Last year, Arbor Custom Homes closed 216 houses, a number that was slightly below the 236 it settled in 2011.
That same year, for the first time in its history, Arbor started more rental apartment units than single-family for-sale homes. This summer, it’s aiming to complete an apartment building in Hillsboro, Ore., with 193 rental units. And in March, the company was scheduled to begin construction on another, 203-unit building in that same Portland suburb.
The Beaverton, Ore.–based company isn’t abandoning the for-sale market. In fact, it expects to add 600 finished lots to its inventory by the end of this year on which it will build single-family houses.
“We’re in growth mode again,” proclaims its COO, Brad Hosmar.
But like a handful of production builders around the country, Arbor is cashing in on the rising demand for apartments in metros like Greater Portland, where over the past few years only about 1,000 to 1,500 new apartments have been built annually, compared with 4,000 per year historically.
The increased demand for rental apartments is a residual effect of a housing recession that rattled the wisdom and logic of homeownership, particularly among young adults. But during the downturn, there wasn’t much multifamily construction going on, either, so rental demand is easily outpacing supply.
There are about 3.8 million vacant rental units available in the United States, according to a December report published by the National Multi Housing Council (NMHC). Apartment completions are projected to approach 200,000 units this year, which would fall short of the 300,000 to 400,000 new units the NMHC believes are needed to meet demand each year through 2020.
“I’m very bullish about the future,” says Doug Bibby, NMHC president. “The demographics and household formation numbers are compelling.”
Bibby isn’t surprised that some for-sale production builders have hopped onto this bandwagon, especially after a withering recession during which rental and student housing “held up better” than the single-family market, he says.
Another reason some single-family builders might be coveting rental is it gives them first crack at eventual home buyers. A recent poll of 1,006 renters found that 52 percent—including 60 percent of single-family renters and 44 percent of apartment tenants—anticipate becoming homeowners within the next five years. That percentage rises significantly among families with three or more members and with children under 13 years old, according to the survey, conducted by ORC International, whose U.S. headquarters are in Princeton, N.J.
But Bibby isn’t holding his breath waiting for production builders to fill the rental construction void, any more than he expects production builders to become a major factor in student housing.
“I wouldn’t call it a trend,” he says of builders diversifying into rental. “It’s more of a natural response to a devastating downturn.”
More than a flirtation
It’s true that most production builders still view rental as a curiosity and say they have no plans to diversify. And it’s too early to say whether those builders entering the rental arena will stick to it once demand for new single-family houses revives.
But rental, per se, is undeniably trending and picked up steam last year, when structures with five or more units accounted for 29 percent of new construction, versus 15 percent to 19 percent of existing housing stock historically.
The National Association of Home Builders (NAHB) projects—conservatively, by its own admission—that starts of multifamily housing will jump by 22 percent, to 299,000 units, in 2013, or about the same percentage growth that the NAHB foresees for single-family starts this year. The vast majority of multifamily starts will be in buildings with five or more units, and it’s safe to assume that a sizable percentage of those units will be rental apartments.
There remains some skepticism about just how deep the demand for rental housing actually is. The NAHB, for example, projects only a 6 percent increase in multifamily starts in 2014, suggesting that supply by then will have caught up with demand.
But so far, there’s been little doubt about this sector’s growth potential among the dozen or more institutional investors that have been gobbling up foreclosed homes and converting them to rentals. One of those investors, New York–based Kohlberg Kravis Roberts, was the financial muscle behind Beazer Pre-Owned Rental Homes, a real estate investment trust that launched on May 3, 2012, with a portfolio of 190 distressed single-family houses that Beazer Homes had acquired in Phoenix and Las Vegas. (At the close of its fiscal year ended Sept. 30, 2012, Beazer held an 18.1 percent stake in this REIT, from which it reported $1.1 million in operating revenue. Beazer’s CEO, Allan Merrill, is Pre-Owned Rental Homes’ chairman.)
Tempe, Ariz.–based Pre-Owned Rental Homes operates as a separate business entity from the builder. Its president and CEO, Patrick Whelan, tells multifamily executive that his company has since expanded its footprint to California and central Florida and is looking at other markets for growth. He declined to disclose how many housing units have been added to its portfolio, but the company’s exclusive focus remains on single-family rentals, which Whelan says account for 53 percent of the rental market nationwide and represent a $1 trillion asset class.
“What we’re looking to create is a branded service offering for our residents,” Whelan explains.
On Feb. 26, after six years of development and two years of construction, Sares Regis Group of Northern California (SRGNC) celebrated the completion of the 307-unit Plaza Apartments in Foster City, Calif., which Sares-Regis is developing for The Plaza’s owner, Northwestern Mutual. Institutional investors play key financial roles in the baker’s dozen of multifamily rental projects that SRGNC had in the works as it entered 2013. In January, these included 600 apartments under construction, 600 about to break ground, and 1,000 in the entitlement phase.
