Speaking with private equity groups and learning of their new housing initiatives, I’m enthusiastic and amazed by what I’m hearing. The pool of private equity funds jumping into the home building industry is staggering. Enormous funds are creating large-scale joint ventures with builders and residential land developers nationally. Furthermore, access is not only for large builders as tremendous opportunities are available for all.
Private equity funds aggregate capital from a number of sources; pension funds, financial institutions, high-net-worth individuals, endowments, corporations, and family offices. Private equity real estate funds allow these institutions to invest in equity and debt holdings related to real estate assets.
As income-driven returns from traditional real estate asset classes and other yield-based investments become difficult to achieve, private equity fund managers have significantly increased their allocations to housing. Many have never entered home building before, getting educated in the industry on the fly, billions of dollars of investment capital in hand. Their grand entrance being based on careful analysis of the industry’s economics, bullish forecasts, and a fear of missed opportunity. It’s the wild west out there as private equity groups boldly stake their claim.
In fact, things are changing fast. Builders should welcome these new industry players and learn how best to navigate the playing field, or they will stay static. Capital previously earmarked for commercial real estate and other industries have their eyes on home building, bringing creativity and innovation through joint venture equity partnering and debt structures new to the industry.
Demographics and market conditions are extremely favorable for home builders today, and institutional investors have taken note. “The U.S. housing market is 3.8 million single-family homes short of what is needed to meet the country’s demand,” according to a new analysis by mortgage finance company Freddie Mac. “We should have almost 4 million more housing units if we had kept up with demand the last few years. This is what you get when you underbuild for 10 years.”
The Aggressive Push to Own Build-to-Rent Communities
Potential home buyers aren’t the only ones in bidding wars. Private equity funds with large mandates are canvassing the country seeking projects that fit their investment platforms, and it’s very competitive. Their advantages I find are in customized capital structuring, strong underwriting teams, and prompt execution. Projects must fit their criteria, and firms differ, so it’s best to talk with groups upfront to ensure alignment. If a project fits they will move fast with the end goal of owning the build-to-rent community in its entirety, or partially in some instances.
Private equity funds will work with builders and developers on build-to-rent projects in a variety of ways during different stages of development, including:
- purchase entire or partial communities upon stabilization;
- purchase a specified number of homes at certificate of occupancy, (i.e., 10 per month);
- purchase finished lots;
- purchase finished lots while contracting with the builder on a fee basis to construct the homes;
- purchase entitled and undeveloped land, funding horizontal improvements and vertical construction, while contracting with the builder on a fee basis to provide horizontal and vertical construction services;
- provide land banking opportunities so the builder can go “land light”;
- provide programmatic equity investment in projects while contracting to purchase the completed homes; and
- provide pre-development funding in order to get the project approved and shovel ready.
The Expansion of Debt Funds Backed By Private Equity
Private capital groups and debt funds provide an alternative to bank debt. Their investors are private equity and seek returns higher than banks, but being in a secured position will accept less returns than the usual private equity investment. They have greater flexibility with higher loan to costs and different recourse/non-recourse options. They help builders grow by allowing them to put less equity in each deal, thus creating a larger pipeline of projects. These groups are funding debt for home builders and residential land developers in for-sale as well as build-to-rent projects. They are very active, increasing their footprint on a national level, creating new funds, and opening new offices. These are nontraditional lenders who will fund debt on AD&C, A&D, just C, or will be land bankers for your project.
Builder Business Models Are Changing
Many builders' business models have shifted due to this influx of capital and the de-risked platforms private equity is offering in the build-to-rent sector. Some builders who historically were 100% for-sale are now 80% build-to-rent, 20% for-sale. Others are moving to a 50-50 approach, or somewhere in between. The point is, builders are changing, and they are able to aggressively pursue projects at a pace not seen before while creating more of a merchant builder operation. Why? They have aligned with private equity groups seeking to own build-to-rent projects, offering to purchase homes in bulk while giving an ease of capital along the way. Builders I speak with have similar reactions. Why not? Projects are non-recourse, we’re growing our company, we sell out before breaking ground, and there is little risk. In other words, they are rolling with it, capitalizing on the current opportunities the market is offering as they remember down cycles of the past.
Builders are growing their organizations, increasing land pipelines, and selling homes to consumers and investors, and it is full speed ahead. Private equity funds continue to enter home building, raising more money, increasing underwriting teams, reaching into new markets, and becoming more innovative on a daily basis. Their partnerships are reshaping the industry.