Being the multifamily voice in a single-family operation is nothing new to Charles Elliott. The managing director of for-sale heavyweight Toll Brothers’ Apartment Living subsidiary served as president of Dewey Commercial at regional single-family builder The Dewey Cos..
But even as the leading internal advocate of what’s often seen as a rival industry, Elliott doesn’t feel like an outsider at Toll. In fact, the business he leads, rental housing, has been embraced by the firm’s co-founders for years: Bob and Bruce Toll have privately owned apartments for decades. And heading into the recession, Toll Brothers owned two properties— Dulles Greene in Dulles, Va. and The Mews at Princeton Junction in Princeton, N.J.
“The thought process on what an apartment deal means in terms of valuation and how you look at a deal is different than how you look at home building,” Elliott says. “But because of Bob’s and Bruce’s experience in the apartment business, they understand that.”
While the for-sale business was still mired in one of the worst recessions in generations, Toll took note that its Virginia and New Jersey apartments were doing “phenomenally well” in 2008 and 2009.
“What public home builder wouldn’t have wanted to have an apartment business from 2007 to 2011, when the for-sale market hit the deepest, darkest housing depression ever?” said Toll CEO Doug Yearley in an interview with multifamily executive last year. “It’s a good hedge.”
So the luxury builder set out to build more apartments. In 2011, Toll lured former architect and commercial developer Elliott from The Dewey Cos. to lead its apartment group.
Already, Toll has 17 multifamily projects (with 6,596 units) from Washington, D.C., to Boston, with a value of $2.2 billion, in various stages of development. But there’s more to come.
Toll isn’t alone among single-family firms. Lennar Corp., the second-largest builder on the BUILDER 100, began building apartments during the recession. Its offshoot, Lennar Multifamily Communities, is now the fifth-largest multifamily builder in the country, with 4,565 units.
Many private builders, too, around the country have long maintained a stake in rentals. Fayetteville, N.C.–based Caviness and Cates Communities, for instance, builds 400 homes a year for sale and also rents out apartments in the 85 multifamily buildings it has constructed since 1998. Others, like Irvine, Calif.–based MBK Homes jumped into the mix after the recession in 2008.
Though apartment industry veterans harbor some doubts about the staying power of their single-family rivals, it seems the for-sale builders that came into the apartment market are here to stay.
Back to the Future
It wasn’t always this way—with different “providers of shelter” huddling into discrete single-family and multifamily camps. The Tolls built apartments. Bensalem, Pa.–based single-family builder Orleans Homes, in business since 1918, built apartments in the ’40s. Even Alfred Levitt built apartments in Queens and on Long Island after he left Levitt and Sons in the ’50s.
But then, things started to change. A number of observers blame Wall Street, which demanded simple, clean stories from single-family builders (and apartment REITs) that went public. Being a company with tentacles in too many parts of the residential sector was seen as an Achilles’ heel.
“For a long time, [analysts] were of the perspective thathome builders should stick to home building and apartment companies should stick to apartments,” says Toll’s CFO, Marty Connor. “But this last downturn in home building was so significant that we decided we can’t really let that happen again. We’re trying to protect ourselves from that down side. One way to do that is coming up with other income streams.”
Others see value in the back-to-the-future strategy that some builders are taking.“All you’re doing [with builders producing apartments] is getting back to the way it was,” says George Casey, CEO of consulting firm Stockbridge Associates and former CEO at Orleans. “When you did both [for-sale and apartments], you basically became a company that hedged the cycles. And when for-sale went way down, you at least had the cash flow of your apartment business that kept the organization together.
“When you don’t have that, you have these loose cannons on the deck of the ship in a rolling sea—they swing to one side and then swing to the other.”
For most of the past decade, many for-sale builders have probably felt as if they’ve been in the line of cannon fire.
