By Sam Tenenbaum, Head of Multifamily Insights, Cushman & Wakefield
Rising interest rates have certainly challenged the commercial real estate industry. Still, they have also spotlighted an emerging asset class: single-family rentals (SFR) or build-to-rent (BTR) product. Both describe similar styles of rentals – units that look like single-family homes. They can either be in cohesive neighborhoods (typically BTR) or scattered homes across a larger geography (SFR). The former represents about 1% of the overall apartment market – meaning the sector is still in its relative infancy. The niche nature of the asset class presents substantial opportunities for investors to be in the space early and capitalize on the growth of the sector that is certainly coming.
Riding The Demographic Wave
The Millennial generation, the largest generation in the U.S., is getting older. After the 2008 recession, most of this generation entered the renter pool, growing substantially in the 2010s and driving outsized performance for multifamily. Now, that group is aging into their 30s and 40s, making up the bulk of the population growth over the next decade. This is the time that Millennials start getting married and having children, typically a trigger point for upsizing their living conditions.
With aging demographics and major life events colliding, we would expect renters to purchase homes more frequently over the next decade. The confounding factor, however, is how unattainable single-family homeownership is in today’s market.
The easiest way to visualize this lack of affordability is to show how much home a prospective buyer could afford based on the average rent. In the third quarter of 2021, when rents were about $1,670 per month, and the mortgage rate dropped to 2.9%, a buyer could afford to pay just over $500,000, or more than 40% above the median-priced home. Today, the average monthly rent is about 8% higher, at $1,800. With mortgages north of 7%, a buyer could afford to purchase a roughly $330,000 home, which is more than 15% below the median-priced home today, and, more importantly, a 34% reduction in prospective buying power in just two years.
Institutionalization Is Imminent
Build-to-rent properties have become increasingly attractive to the investment community. Sales volume for BTR peaked at nearly $3 billion in 2022, with YTD sales volume of about half that mark through most of the year. The $1.5 billion sold is about 40% more than what traded in 2019. The opposite is true for the broader multifamily market, which is off 65% from its 2019 mark.
Near-Term Headwinds, But Long-Term Growth
Because the BTR inventory is small, performance is inherently volatile. Today, nearly 20% of the existing BTR inventory is under construction, roughly four times the level of the broader multifamily market. However, that 20% of inventory is down nearly half from the peak and amounts to less than 40,000 units nationally. New construction has still pressured the vacancy rate for this product type, however, as stabilized vacancies have broadly been 50 bps higher than market rate over the past decade.
The sector typically sees substantially more absorption than traditional multifamily. Since 2020, BTR product has averaged about 3% absorption as a share of stock, topping out at nearly 5% earlier this year, whereas market rate product has averaged 0.6% of its inventory. That implies this supply wave is unlikely to last long.
Using a similar methodology as laid out in Contextualizing Development Risk, it would take just a year and a half to absorb all of the new BTR construction. By contrast, it would take close to four years to absorb the broader market rate, assuming recent demand trends hold. Despite seemingly heavy construction levels, the BTR market may quickly become under-supplied.