Webinar: Build To Rent - Solving the housing crisis, catching the curveballs
On November 18, 2022, we held a panel discussion on the housing crisis with a panel of Build To Rent experts.
You can watch a recording of this webinar above.
[00:00:04.040] – Vidur Gupta
Hello. Happy Friday. My name is Vidur Gupta. I’m the CEO of Beekin. Thank you so much, all of you, for joining our webinar. A very exciting topic of Build To Rent, an emerging asset class. With us ,we have three prominent speakers, investors, experienced BTR folks from the industry. We’ll give it a minute to start because I know people are still joining, but we’re expecting a banner turnout today. It promises to be an interesting conversation. While folks join, just housekeeping stuff. We will be running through a few slides, our speakers will be providing their thoughts. We also have a live channel for questions. When you ask questions, please introduce yourself for the sake of the speakers, and we will leave some time toward the end for answering those questions. We’ll also have a few audience poll questions. Please do participate and if there are any technical issues, feel free to use the support or the chat functionality. Couple of our Beekin colleagues would help you out. Great. So with that said, it’s two minutes past ten Eastern, so let’s get going. I know we have under an hour left, so why don’t I set the stage, I have with me Bruce, Audrey and Geoff.
[00:01:57.240] – Vidur Gupta
And maybe we can start by them just introducing themselves as well as their prior experiences in BTR. And maybe we’ll go first to Bruce.
[00:02:12.310] – Bruce W. McNeilage
Yeah, thanks for the introduction and I appreciate being part of this webinar. I think we’re going to have great content. And I would like to thank everybody that’s watching today. My name is Bruce McNeilage. I’m the CEO and founder of Kinloch Partners. We are an SFR BTR operator and we operate in Nashville, throughout Georgia and throughout South Carolina. I’ve been in the business since 2005 and we are what I call a boutique operator. Our neighborhoods are roughly 50, 60, 70 house communities. And then we also do scattered sites, all brand new houses, again throughout the Southeast.
[00:02:55.140] – Audrey Carlson
Good morning and thank you everybody for joining. My name is Audrey Carlson. I am the director of asset optimization and design at SVN SFR Capital Management. We are a Build For Rent aggregation platform with the goal of aggregating 35,000 homes over the next three to five years. We do that through relationships, building JV relationships with builders and developers nationwide. And I’m excited to be here. We have a great group.
[00:03:24.160] – Geoffrey Kristof
Hi everyone. I am Geoffrey Kristof, head of a single-family rental at APL Group. We are a global investment firm with about a $5 billion balance sheet and in SFR, we’ve been focusing on the build for rent space. We’ve got about 4000 doors, owner contracted across the Sun Belt.
[00:03:48.010] – Vidur Gupta
[00:03:51.600] – Vidur Gupta
So let’s dive right into it and maybe we start with basics. For the benefit of the audience, it will be helpful to understand what is BTR. And on the slide we have data on the United States rental units single family in the first column. And as you can see, the age of the inventory is pretty old. More than 50% is 50 years plus. So with that, how do you define BTR in your own words? And maybe this time we start with Audrey.
[00:04:33.650] – Audrey Carlson
All right, yeah, absolutely. So I think there’s a very important difference to make here. There’s obviously two different types of build for rent. We have the horizontal apartment model, which is much more like multifamily. And then we have what we call traditional build for rent, which is going to be your single-family homes, fee simple lots. And these are typically three and four and five-bedroom homes, typically ranging from 1400 square feet, upto about 2200 square feet. These can be infill locations, they can be suburban locations, difference in product type, there may be detached, attached, townhome duplex. So that’s how we view build for rent.
[00:05:16.660] – Vidur Gupta
[00:05:20.410] – Bruce W. McNeilage
So I look at things two different ways. There’s build for rent and there’s build to rent. And build for rent is when an operator hires or does a JV with a home builder. You can look at these national home builders that are building houses for organizations like ours that’s build for rent. Build to rent is the operator taking risk, whether it be development or construction risk. And so they have more risk on their shoulders, but potential more reward. So, build for rent or versus build to rent. And I’m seeing the industry doing a lot more build to rent versus taking all the risk on the shoulders of the operator and building the assets for themselves.
[00:06:11.110] – Geoffrey Kristof
[00:06:11.960] – Vidur Gupta
Geoff, did you want to add?
