I am taking a firm stance the BTR talk is the most overhyped bs in decades. The only exceptions might be in military towns or other places with a more transient workforce. Everyone else will get crushed. This whole situation is just a product of GP’s convincing LP’s there’s this hidden demand and a gap in the market, and LP’s just throw money at it because there’s not enough long-term data to prove out the investment.
Let’s make the following assumptions:
1. LP wants to invest in real estate due to the risk profile and tax benefits. The value of residential RE at its core is essentially derived by securitizing the leases at a preferred coupon, less capex. A property is really just liability.
2. Part of the favorable risk profile is demographics. Let’s assume you’re in a suburban area proximate to a big city that can support a strong labor market, and you’re not in the middle of nowhere or a town reliant on a single industry.
3. You’ve identified a few pieces of land in a great suburb, and let’s just say zoning essentially permits you to build whatever residential you want.
We now have a basic investment strategy. This is why this doesn’t work:
1. In every great suburb, the VAST majority of single family homes are priced for owner-occupants. Let’s oversimplify things here and just use the 1% rule and say you need 1% of the purchase price in monthly rent for an investment to make sense (or close to it). Someone show me a market where that’s a thing, and I’ll show you a shitty market. It’s clear people will pay a premium to own their home. To those saying it solves an affordability issue, I say bullshit. The residential home market remains strong in most areas (despite some pullbacks in places like Florida and Vegas). Generally speaking, people are finding ways to buy.
2. So now you look at a piece or land. Instead of just building SFH where the data supports people will pay a premium for, you gaslight an investor into thinking BTR is a good idea because ‘supply’. You then argue that renewal rates are higher (lower opex), tenants are better than those who want apartments (low bad debt), and because tenants are more sticky, you think you can push rents. You underwrite a terminal cap rate of 5% because you’ve created this faux investor demand solely based of lack of supply, and you juice the IRR.
3. You now get funding to build this shitty tract home community, and think managing it will be marginally more intensive than an apartment. This is a direct result of GP’s who have little operational experience. Their skillset is development management & capital allocation. Let’s think about this. A 300-unit apartment building shares many mechanical systems. BTR cannot. Let’s look at the surface area of the building envelope. BTR will have like 5x-10x the surface area. More leaks. More maintenance. Let’s look at landscaping. Could be 50x the amount of work. Let’s fast forward 20 years when you have to do refreshes & capex work. You now have 300 large BTR units in varying degrees of condition.
My point: the yield an investor needs to justify the risk & long-term capital is substantially higher than what’s being underwritten. It’s not a 5% cap rate. It’s a 7% cap rate. Even if it did trade at a 7% or 5% cap rate, an investor would still probably make more money converting it to SFH since the average American doesn’t give a shit about yield.
Can we all stop pretending Americans are going to end up renting everything? This all boils down to what an investor is willing to pay vs what a homeowner would pay, and you are not going to win going against a group of people who doesn’t care about yield. Don’t give me this affordability bs when the overall housing market remains strong. Even in markets that pulled back, most single family homes don’t come close to making sense as an investment.
If it was really that favorable as an investment community, go try to de-convert an HOA. Pay everyone a 10% premium. Lmk how that works out for you.
End of my rant.
Not in the US, but completely agree.
I think the BTR idea was a byproduct of the COVID era where investors were throwing money at everything. It had all the hype, and given the environment of rents appreciating so rapidly, GPs were able to underwrite ridiculous annual rent increases (assuming no rent control, which applies where I am) and promise healthy IRRs. In my neck of the woods, subsidized financing and political speak re "homes are too expensive nowadays" were also huge tailwinds.
To your point, the implied "yield" that a condo purchaser buys their condo at (and in turn, the building is valued at given all units are sold) is substantially higher than what a rental asset would trade at on the open market. I also think individual condos are a great entry point to the real estate investment market for everyday people who want exposure to real estate with very little oversight/management.
Having seen rent decreases for the last couple of years, the value of the equity in the assets that have been built is negative. Cash flow is also a fraction of what was promised.
The idea that overnight, consumer behaviour of an entire generation was flipped on its head, such that no condos will ever be sold again and everyone will rent is outrageous.
Respectfully, you have no idea what you’re talking about lol. Please do actual research (ie DD) and dig into the offerings… it’s pretty clear why it’s moving that way. Next
The good old ‘do your research’ comment. Naturally, from a developer and not an operator.
