Build-to-Rent Projects Weathering Higher Interest Rates, Shifting Strategies

Higher interest rates have cut both ways for businesses that build and rent out single-family homes. But they have not diminished Sudha Reddy’s optimism about the long-term future of the market.

Reddy’s firm, Haven Realty Capital, formed a joint venture with J.P. Morgan Chase in November to buy and build more than $1 billion worth of single-family rentals, starting in the Atlanta area.

“There’s a dearth of this type of asset everywhere,” says Reddy, founder and managing principal of West Hollywood, California–based Haven. “Anywhere these can be built, there’s a need for them.”

In a market that has been disrupted by rising interest rates and unsteady financial markets, Reddy and other single-family rental investors and developers have not lost sight of the bigger picture. Demand for housing still exceeds supply, especially from millennials raising young families who want a home with a backyard in the suburbs.

That is not changing anytime soon, even with all the capital that has flooded into the market the past few years, says Brad Hunter, president of Hunter Housing Economics, a West Palm Beach, Florida–based consulting firm.

“The long-term story is that there’s a huge amount of pent-up demand,” says Hunter. Rising rates have boosted demand for single-family rentals by driving up borrowing costs and pushing home ownership out of reach for many first-time buyers, he says.

Rising rates also are starting to create opportunities for single-family-rental developers seeking land or even finished homes to buy. Stuck with unsold homes or surplus land, many homebuilders are looking for ways to reduce their inventory to improve their balance sheets. They’re willing to sell it to single-family rental businesses at prices that are coming down, though not to distressed levels—at least for now.

Still, higher rates have also boosted borrowing costs for developers that specialize in the build-to-rent, or BTR market. With fewer projects securing financing, BTR construction is slowing down. That may be a good thing.

“The cost of capital is higher right now, which means that bad build-to-rent deals won’t work,” Hunter said in a recent YouTube video. “Last year and the year before that, every build-to-rent deal seemed to work. Everybody was a genius. Now capital is scrutinizing, very appropriately, every build-to-rent deal.”

The market is still poised for strong growth. Hunter forecasts that BTR developers will build 132,000 homes in the United States this year, up nearly 11 percent from 119,000 in 2022. Development should jump to 167,000 units by 2025, according to Hunter.

In the past few years, the temptation to enter the BTR market has been irresistible for many in real estate and finance. “Fear of missing out” seemed to be a motivation for many, as apartment landlords, student housing investors, and even hotel developers formed new ventures to get into the business. Last year, for instance, Chicago-based private equity firm Harrison Street Real Estate Capital entered the market in a $1.5 billion joint venture with Core Spaces, a student housing developer also based in Chicago. The venture just broke ground on its first project, outside Dallas.

But given the more cautious state of the capital markets today, Reddy doesn’t expect to see more large joint venture deals like the one Haven cut with J.P. Morgan last fall. During the second half of 2022, the market went through a bit of a shake-out, forcing investors and developers to accept “a new world order,” he said.

“I don’t know that there’s a lot more capital coming in,” Reddy said.

Haven’s story tracks closely with the growth of the single-family rental market, which was largely the domain of mom-and-pop investors before the housing crash. After the bust, it attracted the attention of big private equity firms like Blackstone and Starwood Capital Group, which focused on buying distressed homes and renting them out. Reddy founded Haven in 2010 with the same strategy.

By 2015, the housing market had healed and distressed opportunities started to dry up. So Haven expanded first into the multifamily market and then launched a single-family build-to-rent business in 2019, Reddy said.

The 2.0 version of the single-family rental business was built on a different model: Instead of buying single homes scattered over a metropolitan area, developers like Haven would build or acquire entire rental housing developments with hundreds of homes.

Today, Haven oversees 36 developments with about 3,500 homes in nine states, including Georgia, Tennessee, North Carolina, Arizona, and Illinois. The firm has acquired completed developments from homebuilders on a forward contract for about 60 percent of its projects and has bought and developed the land itself for the other 40 percent, Reddy said. He expects to stick with that approach in Haven’s joint venture with J.P. Morgan.