[00:06:14.790] – Geoffrey Kristof
Yeah, I’m not sure that I have much to add. At the end of the day, what we’re doing is we’re building new construction resi product, and resi product comes in all different shapes and forms and types, and new construction multifamily has been around forever, and until very recently, it’s been because there hasn’t been an institutional single family housing stock, brand new construction, single family homes, as dedicated rental stock didn’t exist. I think that what the capital flooding into BTR the last couple of years is trying to fill a gap in the market because we’ve had lots of new construction, class A multifamily. I mean, that product has been around forever. But if you wanted to rent a very high quality, brand new single-family home from an institutional landlord, that product didn’t exist until very recently. And so there’s certainly a range of interpretations of what BTR existed, because none of them existed until very recently, including horizontal multifamily. And where you sit on that spectrum just depends on where you think the ROI is going to be greatest. I think that APL is similar to Bruce and Audrey, that you want to be building a product that has the look and feel of the single family home, because that’s what’s been most undersupplied and that’s most differentiated from the existing institutional housing stock.
[00:08:07.010] – Vidur Gupta
Thanks, with that, I think let’s dive into our first audience poll for you to understand what kind of audience we have today. Let’s give it a minute more. Thanks, everyone who’s already answered. The rest of you, great to understand. And then we quickly share the results with all of you at the end of the call. But sounds like we have quite a few developers and institutional investors, which is to be expected. Great.
[00:09:17.220] – Vidur Gupta
So for the sake of our developer audience, let’s talk about the elephant in the room, the rate hike. So, as you can see, the Fed has been increasing rates at probably the most aggressive pace in the past three to six months. Given what’s happened to interest rates, what are you seeing happen in the market and what do you think the impact will be in the near future? And maybe, Bruce, did you want to start? Take this one first?
[00:09:56.650] – Bruce W. McNeilage
Sure. So the interest rates have significantly hurt both institutional investors and owners of rental houses, as well as individual buyers that are trying to buy a house for the first time. And what it’s causing is a lot of paralysis in the market. You have people that used to buy, people that used to sell like builders, and things have really slowed down significantly. Now, that could be good for our industry because more and more people are struggling to buy, however tougher and tougher, to access capital and debt for companies in our business. And what that’s going to do long term, is it’s going to drive up the cost of housing both on a rental perspective and purchasing a home. So it’s going to hurt people financially. It’s hurting people financially right now. And I think a year or two years in future, many of these builders that are slowing down are starting to stop construction or development. When the pendulum swings the other way, interest rates go down a little bit, that’s going to create even a smaller supply of housing, affordable housing. And it’s going to take us many years to recover. So we don’t have enough affordable housing now.
[00:11:17.400] – Bruce W. McNeilage
We didn’t have enough a year ago when interest rates were low. And I believe that we will not and it will send us back many years. The numbers and for us to provide the numbers of housing, whether it’s either for rent housing or for sale housing, I’m seeing a lot of builders, national builders, pivot on a dime. We’re getting calls from builders that are ready to start construction, not horizontal development, but construction in the next 60 days. Now, certainly builders did not plan for that. They didn’t know, hey, we’ll do build to rent. We’ll wait to 60 days before we’re getting called from builders that are pivoting. And they’re looking at operators like us as being an out and helping them with liquidity events because quite frankly, they know the retail buyer out there either doesn’t exist or there’s a small number of retail buyers. And it’s going to be tougher and tougher to sell out a community.
[00:12:22.090] – Audrey Carlson
And I’ll just build on top of that as well. I think the issue with what you just stated, Bruce, is that the hard part is find some equal playing ground with those builders. Because a lot of the time this product that’s ready to go vertical doesn’t necessarily make sense from a build for rent perspective. So we’ve looked at probably 15,000 new homes that have come to our group to look at and I would say maybe 90-95% does not make sense. And that’s really because of the products, the specs, the floor plans are too large, too over specced, and also just too expensive. So at that point you have to start thinking about discounts which build for rent groups really haven’t participated in discounts in the past two years we’ve been buying at retail. And so it’s finding, you know, that difference that we can make it work because we truly do want to be that opportunity for the builders to keep their starts going, keep their GCs working. And so I think there’s big opportunity there. It’s just a little challenging to make it work in some cases.