It’s like the universe is proving my point when all the critical opinions on this hot take are from developers and not LP’s! Good for you if you get it done, take your development fee and run while it lasts.
Admittedly, my comment was a little curt without much to chew on. I will say this though: the amenitized rent you can obtain (garages, private yards, driveways, etc.) and the “feel” of a single-family home community, paired with what appears to be affordable construction pricing, is why these assets are penciling vs conventional multi. Take that for what you will.
I think your stance is not correct. Our firm owns/manages around 10 BTR assets and they largely do operate at OPEX margins consistent with traditional multi. It absolutely is about affordability and people recognizing the American dream of owning a home is out of reach, and that renting can make economic sense and offer the benefits of a traditional home without requiring a large down payment and the other costs associated with home ownership. It remains (by far) the most attractive subsector asset class for multi in the country for LPs.
It’s really a capital expense issue, not operating expenses. But it’s so new you probably haven’t owned it long enough for it to be impactful yet. That’s my whole point. There’s not really any 90’s vintage BTR.
Your perspective on affordability is misguided. Nothing else to say. The market objectively disagrees.
Wha do you mean by the market objectively disagrees about affordability? To me, BTR is just a substitute for otherwise first time home buyers who can’t afford a down payment, qualify for a mortgage due to student loan or other debt, and/or or can’t afford the monthly payment. First time home buyers are down. Atlanta Fed HOAM index show all-time worst affordability of owning a home.
I see these deals leasing up. It’s not like there is no tenant demand.
Maybe I’m misunderstanding what you are saying.
This is my concern with the space, primarily because I don't see many pro formas that have an appropriate ongoing capex number. In a 200 unit BTR community, you have 200 roofs, 200 foundations, more siding, doors, driveways, roads, etc. This stuff adds up, and there are many more failpoints.
How do multifamily cap rates compare with BTR in the same market? Let's assume newly built Class A for both
Not enough publically available data to say for sure, but from what I’ve seen they’re about the same. 4.75%-5.50% give or take depending on the market & quality.
That being said, there a plenty of trophy multifamily assets a laughably low cap rates that BTR will never be able to touch.
BTR communities don’t have the same aesthetic appeal as a fancy sky scraper in NY. They don’t look as nice as screensavers on a billionaire’s laptop.
Within 25 bps (plus), but generally tracks multi
Have seen a ~.25 - .50% premium for TH/BTR builds in my midwest market
@John.Newton and @ Milkyway - how many of these have you seen trade, because I don't think this is accurate. Has a B2R community ever traded sub 5? I see them 5-6%. The institutions are buying new homes directly from builders at 6.0%, which is easier lease-up and better rev mgmt. I don't think the bid for BTR is there like the developers thought
BTR does have capex risks. But that doesn’t mean it won’t or is not a good investment. Look at office buildings - they are appreciation plays not cashflow plays due to the high TI and LC. That can be BTR. The demographics of renter nation support BTR. Young families who can’t afford a home but need a home due to having a growing family, will stay in BTR longer. Especially if it’s a good school district. Young families can’t fit in small apartments. Most buildings build few 3 bedrooms and barely any build 4 bedrooms - so you need a home once you start having kids.
Capex 20 years in the future - doesn’t matter. You can / should start reserving for those costs. It just becomes part of your budget. High capex doesn’t make something a bad investment. If it did - no one would invest in retail and office due to the TI/LC costs.
Not going to argue, time will tell if this pays off. If it was really that great of a play, HOA’s would be converted to rentals at a premium similar how condo conversions work.
Like I said, just because it leases up doesn’t mean it was the highest and best use of the land. It’s GP’s who just want money & fees, and LP’s trying to fill a mandate jumping in on the hype because there’s not enough data to support long-term performance yet. Someone will end up holding the bag eventually.
HOAs would never get converted. Condos and SFR always will sell for more..
I’ve literally haven’t heard a single person rent single family before but then again I am in NY/NJ and understand it’s a thing in SE/Sunbelt markets. Sounds like a soon to be very saturated asset class.
Saturated isn’t the word I’d use, I’d say misunderstood.
Developers and some LP’s are often only concerned about lease up and 5-year recap, which is not enough time for deferred capex to pile up. Someone at some point will hold a big bag of excrement, and LP’s are not understanding (or don’t care) about the risks depending on their timeline.
I can only see this working in a military town where you have a lot of people with families who often don’t stay in the area for long. Makes a lot of sense why people would pay a premium to rent if you’d probably need to end up selling your house in a few years. Commissions and closing costs will eat into any equity you’ve built up.
