Single-family rental (SFR) and build-to-rent (BTR) communities have gained significant attention from institutional investors during the COVID-19 pandemic, becoming the hottest asset class in the multifamily space.
Strong real estate fundamentals, such as high rental demand and rent growth, have supported this trend. However, like every investment, a successful outcome is dependent upon many factors; not every deal is an automatic success, even for institutional investors. Rigorous underwriting is key to identifying the strongest markets and deals with the highest potential for success.
This article highlights several factors seasoned underwriters consider when evaluating an investment in SFR and BTR deals. To better understand the general principles of underwriting, see our extensive article about the underwriting process.
SFR and BTR Underwriting Similarities and Differences to Traditional Multifamily Investments
As SFR and BTR communities are an asset class within the broader multifamily sector, there are some similarities to underwriting for any commercial residential property. Much like other multifamily properties, some highly valued market factors for SFR and BTR developments include strong population and employment growth, diverse industries and economic drivers, and high rental demand compared to supply.
However, it is important to keep in mind that these assets are distinct from other multifamily property types; an SFR and BTR community inherently requires more land area per unit than a typical apartment building. Therefore, acquiring a large enough parcel of land at a favorable basis is a significant factor for the success of an SFR and BTR community. Additionally, SFR and BTR units are typically larger than apartments and comprise of 2-,3-, and 4-bedroom units and few (if any) studios and 1-bedroom units, making these assets more suitable to areas with typically larger households. These unit characteristics need to be considered when analyzing market demographics for the property in question.
Another factor that sets SFR and BTR apart is the entire development doesn’t need to be completed to begin leasing units. As individual homes are constructed, they can be leased, which may reduce development risk. It also means revenues from an SFR and BTR project can be gained earlier than a typical ground-up apartment development — an important factor when underwriters create a pro forma model to project the finances of an SFR and BTR deal under evaluation.
Turnover costs, which includes expenses to make a newly vacant unit ready to be occupied by another tenant, can be a larger expense for SFR and BTR units than apartments. With that said, SFR and BTR communities typically retain tenants for a longer period of time, leading to a lower rate of turnover. This may be because these assets are akin to homeownership due to increased privacy, space, and amenities, such as driveways and yards, as well as families wanting to stay in a unit or community to keep their kids in a favored school district.
Taxes are another major expense for SFR and BTR deals, and in some municipalities an SFR and BTR community may not be taxed as one cohesive multifamily property. In addition, certain municipalities may apply commercial assessment ratios to SFR and BTR communities while others may apply residential assessment ratios. These can vary significantly, emphasizing the importance for underwriters to have a strong understanding of the methodology applied by local government and tax assessors.
Rent and Sales Comparables, and Financing for a Maturing SFR and BTR Asset Class
The SFR and BTR asset class has existed for quite some time, but it was not as popular as apartment buildings or other multifamily properties. The asset class has only recently become an institutional focus.
Underwriters typically value commercial properties by evaluating the recent performance and sales of similar properties nearby, often referred to as rent and sales comparables. As a newly growing asset class, there often aren’t similar SFR and BTR developments in the area of a proposed deal. One effective solution to this dilemma has been to look at the activity of other residential properties in the area such as traditional multifamily properties with similar unit sizes to help establish an understanding of market demand and rent trends.
Obtaining financing for SFR and BTR deals may have also been challenging in the past because of a lack of similar assets to compare values and project future performance. The recent explosion of interest for the asset class, however, has greatly improved the financing environment.
Due to high demand, government agency lenders Freddie Mac and Fannie Mae entered the asset class with a pilot program in 2017, which spurred interest from private lenders and mortgage real estate investment trusts, such as Arbor Realty Trust (Arbor), a member of The Arbor Family of Companies like ArborCrowd. Arbor pioneered an SFR and BTR lending program in 2019 that offers end-to-end financing from construction through permanent debt and is a leading lender in the SFR and BTR space with more than $866 million originated or financed in 2021, and over $1 billion of deals in the pipeline.
Lenders such as Arbor have dramatically enhanced the liquidity of the SFR and BTR space. There are now many more options and sources of capital available to those seeking financing for BTR and SFR developments, which has been a major contributing factor to the growth of the asset class and why it has become the rising star of the multifamily sector.
Although the SFR and BTR space has outperformed the overall multifamily sector recently, every deal must be properly vetted by experienced underwriters. SFR and BTR communities may share some similarities with other commercial multifamily properties, but the asset class has important distinctions that should not be overlooked. Investing with platforms that employ rigorous underwriting, such as ArborCrowd, may help investors find SFR and BTR deals with strong upside potential.