[00:13:38.280] – Geoffrey Kristof
Yeah, I guess the way that I think about it is that a rising rate environment has three main impacts, three main flow throughs to the institutional market. The first is that it decreases capital values and that’s just a mechanical impact due to the opportunity cost of capital and there’s really nothing you can do about it. All asset classes fall in value. The second is that the present value of future cash flows is worth less because discount rates are higher. That means that whereas in a low rate environment deals with first deliveries far off in the future that wouldn’t be stabilized for three years would converge in pricing on a asset that’s stabilized today. Now there’s a big difference between two. And no one’s going to be paying top dollar for an asset that’s going to be stabilized in three years. The third is you see risk premium expansion and that is due to both increased risks, there’s rising volatility is correlated with rising interest rates, as well as greater compensation demanded per unit of risk by the market. And that means that the type of that has sort of two main impacts. One impact is that the type of deals that can get done in the market shift.
[00:15:14.130] – Geoffrey Kristof
People move away from riskier locations. People want to focus on core markets. People want to focus on deals where the perceived risk is lower because they see the likelihood of high risk events increasing and they demand greater compensation for taking risk. They’re going to want a much, much bigger discount relative to nine months ago to build a community in the middle of nowhere in an area with high crime and poor schools. Then the discount they need in a urban core location relative to what they would have paid nine months ago. The second impact is that because there’s greater volatility, it’s very difficult to get a deal done in private markets because you strike a deal today, then it takes a few weeks to pay for the deal. You have to survive another 30 to 60 days in diligence. And the market is moving so fast because people are so jittery. It’s very difficult for any deal that you strike today to survive that sort of 60 to 75 day period needed for any money to go hard for you to actually close the transaction. So you see, bid-ask spreads widen and then on top of that, bid-ask spreads have widened pretty dramatically.
[00:16:43.220] – Geoffrey Kristof
So, you know, when we’re sort of in this interesting place right now where bid ask spreads are pretty wide, no one’s transacting. You’re not really seeing much in the way of forced sellers, of players being really squeezed across the economy. People generally haven’t been that over levered, and the same is true among both consumers and homebuilders. You’re not seeing any mortgage delinquencies, so no forced sellers there. And homebuilders are less for sellers because they’re squeezed due to being over levered. Certain builders are panicking or sort of playing forward the script nine to twelve months and are panicking more than others. So we’re seeing a real dispersion among the behavior of homebuilder counterparts. Some of them are really slashing prices and offering very, very material discounts to institutional buyers and others are really not. And they’re just continuing to sell stuff retail and we’ll sort of see what happens. But at the end of the day, the goal of rising rates is to choke off demand via exposure to capital markets. And that’s exactly what we’re seeing happen across the market.
[00:18:14.280] – Bruce W. McNeilage
So Geoffrey brings up a very important point. How do you underwrite a deal? What interest rate do you put down for your pro forma? And so we just built a subdivision where the first tranche we borrowed the money at was in the fives, the next tranche was in the sevens. And we’re hoping the last tranche should be in the sevens. And so it hurts your pro forma significantly. And again, if you’re raising capital or looking at a deal, how do you formulate the deal and do the pro forma if you don’t know the cost of money? The other thing is how much you borrow. Is it 75%, 70, 65, 60? And that’s creating an issue because you have to bring more and more money, more and more equity to each deal, and that’s going to change yields going forward as well.
[00:19:10.080] – Geoffrey Kristof
And that risk is something that you can quantify. If you wanted to, you could go out and hedge that interest rate risk with swaps or in the option market and boy, is that expensive. I mean, it’s really just not feasible. Twelve months ago you could have done that easy. And that is just the risk that’s being priced into the market. The only thing that I would add though, is that these impacts, the flow through of these things, are the result of a rising interest rate environment. They’re not necessarily the implications of a high rate environment. And so if Treasuries, five and ten year treasuries just stay flat for the next twelve months, they just don’t move at all. That would be a very, very material improvement in the state of the capital markets, in the state of institutional liquidity and so on for SFR and for private markets generally.
[00:20:26.430] – Audrey Carlson
And I think this is truly affecting the buy box of a lot of institutional operators right now. In order to minimize the risk, we’re seeing shifting back to mostly focusing on primary market, some secondary markets. Really big emphasis on where is the job growth, where is the population growth, and I just don’t think that people are underwriting the same rent premiums. Our group. For example, we’ve never underwrote to the rent premiums that were happening in the last two years because it was just truly unsustainable. But really being conservative on where you’re setting rents. Not necessarily knowing what’s going to happen in the market, but being confident that builds for rents are going to rise. But maybe steadying off a little bit.