Very common to rent a home in Southern California.
Rent on a 4BR house is around $6,000. A mortgage for the same house would be $13,000.
I think the increase in single family rentals in Southern California, especially in Los Angeles, is driven by a few key factors. These include mortgage rate lock-in, Measure ULA (the mansion tax), very low property tax bases due to Proposition 13, and displacement from wildfires. Three of these four are post-COVID developments, and two of them, ULA and wildfire-related displacement, have only become meaningful in the last one to two years.
Los Angeles does have single family rentals, but the proportion is much lower than in many Sunbelt markets. The main reason is that the real estate economics are less compelling here. The relationship between net operating income and purchase price does not pencil the same way it does in places like Phoenix, Dallas, or Atlanta. Homeownership is so unaffordable in Los Angeles because the rent-to-home-price ratio is out of balance, which forces many people to rent (apartments) even if they would rather own.
As a personal example, I rent a house in Southern California for $8,500 per month. If I bought the same house with 80 percent loan-to-value financing at 6 percent, the monthly cost including taxes and insurance, but excluding principal to keep it comparable, would be closer to $13,000.
The only reason it makes sense for the owner to rent it out is because they bought it around the time of the GFC and have a much lower mortgage and property tax basis.
Plenty of people rent SFR in NY and NJ. Many in my town 45 min outside Manhattan
I typed a whole thing, but WSO glitched and it didn't post.
TLDR: Im in a HCOL and BTR will never and has never worked here. Very difficult to compete against homeowners
If you have relatively recent garden multi then BTR more often than not works (and most likely better).
Hm maybe I should have re-typed my entire post. Sorry I meant specifically SFH BTR does not work, but also new multi's do not either due to high rates (although decreasing), significantly higher construction cost post covid, and new legislation requiring even higher affordable housing mandates. Only way to make BTR work is by buying existing stock "below replacement cost" and renovating
Right multi does not work at all right now lol. But soon™️
Developer friends - my point is it’s not about a deal penciling to build something ing and either sell or recap in 5 years. That’s purely a developer mindset.
I’m saying the product itself will eventually require a much higher amount of capital than every other residential asset class, so the cap rates people are underwriting shouldn’t be on par with multifamily.
Forget about rates & a deal being doable with accretive financing. Just assume unleveraged. You need an ROC above market cap rates. I’m saying people are solving to a 5% market cap and like a 6% ROC, and that might work in a 5-year horizon, but eventually market cap rates will be like 7%+. If the yield becomes lower or equal to market cap rates, big oops.
If you want to do BTR and HOLD, you need a real, not-fluffed 7.5% ROC at a minimum. Everything else is a time bomb.
Where are you getting your numbers from? Nobody is solving to a 6%. If anything, it’s at least an untrended 6.5% (but more like 6.75%+) where caps are 5% today and will likely compress over the next few years with rate decreases. That’s a 150 bp spread, quite standard, and some are achieving upwards of 200 bps.
Also, you are putting way too much stock into capex. Additionally, it’s not easy to afford a home, don’t know what world you are living in? Factoring in a 20% down payment (which is unobtainable for many right now) and throw on high rates on top of that (which yes, will be decreasing, but are not going to reach levels during COVID and prior), it’s much more expensive compared to renting. Would like you to point to why this will change anytime soon—genuinely curious.
Oh and big point which you are missing: people are not automatically equating BTR caps with conventional multi. Generally you are underwriting 25 bps higher than multi, but there are those that trade in-line with multi at 5% or lower today.
Neither one of us can prove what developers are underwriting so this is a moot point. Anyone can plug numbers into a proforma.
I don’t care if what the future of affordability looks like. All I know for sure is today, people pay a premium to own home and that is a clear fact.
This is the disconnect between developers and capital allocators. By virtue of increasing the supply of something with perceived demand, that doesn’t mean it creates outsized returns or helps solve an affordability issue. Nobody is asking for BTR, GP’s are just too eager to solve what they perceive as a gap in the market.
Two things are objectively true: the price of housing will always be based on a ratio to average wages (or NW), and people will continue to pay a premium to own their own homes. If you believe in those two premises, BTR hardly ever makes sense.
If it was a moot point what developers are underwriting to, then why bring it up in the first place? Also, yes, there is a consensus regarding underwriting; it’s called capital markets, and is largely dictated by LPs at the end of the day…
To be honest, my problem with this thread and quite frankly you in particular is that you seem to think you are this purveyor of truth (or at least comes across this way)—maybe a better term is condescending or pretentious—and you began this to stroke your own ego and not really come to a more enlightened conclusion than where you started.
