It was a little more than six months ago when I last sat down with my colleague, Tim Sullivan, to discuss the single-family build-to-rent (BTR) market. In that discussion, Sullivan, Zonda’s senior managing principal and in-house BTR expert, laid out the evolution of the industry and highlighted what to expect this year. Market dynamics have evolved quickly throughout 2021, so the two of us recently took time to check in on the ever-popular sector.
Q: What has surprised you the most about the BTR market since we last met?
Sullivan: As expected, the space has held up exceptionally well from a demand point of view. That success, however, has come with challenges that have become pervasive quicker than expected. BTR operators are now faced with fierce competition, high land costs, a tight labor supply, and decreasing returns.
Q: How much have returns been impacted?
Sullivan: Operators are reporting that returns are continually compressing. For example, we’ve seen cap rates generally move from the 4% range to the 3% range, and the return on cost drop from the 6% range to the 5% range.
Q: Earlier this year, you said we should expect to see more competition, more amenities, and more attention from capital in the BTR space. It sounds like the competition and capital parts have proved true. How about amenities?
Sullivan: Amenities have proved to be less of a sure thing because there is a close eye on the yield. The development community is looking at the cost benefit of amenities and choosing to be conservative. It is pretty common to provide residents with some open space, a pool, and a ramada, but we aren’t seeing many decked out workout facilities with yoga rooms and spin studios like you’d see at some resort-style apartment communities.
Q: OK, so not as much amenity diversification as originally thought. What about location? Have you seen BTR expand outside of markets where it traditionally does well?
Sullivan: Unequivocally yes. Every market—not just the traditional Southeastern and Southwestern ones—is now being considered for some kind rental product, whether that is conventional townhomes, duplexes, small-lot single-family detached homes, or traditional single-family detached homes. Rental product generally fits best in locations where incomes and rents are closely aligned, but we’ve seen conventional wisdom be turned upside down recently. For example, our advisory team has looked at multiple locations and product types in California to find the right BTR solution.
Q: What about the players?
Sullivan: There’s a continuous influx of new players into the BTR market. The players include operators with industry knowledge, landowners, and outsiders. When you look at landowners, for example, some have started to consider BTR as a cash flow instrument and have entered the space, making the environment even more competitive.
Q: Is the competitiveness good or bad?
Sullivan: That depends on a lot of factors. There is this evolving awareness that a game of musical chairs is going to start soon, where at some point there will be more players and more capital sources than chairs for BTR opportunities. No one was talking about market saturation two years ago, but we are hearing that more and more today. As such, those not well-versed in construction methods, management, appropriate underwriting, and market dynamics will struggle to be successful. I think we need to be aware that at some point, there will be a day of reckoning. That reckoning will be defined by three key points: 1. Best locations win; 2. Great partners are the secret sauce; and 3. Property management/maintenance will be a differentiating factor and will help the resilience of the space as the product ages.
Q: Your tone has changed a bit from last time we spoke. Why should industry players stay invested and interested?
Sullivan: To start, think about alternative investments. Where else can investors put their money to get a consistent return? I’d argue not in commercial or hospitality yet, and the hotness in industrial is keeping returns compressed, so, in some cases, BTR is still a great bet. Besides that, I am still very positive about the space and believe demand is deep at this stage for rental product, but we need to acknowledge the reality as well. I see the BTR space working forever, but it will work at returns that are more modest than we’ve seen in recent years, and it will take a lot of hard work to execute well and consistently.
Q: What should we expect from the BTR market going into 2022?
Sullivan: Three things: 1. Significant demand; 2. More players, fewer opportunities; and 3. The best locations and best operators win.