[00:21:09.780] – Vidur Gupta
Great. So fall in asset values matched by a drop in liability through lower leverage and possible higher equity investment is an interesting theme. And just to build on what you said Audrey. Fundementals. We talked about how has the buy box or the underwriting changed and we talked a little bit around leverage, leverage assumptions, cost of leverage. Let’s talk about fundamentals right? When we look at our rental indices going back to 2015, across multifamily in the blue and single family in red, what is clear is multifamily rents are have peaked and they are starting to drop. And on the other hand, single family has started to flatline, hasn’t seen the month on month drop that we are starting to observe in multifamily. But given BTR is sort of a crossover of some sort between apartments and single family homes, how do you think of fundamentals as you underwrite or what are you observing in the portfolio?
[00:22:30.700] – Audrey Carlson
I’ll start with that one. I truly think it’s a supply issue here. So there’s a lot of multifamily units coming on market right now and you’re seeing that head on head supply as apartments are opening right across the street from each other. Build for rent is a little bit different story because there’s just not truly a lot of build for rent communities in a lot of these markets. And we’re going to see that change over the next year or two. But just knowing that there’s a need in these markets, especially as homes are still very unaffordable, especially with the interest rates, people have about half of the buying power that they did a year ago. And so as we’re seeing it become much more unaffordable to buy a home. Those families still have to live somewhere. So that’s why I think it truly explains build for rent SFR rents being much more steady through recessions because people still need homes to live in. And so I think that’s where the emphasis really comes on making sure that you’re building three, four, and now five bedroom homes for rent to provide that product for these families.
[00:23:37.000] – Audrey Carlson
So I think that’s also where you’re going to see the difference between the horizontal apartment model and the traditional build to rent model start to shake out. I think that the horizontal apartment model is not going to remain as steady. I think it’s going to be closer to this drop off and multifamily rent as we get into harder times.
[00:23:55.600] – Bruce W. McNeilage
I’m seeing the multifamily operators because there was so much money from pension plans, insurance companies. As far as those investments, there are not one, but two month incentives and free just to sign a one-year lease, while keep hopping from complex to complex. And we can’t do that. I’ve never done that in the single-family business, because quite frankly, we haven’t had to do that. And so I think that’s why our own business model as far as our returns to operators, but this is what people want. Millennials are having families because people are telecommuting. They can live farther out in the suburbs. And as you get land cheaper, they can start to afford rents. Maybe in urban core they couldn’t. And so people can go from one or two bedroom apartments to four bedroom houses. For people that are having children that’s a big deal. And Audrey, you’re correct. There just wasn’t enough product. Truthfully, today there’s not enough product. And, you know, that makes all of us, I think it creates a wonderful opportunity going forward to create this product and deliver this product to people that need it.
[00:25:20.580] – Geoffrey Kristof
I think that it’s a very interesting question because multifamily and single-family have behaved very differently historically. If you go back 30 years, single-family rents had the same growth rate as multifamily, with half the volatility and less correlation with the cycle. And so that’s really the fundamental feature of single family. It makes it extraordinarily attractive from the standpoint of an institutional capital allocator. You’ve got something that’s extraordinarily undervalued relative to multifamily and very little exposure to it, an extraordinarily large asset class too. And as you know, there’s this question of like, well, build for rent is that going to behave like multifamily, which were already allocated to, or is it going to behave more like single family? And I think the real takeaway from the last six to nine months, as we’re starting to enter this period of weakening demand, is that it behaves more like single family. The benefit of multifamily is that you have you can have true institutional on site management. You can hire and fire property managers. You can really involved from adding value and shore up ancillary income through active onsite management. And the benefit of single family is that you’ve got a very stable demand profile. And I think it’s becoming clear that with BTR, you get the benefits of both.
