standard deduction for many people, eliminating the deduction they can take on, on homeownership. So.

Yeah, yeah, you mean from the million to 750, right?

Definitely true. So it's, it's interesting. No, I think, I think that's a, that's a healthy trend. But what I'm saying is from the developer's perspective, from the home builder's perspective, that's what I was really referring to. So yeah, interesting stuff. Wrap it up with a thought for us and give out your website.

Well, I just want to thank you for your time. To any of the capital groups and apartment investors out there that haven't started looking at Build for Rent space, I encourage you to call, call us here at SFR Hub Advisors and or take a look at our technology platform which is a data valuation and digital transaction site. @sfrhub.com we would love to talk. We spend a lot of time just consulting and educating and kind of spreading the gospel, so to speak of Build for Rent. We are big believers and think it's going to be the biggest asset class in commercial real estate. Moving forward, I think we have a very, very long way Runway for the Build for Rent developments.

Good stuff. Michael, thanks for joining us.

Yeah, thank you.

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