2024 FORECAST: THE ENDURING STRENGTH OF BUILD-TO-RENT
Snowdon Residential
January 5, 2024
Real Estate's Most Rapidly Expanding Sector
What strategies enable the most rapidly expanding sector in real estate's annals to navigate its inaugural economic challenges? How do nascent and unproven alliances among a diverse cast of stakeholders—ranging from operators, financiers, and equity sponsors to architects, builders, and property managers—fare during such periods? Are we witnessing a retreat from this arena, or are stakeholders doubling down on their commitments?
Grounded in observations from various U.S. locales, armed with insights from operators who range from casual BTR participants to those with a more institutional focus, and after reviewing hundreds of projects in the past year, we find ourselves cautiously encouraged. Let's explore why.
Entrenchment of Established Players
In 2023, the seasoned professionals at BTR solidified their positions, setting themselves apart from new challengers in an era of consistently advantageous industry dynamics. This distinguished circle includes national homebuilders who were pioneers in their field and enterprises dedicated to BTR, both of which already possess a significant competitive advantage.
In times fraught with uncertainty, capital sources—both debt and equity—gravitate towards entities with proven track records and robust, existing financial partnerships. These foundational relationships, crucial under normal circumstances, undergo rigorous stress tests in turbulent times. The seasoned players are poised to secure superior terms on fundamental financial metrics such as interest rates and profit-sharing structures, leaving their less established counterparts struggling for recognition and financial support. This advantage allows them to consolidate their land holdings, secure new development opportunities, capitalize on anticipated dips in construction costs, and extend their lead.
The Surprising Edge of Personal Capital Networks
The debate between the benefits of personal versus institutional capital has long been a topic of discussion. Personal capital, raised from one's own network, demands extensive engagement and reassurance, yet it offers more flexibility in terms of oversight and reporting. This type of funding is built on the foundation of pre-existing relationships, enabling decision-makers to act with a high degree of autonomy and trust. On the other hand, institutional capital, though harder to secure, allows for the funding of ventures on a larger scale, providing a pathway to significant growth and scalability.
In the face of current economic challenges, the advantages of personal capital become even more pronounced. The autonomy and ease of decision-making facilitated by the trust inherent in personal relationships can be particularly valuable. Personal investors typically invest based on their confidence in the individual, rather than on exhaustive analyses, granting operators the freedom to pursue their vision without the constant oversight that institutional funding might entail.
However, institutional investors bring their own set of benefits, including rigorous analysis and the potential for larger sums of capital that can accelerate growth. The scrutiny from institutional investors, while more intense, can also serve as a valuable mechanism for ensuring that ventures are thoroughly vetted and positioned for success. The involvement of limited partners in institutional investing adds another layer of accountability, potentially enhancing the strategic direction of the investments.
Given these considerations, a blend of personal and institutional capital may offer the best of both worlds. Combining the trust and flexibility of personal capital with the strategic oversight and scalability of institutional funding can provide ventures with a nuanced approach to financing. This hybrid model allows for the rapid scaling potential of institutional capital while retaining the autonomy and personal trust relationships that facilitate quick decision-making and flexibility. In the current economic landscape, leveraging a mix of capital sources may thus offer a superior strategy for operators looking to capitalize on new opportunities with both agility and depth.
Selective Financing Leads to Elevated Project Quality
Projects in lesser markets face increasing pressure. The primary bottleneck is the senior lending market, which has seen a significant contraction in willing lenders. Only top-tier projects, helmed by leading operators in prime locations, are securing financing. The cost of borrowing has risen, and lenders are demanding higher equity contributions, adversely affecting project feasibilities.
The Lifeline of Construction Costs
Historic rent hikes have salvaged many project budgets in recent years. Going forward, a reduction in construction costs and continued migration will likely provide a similar reprieve. Even as borrowing costs rise, many markets are experiencing construction cost reductions, offsetting increased financing expenses. This decrease in construction expenses benefits the entire project budget, not just the financed portion.
Rental Market Resilience and Potential for Growth
While explosive rent growth may be behind us, BTR rents are expected to remain stable and might even experience slight increases over traditional multifamily projects. Factors such as household formation dynamics and high lease renewal rates suggest a balanced rental market. Continued demand and limited supply could spark significant demand in the near future.
Evolution of BTR Projects
As multifamily developers venture into BTR, they apply their expertise to diversify community offerings, focusing on larger units and varied designs. This influx of multifamily experience is expected to enrich the BTR sector, attracting more institutional interest.
Shifts in Trade Capacity
With homebuilders actively adjusting to market conditions, tradespeople, recalling the lessons of past downturns, are diversifying their client base. The BTR sector's steady workflow, accelerated construction timelines, and simpler designs are attracting top-tier subcontractors, benefiting BTR projects through more efficient and cost-effective execution. This symbiotic relationship between the BTR sector and tradespeople highlights a significant shift in trade capacity and strategy. It illustrates how diversification and strategic alignment with growing sectors can provide resilience and opportunity in the face of changing market conditions. As the construction industry continues to evolve, these shifts in trade capacity underscore the importance of adaptability and strategic planning for all stakeholders involved.