[00:27:04.230] – Geoffrey Kristof
And that’s because at the end of the day, the core reason why single family rents are so stable is because of the tenant profile. You have a different tenant. And so what really matters is the number is I think the fundamental thing that matters is the bed-bath count. You don’t have families with kids in multifamily product because that’s a one bedroom, maybe a two bedroom product, and that’s vastly different than the BTR model. So when you look at things and you try and wonder how they’re going to behave, the question you got to ask is, who are they renting to? Are they renting families or with kids whose kids are going to local school and so on? Or are you renting to a couple of roommates who are going to take a third roommate when someone loses their job and some BTR looks has some one and two bedroom product, the horizontal multifamily stuff. But I think the stuff that we’re doing and the stuff that Bruce and Audrey are doing are more on the sort of traditional single-family product, three/four bed product.
[00:28:23.950] – Vidur Gupta
Great. And a related question, just because we are looking at multifamily and single family together, and everyone talks about the BTR premium to single family, which is, as you can see, the red line here in single family, primarily comprises what are classified as mom and pop landlords, right? Because that’s a disproportionate number (of owners). But as you, as institutional investors and operators are building stuff, where are you seeing things shake out in terms of rent premium to traditional single family when it comes to BTR?
[00:29:04.600] – Audrey Carlson
So I think it’s definitely dependent where you are in the US. And also how much supply there is around you. But I would say on average nationally, we’re seeing the build for rent premium being about 15% to 25% average nationwide over that scattered single-family rental. So there’s a few premiums that go into that obviously being newly built products. There’s a premium for having a new home versus older vintage home. There’s a premium for being a part of a fully contained build for rent community. So if the whole subdivision is owned by one institutional operator and is rented out, renters actually value that and therefore will pay more for that because they feel like they are part of a true community. And that’s not there when there’s one renter in between two owner-occupied homes. And then there’s also a premium for having the professional institutional management. So there’s a few premiums that we can apply to that. I think the question in the industry is, what exactly is that premium? There’s no right answer that you can just apply the exact premium to a site every single time that you’re underwriting. So it really does take some deep market research finding out if there’s new build for rent communities that are coming online. We are seeing some of these communities start to lease up and operate and seeing that those premiums in some cases are even higher than we originally projected.
[00:30:35.580] – Audrey Carlson
So we’ve seen some cases where there’s just no supply, no build for rent supply in the market, and we see those premiums upwards of 50%. Now, we would never underwrite to that necessarily unless that was a comp on the ground, you know, operating, but I think it’s still extremely conservative to apply a ten to 15% premium for our build for rent community.
[00:30:59.130] – Vidur Gupta
Thank you. Are any of the panelists seeing any different or do you like to add?
[00:31:08.280] – Geoffrey Kristof
Yeah, we’re seeing stuff that’s pretty similar. When we strip out the vintage premium, which we do with, we try to find new construction comps nearby. If there aren’t any, then we use a relatively straightforward multivariate model with some geospatial clustering to try and pinpoint what the vintage premium would be to strip that out. And then we also strip out the amenity premium if our community is amenitized. And after we do that, on average, we’re seeing about 10% premium just for the professional property management and being in a wholly-owned community, something like 7 to 12,15 or something like that, depending on the area and the location, which is, it sounds pretty comparable to what others say.
[00:32:19.830] – Vidur Gupta
Great. You might have gone off video, but if you have something to add, please do.
[00:32:30.030] – Audrey Carlson
I think another thing to add is talking about the premium four bedrooms. So because you’re typically looking at markets that have only seen multifamily comps and so you’re looking at studios, ones and twos, you really do see quite the premium for providing a three bedroom home or a four bedroom home. And even the difference between that three and four bedroom home has increased in the past two years. So I think most of that is in part to a lot of people being able to work from home. All of a sudden the whole family is home more often or maybe in a hybrid situation. And so having that flex space, which adding that additional bedroom where you can close the door, have a quieter room for whether it be an office or a play room or an additional bedroom, it’s super helpful. So over the past two years, I would say pre-COVID we were seeing about a 7% premium from a three to a four bedroom home. So adding in that additional bedroom was about a 7% premium. Now, post-COVID and kind of the new normal, we’re seeing about that same premium be worth 15%.
[00:33:39.730] – Audrey Carlson
So that value from a three bedroom home to a four bedroom home or a four bedroom home to a five bedroom home has substantially increased. So that’s really changed how we’re putting together our communities and structuring our unit mix as we used to be probably 60 or 70% three bedroom homes in our communities. Now we’re shifting over to underwriting these to be probably 60% to 70% four bedroom homes with a handful of five bedroom homes.
