Financing BTR: What Are the Lending Drivers?

Annual production of BTR units dips in 2024 due to restrictive capital conditions, not a decline in demand, according to NAHB and Hunter Housing Economics Forecast.

Doug Ressler

Single-family rentals and build-to-rent houses are in high demand. This product type allows households plenty of space and mobility, without worrying about the high costs of home ownership. As more renters want to live in SFRs, more developers are jumping into the space to offer BTR homes and communities.

There are two primary types of BTR products. First, are single-family homes built on platted lots that make up an entire neighborhood of rental homes due to a developer’s control of multiple lots. The second is the “horizontal multifamily.” These homes are not built on platted lots but are platted as an apartment project would be platted, typically built on commercial land that is rezoned to allow for this product type.

Uncertainty exists regarding how to obtain financing for development since BTR homes are different from apartments and for-sale homes.


READ ALSO: Build-to-Rent Units Move Into Master-Planned Communities


Phases of construction

BTR projects typically go through four phases: pre-construction, construction, stabilization, and operational phase. Lenders are exposed to distinct credit risks at each of these phases.

Project scalability and cash flow

It’s crucial for the build-to-rent sponsor to demonstrate to financiers that the project will scale up, stabilize, and become cash flow positive over the mid- to long-term during a defined period.

BTR developers must understand the area and market conditions in which they’re proposing to build. This requires a well-researched market study focused on an area’s supply, demand, social diversity, schools, retail and grocery, and demographic diversity. The product must establish preapproval through surveys or market studies that “appeal” to the identified target audience and ability to provide a fiducial cash flow regarding other housing asset classes.

Residential housing today possesses some of the strongest fundamentals and one of the lowest risk profiles based on stabilized occupancies and growing demand as the “supply-demand” gap widens.

Government compliance and reporting

Lenders may need to navigate through heightened government compliance standards and reporting requirements, especially when “green lending” principles are involved. This could also extend to projects where affordable housing incentives are provided or lots in the project are being leased to registered community housing providers. In addition, the government is actively pursuing putting more capital into the market.

Fannie Mae just announced changes allowing multifamily loans up to $9 million to be processed through their streamlined Small Loan program. This significant enhancement provides a new opportunity for multifamily borrowers to benefit from the many advantages of the Small Loan program allowance:  streamlined third-party report scope and reduced cost; fewer legal requirements and fees; competitive pricing and terms; and potential streamlined rate lock options.

Rising demand

The BTR sector is experiencing rapid growth, particularly in horizontal apartments and townhomes across various markets, including Dallas, Orlando, Atlanta, Nashville, Tampa, Phoenix, and Denver. I recommend a read of Brad Hunter’s piece in Forbes on key BTR markets.

The delivery of BTR units is on the rise, with a projected 21 percent increase in 2023—64,000 units vs.  53,000 units in the prior year.

For the year 2023, BTR developers are expected to build 120,585 homes in the U.S., according to Hunter Housing Economics estimates, marking a flattening of construction due to a lack of capital, particularly debt.

Rent growth trends

Although rent growth has struggled to gain consistent momentum in 2023, with a modest increase of about 2 percent year-to-date, there are expectations for rent growth to return to longer-term norms ranging between 2.9 percent and 4.0 percent.

Monthly rent price increases were noted in the late summer of 2023, with a 0.71 percent rise in August compared to July’s 0.41 percent gain, although these figures did not surpass the record high set the previous year.

The annual growth rate of rent prices has been on a slowdown, with a 19-month-long trend noted up until September 2023, despite a minor climb of 0.2 percent in asking rents during that month.

Historical growth

The sector has shown significant growth in recent years with a 36 percent growth between 2017 and 2018, and a further 41 percent growth between 2018 and 2019.

Ownership & management

BTR ownership is often larger in scale compared to the familiar single-family rental portfolio. It is described as a hybrid of multifamily and single-family investment properties. Most BTR properties consist of 50 or more homes or townhomes and are owned by investors, and are professionally managed, like multifamily assets.

A significant portion of BTR properties is owned by institutional investors, where a single entity owns the entire residential asset and designates a single operator for management. This contrasts with traditional single-family rentals, where individual investors are more common. The interest from institutional investors in the BTR sector is recent, scaling up in most markets over the last five years due to favorable fundamentals of BTR.

BTR properties are often professionally managed with on-site leasing offices, providing a level of management like multifamily properties but with the characteristics of single-family homes. This professional management includes handling leasing, landscaping, repairs, and maintenance for the entire community.

Comparative features

BTR properties often come with community amenities like those found in high-end apartment complexes, such as swimming pools, clubhouses, walking trails, green spaces, and dog parks. This is alongside the characteristic features of single-family homes like privacy, no residents living above or below, and often a neighborhood feel with low-density homes, yards, and additional green spaces.

BTR homes offer larger unit sizes compared to traditional multifamily units, with features like dedicated outdoor space, higher ceilings, and potentially windows on all walls, catering to the preferences of millennials and empty nesters who are major sources of BTR demand.

Funding models

Funding for BTR residential developments can come from private sector investors or financiers, governments, or a combination of both. Private-sector funding is contingent on the security of income streams from the development and whether the post-tax returns meet market expectations. On the other hand, government funding is usually linked to set eligibility criteria such as environmental and sustainability standards, affordable rents and places, certainty of tenure, and communal amenities and services.

One of the most significant impacts of interest rate increases was evident in the for-sale housing market. Soaring home prices and lack of inventory certainly contributed to weaker home sales, but the doubling of mortgage rates during a nine–month period caused the market to plummet with 2o million fewer existing home sales closing in October than January, a decline of 32 percent. Home prices have been slow to react to market conditions, declining just 2.2 percent through September since peaking in June, according to the S&P/Case-Shiller National Home Price Index. However, home prices were up 10.7 percent from a year ago.

Housing start forecasts run the gamut from flat to decreasing by 26 percent. In addition to the weakening demand factors for home sales, homebuilders continue to face inflated costs for both materials and labor, as well as labor shortages. Multifamily construction fundamentals are expected to weaken, which makes sense since, by most private sector measures, 2023 will be a decades-high year for new completions. 

Sources: U.S. Census Data, NAHB and Hunter Housing Forecast, September 2023

Long-term returns and maintenance costs

Investment in BTR is driven by factors such as longer-term returns and lower maintenance costs when compared to office or commercial developments. These factors may appeal to lenders looking for stable returns over a longer period.

Labor market challenges, inflation, interest rate increases, and challenging regulatory environments will stay top of mind for owners and operators in 2023. Expenses outpacing rent growth will be a major concern next year, the severity of which will depend on the depth of a likely recession. If the labor market does not suffer major setbacks, apartment fundamentals overall should be able to post positive gains, particularly in those sectors which typically experience sustained demand through a downturn, such as moderate income and workforce housing. Demographics remain an upside for the industry.

Performance

BTR developments are new residential communities contributing to the increase in housing supply, thereby addressing housing shortages.

Rent increases

For single-family rentals, which BTR is a subsector of, rent increases have been noted, for instance, a rise from 3 percent in March 2020 to 4.4 percent in March 2021, indicating a potentially profitable market for investors as the sector expands.

Tenant turnover

BTR properties usually experience a lower percentage of tenant turnover compared to traditional multifamily units, which could lead to more stable income streams for owners.

Doug Ressler is director of Business Intelligence, Yardi Matrix.

You May Also Like