The single-family rental market encompasses about 15 million homes, or about 34 percent percent of the total U.S. rental housing stock, according to a recent report from Green Street, a Newport Beach, Calif.-based research firm. Only apartment buildings of five more units account for a bigger share of the overall rental market, 46 percent. But the market is still fragmented, with large institutional investors like Invitation Homes accounting for only about 5 percent of its units, the report says.

Still, the industry is gaining unwanted attention from elected officials as more big investors have entered the market. Some politicians worry that single-family investors that pursue single-property acquisitions are driving up home prices, denying homeownership opportunities for families. Others are suspicious of big corporate landlords, believing they’ll jack up rents on vulnerable tenants. In November, U.S. Senator Jeff Merkley introduced a bill that would impose financial penalties on firms that purchase more than 100 single-family homes in a single metro market.

“In every corner of the country, giant financial corporations are buying up housing and driving up both rents and home prices,” Merkley said in a statement. “They’re pouring fuel on the fire of the affordable housing crisis that so many of our communities are facing, leaving working families behind.”

New BTR developments have filled up quickly over the past couple years, and at higher-than-expected rents, said Hunter. But rent growth is slowing to more normal levels: An index of U.S. single-family rents tracked by Irvine, California-based CoreLogic rose 6.4 percent last year, down from a 12.1 percent jump in 2021. Rent growth will continue to slow this year, but CoreLogic doesn’t foresee a drop in rents that would wipe out the gains of the past two years.

Some investors are testing different strategies to adjust to the shifting single-family rental market. Waterton, a Chicago-based apartment landlord, jumped into the business last year, forming a $500 million joint venture with Second Avenue, a Tampa-based single-family rental investment and development firm.

Though the venture has focused on a scattered-site approach, buying individual homes in target markets, Waterton now is employing a different strategy on its own, buying up batches of unsold homes from homebuilders and renting them out, said Waterton Chairman and CEO David Schwartz. As rising interest rates depressed demand for for-sale housing, homebuilders found themselves stuck with homes they couldn’t sell. Waterton has been happy to buy their unsold inventory—for the right price.

“It was more opportunistic,” Schwartz said. “The homebuilders were motivated to sell at discounts because the market slowed so much because of rising interest rates.”

With homebuilders retrenching, BTR developers are also facing less competition—and more attractive prices—for land. Some are scooping up development sites improved with streets, sewer, and water connections from homebuilders eager to reduce their exposure to the weak for-sale market. But prices haven’t fallen to distressed levels.

“It hasn’t been like the floodgates have opened and there’s been blood in the water,” said Dan Goldberg, president of Core Spaces.

Backed by Harrison Street, Core Spaces is launching a new chain of single-family rental developments called Oxenfree. The venture has aggressive growth plans, with a pipeline of 19 projects totaling 5,000 homes in markets including Austin, Denver, Dallas, and Nashville. It recently started construction on a 408-unit development in Princeton, Texas, outside Dallas, its first project.

The development will cater to a mix of tenants, with rents starting in the low $2,000-per-month range for a two-bedroom house and rising to as much as $4,000 for one with four bedrooms and a bigger yard, Goldberg said. Core Spaces believes it can differentiate its properties from “cookie-cutter” competitors through strong design and amenities including a coffeehouse, co-working space, fitness center, and children’s playroom.

“We see this as a perfect analog to what we have done on the student housing side,” Goldberg said.

AJ Capital, a Nashville-based developer with roots in the hotel market, also believes it has some natural advantages over its competition. The firm has launched a new single-family brand, Outpost Residential, with a focus on the Southeast. AJ just started construction on its first project, totaling 247 homes, in Foley, Ala., not far from the Gulf of Mexico.

Like Core Spaces, the firm, which owns the Graduate Hotel chain, sees an opportunity to distinguish itself from its competitors by prioritizing design and amenities, said Phil Kayden, chief investment officer at AJ. He described touring a completed BTR project by another developer near an AJ site. The property had minimal landscaping or amenities and units with eight-foot ceilings.

“There was nothing unusual, different or attractive,” he said.

“The bar is fairly low,” Kayden said. “For us, it’s where can we employ our hospitality mindset towards design and placemaking.”