[00:34:08.050] – Vidur Gupta
Great, thank you. We just take a pause again for another audience question. Given everything we’ve talked about, what are the main challenges that you see the growth of BTR?
[00:34:27.700] – Bruce W. McNeilage
I think for us it’s land and finding the available land and then of course, construction materials and labor. Now with the building, I think going down a little bit here, I think labor is going to come down in cost materials. Lumber was really a challenge here in the last year, but it’s the cost of land, and the cost of land is going to decrease as you get farther outside the urban core, and that’s really going to make the difference. And so where we’re looking at and concentrating on is maybe going another 10 miles or so outside of the urban core where people can afford housing but not sacrificing the amenities like parks and schools and those type of items.
[00:35:14.580] – Audrey Carlson
Another headwind to build for rent right now is really the barrier to entry, right? So dealing with the municipalities, it’s truly an education process on why build for rent isn’t necessarily like putting a multifamily community right in the middle of a community, right? So I think that’s going to change a lot over the next year or two, especially as we see some really great build for rent communities starting to operate and lease up. But I would say that’s definitely high barrier to entry, especially in some municipalities that have pretty heavy pushback.
[00:35:47.950] – Geoffrey Kristof
Yeah, I definitely agree with issues on land and barriers to entry, policy pressure, but at the end of the day, I think that the real headwind right now is just institutional liquidity has evaporated because of rising interest rates, and that means that capital values are worth less. And so it’s harder to make anything pencil. And that’s why you have no transactions in the space. You have no transactions and you can’t finance it. You have no exit. What you can do, it makes less sense to do something. The land and policy risks, if you can pay enough, you can find the land. And if a pencil is well enough, you can take the policy risk. But right now you can’t afford to pay for the land at prices that you’re willing to sell it because your exit looks terrible and the work and risk that you’re undertaking doesn’t seem nearly as worth it. When entry cap rates have blown out, you can’t exit on a refi and so on.
[00:37:09.790] – Vidur Gupta
Thank you. It seems like our audience believes land and permitting is a clear winner in terms of the main challenge, but you’re absolutely right. Liquidity and rates are a close second. So on the policy piece, obviously a lot has been said about county-level policy pressure and the increased affordability narrative that fills up all the papers these days. But what is clear about the actual data is when we look at NCRIEF returns for the past ten years. What this graph shows us is moderate income rental housing. So renting to people who make between 60% to 120% of area median income is actually a pretty high return with materially lower risk even compared to several things like office and clearly retail. So this makes sense financially, as I’m sure all of you agree. But despite what the numbers show, how are you navigating the affordability and the policy environment as you look to transact or how have you done it in the past?
[00:38:35.650] – Audrey Carlson
I think making sure that you’re looking at the quality and consistency of income, right? So making sure that you’re located in the right spot with the right job growth. Historically, build for rent tenants have a very high household income. It used to be $120,000 average. I think now it’s pushing 130,000 average. And so if it’s just much stickier tenants, which I think really goes into saying a lot about the risk of build for rent and rental housing over multifamily or some other asset classes, because you have a higher tenency now that’s unique to build for rent versus just all single family rental housing is really that sticky tenant. But still for a single family rental compared to multifamily, you have a higher tenancy rate for build for rent it’s about five and a half year average tenancy rate. So you’re really not dealing with the risk of having to find a new tenant every single year.
[00:39:41.860] – Bruce W. McNeilage
I think for us, people use the word affordable. Affordability is one thing, but attainability is another. Can you attain the housing available – what you may be able to afford is not available. You have multiple applicants for a single house. And so it’s on availability and with people’s income stagnating or the cost becoming tougher to afford to buy a house, can you afford to rent a house? And the difference there is coming up with the deposit and the interest rates that people are looking at. It’s not just the interest rates, it’s can you even qualify for the mortgage? And so again, that plays into our business and gives us, Audrey talked about stickiness of tenants, we’re right there as far as the percentage – we have less turns, less commissions, less time being vacant. We do have a house available and all that again is in our business versus a multifamily business.
[00:41:12.540] – Vidur Gupta
I know Jeff, you’ve transacted a lot on new development and you obviously have nearly $4,000 that you under contract going forward. Are you thinking differently about policy or how have you modeled policy risk as you’ve transacted?