Jeff Smith, a vice president with SRGNC, says his company is looking to expand into markets within the Bay Area peninsula where newly built rental housing is relatively scarce. (The Plaza Apartments was the first new rental project in Foster City in a decade.) The biggest challenge, he says, is finding development sites in places like downtown San Jose, where amenities already exist. “Finding two to three acres in infill scenarios is tough,” he says.
Another California-based production builder, MBK Homes, whose for-sale business has been flat since 2009, last year initiated a rental division, which expects to build about 100 apartment units in the San Diego market in 2013.
Tim Kane, MBK’s chief executive, says he likes rental because “it evens out the earnings curve … and the cash flow is more stable [than with home building].” Rental also rounds out MBK’s operational portfolio, which includes an assisted living division that over the past several years has purchased around 2,500 units.
The boldest move into rental by a production builder thus far has been Lennar’s $1 billion–plus commitment to build more than 6,500 apartment units, $560 million of which is earmarked to build 3,000 units this year.
Lennar didn’t respond to interview requests, but the Miami-based builder has disclosed that it operates rental offices in Atlanta; Charlotte, N.C.; Chicago; Dallas; Denver; Miami; Orange County, Calif.; San Francisco; and Seattle. The company has started working on a 316-unit rental community in Jacksonville, Fla., and a 264-unit community in northeast Atlanta.
Stuart Miller, Lennar’s CEO, told analysts recently that he expects multifamily to contribute to his company’s bottom line within three years.
Another high-profile entry into the rental sweepstakes is Horsham, Pa.–based Toll Brothers, which, according to CEO Doug Yearley, has “assembled a pipeline of sites” for new rental projects that will have approximately 4,000 units. These apartments would augment the approximately 1,500 rental units in Princeton Junction, N.J., and Dulles, Va., that Toll developed and has co-owned, through off–balance sheet joint ventures, for a decade.
Yearley estimates that his company’s investment this year in rental and student housing will be around $200 million. Current projects, according to Charles Elliott, Toll Commercial managing director, include a high-rise complex in Jersey City, N.J., in which one of three condo towers will now be rentals; a controversial redevelopment project in East Brunswick, N.J., known as the Golden Triangle, where demolition of a closed Sam’s Club and flea market has made way for a rental apartment building; a mixed-use project with rental apartments in suburban Philadelphia on which Toll is partnering with Brandywine Realty Trust; and a rental apartment high-rise in Washington, D.C., that, says Elliott, “ties into our City Living expansion into that market.”
Toll also has luxury garden apartment projects in the works.
For Toll Brothers, rental is “a hedge against home building,” says Yearley, and a way to leverage the company’s core competencies. But he and Elliott are quick to note that rental and student housing are, for Toll, ancillary businesses, “an exciting way to diversify our company,” says Yearley.
Arbor Custom Homes is also venturing into rental “cautiously,” says COO Hosmar. While it expects to complete about 1,000 rental units annually for the next few years, Arbor’s “bread and butter” will continue to be new-home construction, and, says Hosmar, “we don’t want to take away from that.”
A True Threat?
Many multifamily veterans will tell you that once the rookies start muscling in to your turf, that’s a sure sign of a market overheating. First-timers don’t always appreciate the pricing dynamics of a given market, and if one owner drops pricing too much, it can hurt every other local owner. But above and beyond that, these new entrants may threaten to oversupply some top markets that are already seeing an increasing wave of new production.
“Traditional multifamily developers might be underestimating the magnitude of the threat of new entrants, which are increasingly announcing their own multifamily development plans,” says Dave Bragg, director of research at Cleveland-based Zelman & Associates.
Bragg adds that this phenomenon is certainly not limited to single-family production builders. Many REITs in the office and retail sectors are similarly slipping into the multifamily business at a time “when the supply figures have already been escalating.
“Nationally, the numbers are increasing at such a rate that it should become a greater concern,” Bragg says.
But all real estate is local, after all, and national numbers can be misleading. Some small markets that might fare better against the influx of new developments are those that are just recovering and have seen little action since the housing bust. Bragg suggests that markets such as Atlanta, Phoenix, and Las Vegas should become a greater focus for new entrants.
“I think these are three markets where developers, whether they’re long-standing developing partners or new entrants, can feel more comfortable putting the shovel in the ground, because there has been little new permitting activity [there] thus far in this recovery,” Bragg says.
On the other hand, Washington, D.C.; Raleigh, N.C.; Austin, Texas; Houston; and San Jose, Calif., will all be facing a larger supply threat in the next two years. Those were the hottest markets throughout the recession for new multifamily construction, and while they were rent-growth stars for a time, that trend is starting to slow down.
“It’s hard to predict, but it will contribute to a continued deceleration of rent growth, which has already begun for those markets,” Bragg says.
Additional reporting by Lindsay Machak