And you know, it reads differently through a screen, so I hope I am and probably am wrong about you and your intentions. That said, it seems you believe what you believe lol so I don’t know why this topic was even started if you are so sure of your convictions. Maybe a blog is a better format.
This whole forum is just opinions. I’m speaking objectively, you’re trying to fit a round peg in a square hole and missing my entire point. Capital markets, relationship between LP’s & GP’s, it’s broadly the same thing. That doesn’t mean GP’s underwrite stupid shit and can’t raise money. There’s no database of underwriting either of us can point to as proof.
Keep raising for BTR, I hope you get your fee and gtfo. Outside of this backwards argument of affordability, no objective metric supports the investment thesis. Due time will prove out everything one way or another.
Rather than speak hypothetically about Capex since that seems to be the primary unconsidered risk you are referencing, let's use specific numbers.
I asked ChatGPT and received the following back for a newly built home in Phoenix.
Phoenix-specific wear due to sun, heat, and monsoon exposure
The total above is $52,000 and taking a average useful life of 15 years, we can assume $3,500 per year (. Now, if we assume this is a 1,800 square foot home in phoenix, we can assume is costs $360,000 ($200 PSF). We can reserve 1% for capex each year, but I would reduce to 0.75% of price since we can assume a large BTR PM has economies of scale on the cost of the work listed above.
If we take the following assumptions:
- PP: $360,000
- Cap Rate: 6%, NOI Growth 3.5%, Capex is 0.75% of Price
- Leverage: 65% LTV, 5.25%, Interest Only
- Exit: 6% Cap
- Hold Period: 15 Years
Levered Returns: 13.1%.
While the returns aren't phenomenal. There is definitely capital willing to pursue long duration (high quality recurring revenue) real estate investments with that return profile.
john.newton121 - You are right and know what you are talking about in terms of capex and needing a 150 bps spread. Here's where I am getting stuck: I not seeing many people hitting 6.5% yields on cost. What I'm seeing is a mixed bag. Doing my own underwriting on a portfolio of new B2R from a top developer and I'm getting 5.4%, 5.5%, 5.7%, 5.6%, 6.2%, 6.4%.... Not seeing 6.75%. Then not all B2R is equal - a lot are townhomes. That's not as attractive. Lease-up time lines have also been long.
Then there's question of who's the takeout? I don't think it's the REITs, they have their own programs or just buy direct from builders at a 6.0%. It makes it difficult for someone to want to come in and pay 5.25% or less. Yes, given cap rate compression that could change. But almost any real estate deal looks good with cap rate compression!
Has anyone taken rental townhome communities and successfully rebranded them as BTR? I feel like a new clubhouse and some exterior upgrades could let you arbitrage rental townhome cap rates vs BTR.
Great thread. I would like to hear from a BTR developer. Why develop BTR over for-sale SFH? Are you even the one entitling the project, or did someone else entitle a resi project and now you're going to build it but retain everything (unlike a homebuilder)? Are you competing with land developers or homebuilders for sites or entitled projects?
I don't deal in the for-sale space, but my sense is that for-sale loans have higher pricing and more stringent recourse. And the equity is almost certainly more expensive.
Not sure about the institutional space, but in the sub-50 unit space pricing and recourse is the same in my experience.
edit Sorry for condos for sale, my lenders will charge a higher origination fee (75-100bps). For rentals, origination fee maybe 50 bps, but there are prepayment penalties. I think paying the extra 25-50 bps is well worth avoiding prepayment penalty. However, the construction loan rate is the same
Developing for sale introduces a totally different risk profile. Profits are usually only realized once a significant majority of homes are sold, which makes market timing critical. Developing for sale also exposes the developer to latent construction defect risk which is the primary reason for a lot of groups. Yes, you definitely compete with builders for land and frequently hire them back on a fee basis to build their cheaper product and then operate it for rent. It depends--we've entitled deals, and also just purchased completed homes from builders at CO and then operated them on a rental basis
BTR is really just a flexibility premium product. It is for people who want SFRs but do not have the confidence that their living situation will be long term fixed in either an immediate or regional geographic sphere. It gives residents space and privacy while giving developers lower costs given the scale and repeatability of the product.
Will every deal be successful? No, but to act like this product can't work at all is insane. It is essentially an apartment complex but spread out rather than vertical. Do apartment buildings work?