[00:41:33.760] – Geoffrey Kristof
Sure, policy risk is I think there are sort of two main risks that we think about when we think about policy risk and both of them are at the local level, which is I think where the risk mostly lies rather than the national level. And I think the two main risks that we see are one is on permitting approvals and that sort of thing that, you know, rental product is looked at a little bit less constructively than for sale product. And that’s something that we saw a little bit of change over the last 18 months when the housing markets were undersupplied. But then we ran into issues of all the permitting offices being understaffed, and we’ll see, when we go back to more normal market, whether we revert back to BTR being looked at extremely skeptically. And the impact of that is that it’s helpful to anyone who already owns BTR and it creates a barrier or a hurdle to anyone who’s trying to build it. The other side is on taxes. Most of these states that were, at least sun belt states that are active and building it, many of them have business-friendly tax policy and their fiscal positions are not necessarily the greatest.
[00:43:20.820] – Geoffrey Kristof
And their primary revenue is often through real estate taxes. And that creates real risk to rising, either raising statutory tax rates more aggressively, enforcing rates that are already on the books, or becoming discriminating between commercial landlords and retail homeowners. And that’s something that impacts the entire sector, whether you’re trying to build it or whether you’re trying to own it or already own it because it has a direct impact on capital values. From that perspective, I think that there’s limits to what you can do, but you do your research and you try to build a diversified portfolio that’s active in many places. We’re long term players, and in the long term, there’s a limit to how to how a negative tax policy that a state regime can implement. At the end of the day, we’re building housing for the labor supply, for the state. It’s also the sort of thing that tends to move slowly. And so, ideally, it’s the sort of thing that you would see coming far in advance. But at the end of the day, it’s a risk. It’s one of many risks. It’s not something that is by any means even close to an existential threat to the industry.
[00:45:11.110] – Vidur Gupta
Great. That’s a very valid point. This is another one for the audience. What’s your view on data usage in 2023? As everyone’s clearly talking data on this platform, on this panel? It’s clear that a lot of our clients are starting to be a lot more empirical in how they analyze risk, how they underwrite, while the audience answers that question. We do have an audience question, which I’d like to bring up right now. Are you seeing different pricing from private homebuilders versus the public or the large private builders in transactions? And maybe start with Geoff. Maybe.
[00:46:06.090] – Geoffrey Kristof
Sure. So we are definitely seeing a very material dispersion in the behavior of homebuilders and their willingness to transact. I would say that it’s interesting. It’s not necessarily cut along the lines of private public. We’re seeing some of the big public home builders willing to be very very constructive and trying to strike a deal with institutional counterparties. But we’re also starting, we’re also seeing some local and regional players also being very willing to transact. It doesn’t seem to be that it’s primarily driven by balance sheet concerns. The public home builders – all their balance sheets look extremely healthy and we’re not seeing that what’s driving the local regional players is them being squeezed by lenders or anything like that. It seems to be more just different groups with varying appetites for risk and different desire to clean up their books over the next nine to twelve months. And that ranges from we’re seeing some of the biggest home builders in the market very aggressively courting that SFR offering very substantial discounts and sitting alongside their large home builder public competitors who are offering almost no discounts and just selling on the retail more slowly because they’re perfectly happy to sell to institutional SFR.
[00:47:54.320] – Geoffrey Kristof
But not at prices that institutional SFR players are willing to pay right in this market.
[00:48:02.040] – Audrey Carlson
I think among every builder I was just going to say, I think among every builder group you’re seeing builders restrategizing and just retooling to how they want their business to grow in the next year or two because they have to at this point with sales slowing basically overnight. And so I think there’s just so much activity and emphasis on relationships at this point. How do you create a strategic pipeline? It’s a win win for builders and institutional groups like ourselves.
[00:48:37.290] – Bruce W. McNeilage
I think Data is going to become more and more important. And one of the reasons that is when you’re borrowing money [with low] interest, it’s easy to hide a mistake, right? But when you’re borrowing money at six and a half or 7% interest, you’ve got to be a lot tighter because a mistake can really sink you. So whether it’s John Burns, an associate, we’ve also used Brad Hunter at Hunter Housing Economics. We look at Data from SVN, different brokerage firms, we look at Data across the and a lot of it is very similar what we’re doing. But we’ve all talked out of deals by Data and Data is going to be more and more needed going into the future. So you make your performance and don’t miss the mark.
[00:49:28.730] – Geoffrey Kristof
Bruce just cut out for me. I don’t know if hello?