As the rate of homeownership has fallen to a 20-year low, the 2010s are on track to become “the strongest decade for renter growth in history,” according to The State of the Nation’s Housing 2015, a Harvard Joint Center for Housing Studies report released in June. Among the 22 million new households that will form from 2010 to 2030, 13 million will rent and 9 million will buy, the report predicts.
The reasons for this trend are both long and, at this point, often repeated. One generation, the millennial, took the brunt of the recession. According to the Federal Reserve Bank of New York, 44% of college grads in their 20s are stuck in low-wage jobs that don’t require a degree.
Then, add staggering amounts of college debt. The Project on Student Debt says 69% of seniors who graduated from public and nonprofit colleges in 2013 had student loan debt, with an average of $28,400 per borrower. And it’s not surprising that millennials, the entry-level buyers who should be driving the for-sale market, can’t scrape together money for a down payment and have been staying in apartments instead.
On top of all that, it’s harder to get a loan today. The Mortgage Bankers Association estimates that lenders deny nearly 30% of mortgage applications, for which they require more documentation, higher credit scores, and tighter debt-to-loan ratios than before the housing boom of the mid-2000s.
Taken together, these factors, high student loan debt, low savings, and stricter mortgage standards, make it easy to understand why some home builders have reached into the rental market. Lawrence Yun, chief economist for the National Association of Realtors, says builders “are just following where the money is. … The builders are saying, ‘Maybe there will be more home buyers in the future, but right now, there are plenty of renters and the rents are rising, so why don’t we follow the money?’ ”
And, once those renters are ready to buy, the builders who provide rentals have a leg up when their tenants are ready to buy. “If we get this big enough, we might have 10,000 to 20,000 renters whom we can sell homes to,” Connor says.
Caviness and Cates offers free appliances and assistance with closing costs to its renters and will let them break their leases with no penalty if they’re moving into one of the company’s new homes.
Still, because of the builder’s lack of entry-level product, says firm co-founder Chris Cates, few of the company’s sales are to current tenants. “We’ve priced ourselves out of that,” he says.
But as millennials save more money and earn higher wages, that could change.
A Comprehensive Plan
With the economic factors in the background, it makes sense that a shrewd builder might not just want to build a few apartments and sell them at today’s obscenely low cap rates; it might want to hold some properties for longer-term income.
And that’s exactly what’s happening. In July, Lennar announced it had formed a $1.1 billion joint venture that will develop and hold apartment communities in 25 U.S. metropolitan markets. Lennar, which will contribute $504 million in the venture, had previously been building through individual partnerships and selling the buildings after their completion.
“Having the ability to recognize current development earnings and continue to own a portfolio of income-producing properties is a game changer for LMC [Lennar Multifamily Communities],” CEO Stuart Miller said in a statement announcing the venture.
With the announcement of its fund, Lennar signaled that it is in the apartment industry to stay.
That appears to be Toll’s plan as well. The builder plans to invest $200 million to $300 million of its own capital in apartments and will rely on joint-venture partners to contribute 50% or more of the equity in each deal.
“Toll as a company is focused on this,” Elliott says. “We’re putting in a significant amount of capital. We would like to get there fairly quickly.”
The plan makes sense. In addition to steadying the ship in a volatile housing market, rentals help these companies more fully utilize their construction and land acquisition expertise in the apartment game.
“We’re really leveraging off our Toll Brothers teams because we have seasoned land acquisition, land development, marketing, and construction people,” Yearley said in last year’s MFE interview. “We have all of these people who are really good at what they do, from land acquisition through to construction. It’s a very easy step [for them to go] from for-sale to rental.”
The strategy also provides flexibility. “From a broader perspective, it allows for repurposing of some for-sale land into for rent if things don’t go the way we want,” Connor says. “Maybe we redesign the for-sale product and build an apartment on it, or vice versa.”
Toll generally plans long-term holds but could execute a merchant-build strategy and sell after lease-up or if a partner wants to exit.