I think you are really off the mark here:
On your #1 point -
The for-sale market is and has been at one of its weakest points since the GFC (look at the data). Unsold finished inventory is at peak levels and is showing marginal improvements even with rate cuts. This is due to several factors that include and do not include affordability, but I will save that for another post.
I understand you are oversimplifying with the "1%" rule, but that needs to be expanded on. In most BTR markets, comparable (age, SF, location, quality) for sale TH/SFD homes are well north of $300k. $3,000 rents (1% of 300k) on BTR is rarely seen outside of a few infill, prime location projects. I would imagine the average net effective rent of the entire BTR rent stock is somewhere around $2,100. If you couple MTG payments, private mortgage insurance, maintenance, HOA fees, and taxes/insurance on a monthly basis, it will exceed $2,150 rent, almost always on a comparable product by at least 30%.
As for your "shitty" market take, I think your main issue is that you are conflating where you would live versus where someone else would live. I personally live within a dense area of a major city and would not want to live where most BTR is located. However, a lot of people choose/need/want to live where BTR is located for a multitude of reasons. I bet 8/10 BTR projects are proximate to a MF project owned by an institutional REIT or private equity shop. So it may be a shitty market based off of where YOU personally want to raise your family, but it makes a lot of sense for someone else, and a whole lot from a real estate perspective.
On your #3 point -
I agree and disagree on your points relating to the operations and maintenance of BTR versus MF. The part I agree with surrounds GP experience. Many operators, especially with a strict MF background jumped into the BTR space and realized they were not cut out for the operational nuances. For this, I think there will be a lot of consolidation in the near future due to inexperienced operators and those who got in the game and could not achieve scale. However, there are many operators who really know what they are doing.
Overall, BTR definitely has holes in it, but I do not think you brought up any of substance. I am bullish on the space, and I strongly believe the "BTR product" is filling a gap for the 35% of Americans who rent and that BTR has major demographic and consumer sentiment tailwinds behind it (happy to discuss this privately with anyone).
Additionally, I am not knocking the for sale market. Globally it is going through a rough patch but it will improve. BTR also does not soley rely on a weak for sale market, and in some instances a weak for sale market can hurt BTR.
You are incorrect my young analyst and completely misunderstanding what I’m saying. This all boils down to sales approach vs income approach valuation, and long-term deferred maintenance. That is it.
1. You cannot prove new homes in an infill area would be worth more as BTR than SF. Using the income approach, show me an area where the unleveraged yield of a SFH as a rental at a 5.5% cap rate, 35% expense ratio is the greater than the market value of the subject or comparable SFH(s).
2. There is objectively not enough data on the cost of long-term capex, but I can say with certainty it’s more expensive than an apartment complex.
3. The cap rates between apartments and BTR are roughly equal, but I am arguing the spread is not equal to the long-term capex differential.
Let me know when you buy one and hold it for 15 years one day. Then come talk to me.
Expedita ea enim asperiores ratione ut consectetur deleniti. Repellendus iure sed quia id eaque saepe consequuntur. Sunt quas placeat omnis consequatur molestiae corporis. Dolorem ab molestiae quia impedit est accusamus aut. Repellat molestiae accusantium tempore nesciunt at quo. Numquam voluptatem nihil excepturi ab occaecati omnis. Quidem corporis eius sed nemo.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...
Ea recusandae autem qui ut suscipit consequatur voluptas qui. Est molestiae laudantium eveniet vero occaecati.
Tempore ut non corrupti distinctio incidunt. Veritatis praesentium nostrum iste soluta. Consequuntur non eos eius perspiciatis quos earum. Aut numquam quia est laudantium deserunt. Dolores animi dolore suscipit ea voluptas odit vero. Laborum ut earum eos veniam. Aliquam qui labore qui aspernatur quis.
Veritatis sequi nobis officiis mollitia rerum. Molestiae nesciunt perferendis vel veritatis et repellendus laboriosam. Quas animi molestias est nisi sed. Facere maiores accusantium omnis voluptate iusto modi harum. Voluptatem nisi non quia saepe sed nam.
Quam similique voluptas ea eos quis aliquam eum. Ex autem culpa aperiam itaque porro eum. Quisquam omnis enim architecto totam adipisci. Assumenda minima voluptatem laborum perspiciatis et voluptate. Consequatur fuga voluptate sit rerum et deserunt itaque. Aperiam sint fuga qui id.