Emerging Housing Niche Takes Growing Share of Rental Market

Article originally posted on CoStar on July 21, 2023

Several Sun Belt markets rank as the top spots for built-to-rent product with Phoenix, Dallas-Fort Worth and Denver taking the top three positions. Developers are homing in on robust population growth and tapping into a consumer segment that bridges the rental market and for-sale market.

Single-family, built-to-rent complexes, also referred to as horizontal apartments, are a hybrid between single-family homes and traditional multifamily. Built-to-rents have the interior layout that a residential home provides, but they still perform like a multifamily rental and appear in CoStar analytics as such. Rentals in these developments typically have 100 or more standalone units on small individual lots and often feature a garage, private fenced backyard and no shared walls. They also offer shared community amenities like a pool, dog park and professional management.

Demand for built-to-rent product is driven by the continued migration away from expensive coastal cities to more affordable markets. The de-densification trend is occurring within markets too, as residents gravitate to high-growth suburban areas, where housing costs are lower. The tenant base is typically comprised of young families or renters by choice who want the privacy and space offered by a single-family home, but don’t have the downpayment or income required to be first-time homeowners.

Would-be home buyers face a difficult market with elevated prices and mortgage rates compared to two years ago. Interest rates have risen at their fastest pace in 40 years, nearly doubling the average mortgage rate over the past 18 months, currently at about 7%. Meanwhile, prices for single-family homes remain elevated in the wake of the buying frenzy and available inventory remains low.

Phoenix is one of the primary targets of built-to-rent development, with builders adding about 9,300 units to the market since 2016. This represents about 13% of total multifamily construction during that time, the largest share among all major markets.

The West Valley, in particular, has been ground-zero for Phoenix’s built-to-rent boom as developers chase the rapid population growth in areas such as Glendale, Peoria, Goodyear and Surprise. The robust demographics, affordable land and ease of entitlement have encouraged construction activity. Since 2016, about 35% of new multifamily builds in the West Valley have been for built-to-rents, compared to about 13% for Phoenix overall.

As the sector gains popularity, the robust operating environment that developers and managers were enjoying is beginning to transition as high inflation and economic uncertainty slow underlying housing demand. Indications from one leading local built-to-rent builder is that they’ve become more targeted in their expansion due to higher interest rates on construction loans, elevated development costs and a 100-to-150-basis-point increase on exit capitalization rates.

The overall Phoenix multifamily market is facing considerable supply pressure and softer property performance. While the built-to-rent niche is somewhat insulated from new construction due to its location and unique product offering, rent growth and lease up duration are expected to downshift from the rampant pace in 2020 and 2021 amid greater competition.

More residential developers have pounced on the opportunity to add built-to-rent product in Dallas-Fort Worth. There were 6,863 units identified as built-to-rent that were delivered in Dallas-Fort Worth since 2016, accounting for about 4% of total multifamily construction during that time.

Most developers are focused in suburban areas with supercharged population growth, led by neighborhoods in Collin County and sections of Denton County. About a third of built-to-rent units are found in Collin County. Most complexes are concentrated in Anna, McKinney and Prosper, tracing a similar development trend in the multifamily market and pushing the geographic boundary further north. Meanwhile, new developments are also coming to market in neighborhoods around Fort Worth and Rockwall.

Traditional built-to-rent players including Phoenix-based NexMetro, have introduced more complexes, but multifamily stalwarts including Greystar and W3 Luxury Living have brought new projects to market. W3 is behind The Mansions of McKinney, a 416-unit project wedged between McKinney and Melissa. The properties offer more three-and-four-bedroom units to renters in an area that’s a magnet for families with asking rents of $2,400 a month.

Overall, the pace of construction is expected to taper through the near term. Rising interest rates have pushed the cost of financing new construction higher across asset classes. Even so, the built-to-rent concept is serving a growing segment of the housing market, bridging the gap between renting and homeownership.