“A lot of it [the hold or sell decision] depends on the market, what the project is, and what we think supply demand will look like in that submarket in the future,” Elliott says. “Some of these cap rates seem pretty incredible, but you have to balance that against what a property will do for you in the long run. You have to be rational about it. Sometimes that means selling. And many times that means holding.”
So far, Toll has built a $1.6 billion Northeastern portfolio in only three and a half years, and Elliott predicts it will ramp up just as quickly on the West Coast and then move to markets in between the coasts.
“We already have a project in the East Bay of San Francisco,” Elliott says. “We’re focused on Los Angeles and San Diego. We’re also looking at what we believe to be strong rental markets—Dallas, Denver, and Atlanta. Eventually, we’ll take the platform national and add cities like Chicago, Miami, Seattle, and maybe others.”
Toll plans to take its management platform to each of these markets. Part of the reason is the fees it earns from its partnerships (along with fees for construction, financing, and asset management). But that’s not the only driver.
“We think it’s critical to the customer experience [to do its own property management], but it also provides us with market intelligence. The real core of it is managing the customer experience, which is a Toll strength.”
While Elliott acknowledges that apartment management “brings challenges” that don’t exist in single-family sales, he does see some common threads.
“The front-end sales process is very similar to the front-end lease-up process in apartments,” he says. “The long-term management is different, but there is a consistent philosophy as far as customer service. Toll Brothers needs to maintain its reputation in the market.”
A More Competitive Marketplace
Whenever a new competitor enters the fray, others are curious. And, if that competitor wins a few deals … well, then, suspicion sets in. That’s what’s happened with Lennar. A number of land acquisition guys at some of the bigger apartment developers around the country insist that the Miami-based builder is bidding up the prices for land in a number of markets around the country. (Lennar wouldn’t respond to a request to be interviewed for this story.)
“We’ve seen a few of them in only a couple of our markets,” said one multifamily developer. “They’re not a big presence, but where they have competed, they seem to overpay for land to secure sites, [because] they don’t have the track record or local connections to compete well otherwise.”
If they are overpaying, it’s at least led to results, with Lennar clocking in as the fifth-largest apartment builder last year on the NMHC’s Top 25 Developers list.
“In no time at all, they went from being no one to fifth-largest,” says UBS home building analyst Susan Maklari. “That doesn’t just happen because they were so disciplined.”
Toll prides itself on a more conservative approach. Elliott says the company generally focuses on comparables and takes a conservative underwriting stance when buying land, preferring to underwrite deals to hold rather than under a merchant-build model.
“We underwrite from a build-to-hold perspective, which usually makes you a little more conservative in terms of where you see land value,” Elliott says.
While Toll uses its existing teams on the ground to identify and secure dirt, it layers on a second group to analyze and structure apartment deals.
“Even as a home builder, when you enter a new market, you don’t want to be the guy who’s paying too much for the ground,” Elliott continues. “It’s why we have the two-pronged strategy of having land guys in the market who know the market and who know the players and, in terms of our housing product, where it will work in the market.”
Here to Stay?
With Lennar’s new fund announcement and Toll’s resolve, it appears multifamily builders might have to get used to seeing their single-family counterparts at the bidding table. Steve Patterson, head of The Related Group of Florida’s multifamily housing division, wouldn’t be surprised to see more come along.
“The learning curve is big, but I imagine we’ll see more [single-family builders] jump into the market,” Patterson says. “It might be a little late this [apartment] cycle to start a new business plan, but maybe they’re building up for the next cycle.”
For Toll, the business plan could actually follow the Lennar blueprint. Elliott says Toll could eventually spin its apartment business out, as its Miami rival did.
“I do like what Lennar did putting together a fund because it allows for a wholesome exit with an entity rather than a building-by-building exit,” Connor says. “They can spin that out or keep it in place or sell individual buildings.”
While he admits apartments will never take the place of home building, Elliott reiterates that Toll is serious about apartments and could have a portfolio that eventually reaches 15,000 units.
“We’re an opportunistic company,” Elliott says. “As long as the opportunity is there, we’re going to go after it.”