[00:49:36.690] – Audrey Carlson
You just cut out briefly for me, but not bad. I think to build off of Bruce’s comment I completely agree and I think also just in the reasoning of needing more data and more backing in order to get debt and equity behind these deals, I think it’s becoming more and more important. In the last two years it was easy to make a deal happen because the trajectory was just up and up and up. Now, as things are starting to steady out, you really do have to make the argument to why build for rent demands premiums, and therefore higher rents, higher returns. And data is our number one ally in that regard is how do we start to prove out this concept without needing 10-15 build front communities operating on the ground in order to back us? Because a lot of the time that’s just not possible.
[00:50:28.890] – Geoffrey Kristof
Yeah, I completely agree. I think that is extremely important and it helps you. A lot of this is a highly inefficient market. It’s both highly efficient and one where there’s an enormous amount of data out there. A lot of these nuances that we’ve been talking about, the panel focusing on, the type of tenant you’re putting in the home, the nuances of the location, a lot of that stuff is not appropriately priced in. Appropriately looking at the data and harvesting that data in order to make decisions is, I think, crucial to make sure that you’re able to truly weather it down.
[00:51:26.490] – Vidur Gupta
Absolutely. That’s news to our ears. And finally, as we come towards sort of the later end of the webinar, what are your parting thoughts on risk in 2023? Everyone talks about a recession, poor fundamentals, the Fed action, but how should our audience think about a framework for the next year?
[00:52:04.290] – Audrey Carlson
I think there’s huge opportunity. It’s just being ready and equipped with good data and good education and being ready to strike on the right deal. And we’re going to see lots of deals being dropped and it’s just being in the right place at the right time and making sure that you’re ready to go and also minimizing your risk with underwriting and building relationships. I think that’s always just number one priority is how do you keep and build and maintain great relationships.
[00:52:36.540] – Geoffrey Kristof
Yeah, I totally agree. I also think that one of the benefits of being in a single family space, as I mentioned, as we discussed, it’s one of the areas where there’s the most data. It’s a closely watched industry. There’s an enormous amount of data out there and the market conditions, the land market and the home market is dominated by retail buyers. There’s enormous amount of data there. Slow moving market. The drivers are very obvious things that you can see. You can anyone can look up delinquencies, anyone can look up mortgage rates, anyone can, you know, they can listen in on the public building their earnings calls and see what management is saying. And so I think that everyone is becoming clear that there’s going to be a really big opportunity at some point. It’s not clear when it’s going to be, if it’s going to be in two months or eight months. But I think the important thing is that because this market is not a market where it’s just a bunch of sharks sitting around the table playing against each other, there’s going to be more than enough to go around and sit tight, stay disciplined, and then at some point pretty soon jump in.
[00:54:08.490] – Geoffrey Kristof
And it probably doesn’t matter if you jump in two months too early or two months too late.
[00:54:14.710] – Bruce W. McNeilage
As far as what we’re looking for, it’s a lot riskier. It’s going to be riskier in the future, and there are going to be players that have come in in the last twelve or 24 months that aren’t going to be in business anymore. And the reason is they didn’t underwrite the deals. We were involved in deals with six developments around the country. Each buyer, none of them had visited any of the sites. They did all the underwriting from a desk. And the agent, the company representing builder and seller, didn’t visit any of the sites. You can’t do that anymore. You make the mistakes. The second year reporting to these investors, you’ll start to see the mistakes that were made last year and you can’t keep making those mistakes and missing the yield that these investors are expecting. So you’ll see some of these as a trade and not as a long term buy and hold type of investment.
[00:55:28.060] – Vidur Gupta
Fantastic. Thank you so much. I think this has been very, very informative. So in summary to these useful investors in the audience, it’s a riskier outlook, but the fundamentals still remain strong. The operators on the panel believe they’re able to extract premium, but also meet unmet demand for housing stock. And they’ve clearly given you some frameworks on how to operate with rising interest rate risk. And clearly data is going to be the big differentiator for a lot of their strategies. So yeah, with that said, thanks again for taking time to share your thoughts with us. This was a fantastic panel. I personally learned a lot and have a good rest of your Friday.
[00:56:21.380] – Bruce W. McNeilage
[00:56:23.560] – Audrey Carlson
Thank you so much.
[00:56:26.490] – Vidur Gupta
Thanks a lot.