Blending real estate development and SFR in build-to-rent
admin | June 25, 2021
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
Single-family rental operators are combining forces with home builders to launch or accelerate build-to-rent ventures, tilting the SFR business model in a new direction. Build-to-rent blends real estate development with traditional SFR. If the trend continues, investors looking at SFR sponsors many need tools for assessing development risk. And one tool for assessing that risk is to track how volatile the land share of home prices has been in areas where SFR operators are putting up new homes; this can be a good predictor of potential price declines in the event of a downturn.
The land share of home prices
A common quip among real estate developers is that a home is just a depreciating structure on an appreciating piece of land. One way to assess home price risk in a geographical area—a ZIP code, a metropolitan area, a county—is by focusing on the share of value the land contributes to the overall home price. Across the 500 largest metropolitan areas in the U.S. the average land share of home values is 33.3%; however, that varies considerably from well under 10% in some sparsely populated areas to over 75% in some densely populated coastal cities (Exhibit 1). In many areas where home prices are high, it is primarily due to a high cost of land contributing a greater percentage of the price rather than the cost of the structure.
Exhibit 1: The land share of home price values across large metro regions (ranked)
Note: The land shares are calculated by zip code for some of the largest metropolitan areas.
The signal from volatile land shares
Tracking changes in the land share of home prices can be an important tool for assessing home price risk in an area. In a case study of the Washington DC area from 2000 to 2013, AEI researchers found that during the last housing boom the increase in the land share of home values was a significant predictor of the later decline in home prices during the bust. In all areas land prices were more volatile than home prices, but this was especially true in places where land was relatively inexpensive in 2000.
One takeaway from the study is that single-family rental operators and build-to-rent ventures that have concentrated operations in areas where the land share of home prices is high but has been relatively stable for many years may have less volatile portfolios than those who have concentrated holdings in areas that have experienced large run ups in land share since 2012 (Exhibit 2). From that perspective, home price risk in much of the Northeast Corridor, for example, is very low. Even though the land share in 2020 is quite high in many areas, it has remained relatively stable over the past eight years. Another example of an area with low home price risk is around Little Rock, Arkansas, where the land share is a more moderate 20% to 25% on average and has stayed at those levels for years.
Single-family rental operators with and without build-for-rent ventures are heavily focused on the economically booming areas in the Southeast, into the Sun Belt and along the West Coast. Using this analysis one conclusion that could be drawn is that home or land portfolios in the Carolinas, New Mexico, Ohio and parts of Texas are less risky than those heavily concentrated in Boise, Idaho, Utah, Las Vegas and Florida in the event another correction is on the horizon.
Exhibit 2: Change in land share from 2012 to 2020 (ranked)
Note: The land shares are calculated by zip code for some of the largest metropolitan areas.
Build-for-rent impact on SFR investors
Buying land and developing new properties brings a new set of challenges beyond being an owner and operator of existing properties. For home builders, these joint ventures can arguably lower risk over time as the stable cash flows from rental properties diversify their revenue stream. For single-family operators, a build-for-rent venture adds development risk but may speed property acquisition and improve economies of scale, though for both sides this depends on how the deal is structured.
Investors in single-borrower SFR securitizations are secured by the collateral but are also sensitive to the credit worthiness of the company that stands behind the loan. A company that moves heavily into build-for-rent that is concentrated in areas seeing a large run up in the land share of home prices are potentially taking on more risk. An important caveat is that the pandemic-driven run-up in home prices has also been due to the rising cost of construction. If construction costs remain high, it could dampen potential home price volatility during a correction.
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