Thoughts on Build-to-Rent Investing - EP01
Our very first episode is about to go in the can here, so thank you for reading. I'm with Chase Leavitt and Sherida Zenger today and we felt like it would be a good idea to talk through some of the common questions real estate investors have about the build-to-rent industry.
I remember years ago build-to-rent was not really a thing. I mean, people did it. But it wasn't talked about as an industry on its own. It was kind of a cottage industry.
Build-to-Rent vs Existing Real Estate
How would you compare building a property that you're building for the express purpose of renting out to acquiring an existing rental investment property? What are the key differences?
The first thing that comes to my mind is that when you're dealing with something that is existing, you're dealing with the facts. You have what the rents at that time, and then also what the expenses are.
So when you're building something, you really with both of them either existing are built when you want to do your due diligence, right. But when you're doing bill to rent, you really have to dig into the numbers as far as doing your homework. Looking at other comps, when it comes to rent, looking at what the expenses are going to be, and just doing your homework altogether.
You're dealing with things as they are. What does that mean?
Obviously, you don't know what you're getting yourself into an existing property, right. So you may have a bunch of repairs that you're not quite aware that you have to do yet. Or you will figure that out when you do your due diligence.
So there may be more money upfront doing something as far as existing goes to get that so it is to the quality that you want for a tenant to live in. As far as new construction goes, it's brand new. I mean, you're gonna have less headache upfront, but it's probably gonna cost a little bit more to purchase that property, give or take. Obviously, there are risks both ways, but for a new property, you have to wait for it to stabilize existing, you may like Jay said, you may already have tenants in place.
So I think that's what you were talking about, things as they are your leases, you know what that is, it's signed for X dollars per month. And you can look back in the rearview mirror and see over the last, you know, they call it like at 12. Or, you know, t 24, you know, a certain amount of months, trailing 12 of here's where my costs have been on maintenance and insurance and all those other things, right.
You know that, right, you know, what your cash flow stream is going to look like when you close on the property relatively certain. What you're saying is, there are some things that you still might not know, even though it's been there, it's been performing as a rental for decades, right? Exactly.
Buying an existing property you'll need to vet out current leases. Is there room for improvement there? Are they over leased? Is the property manager even collecting all of the rents that were represented to you? Lastly, what repairs are coming down the pipeline?
Well, if it's brand new construction, my furnace isn't going to kick the bucket. One year in, it's going to be reliable, this property is going to generally be reliable.
How much maintenance is needed in brand new construction?
No, absolutely not. Why not? Because they're that builders doing the best that they can, but there's still going to be stuff that doesn't work, right, you may grid into your unit and say, Oh, my cold water is actually my hot water and things like that. There's just new tweaks, it's with any new construction, you've got to go actually live in it, to figure out what's wrong. And then you're gonna have warranty requests. And usually, a builder will cover that for the first year.
So if you've built your own property, a house to the listeners, and you've moved into it, you know exactly what we're talking about right now. Sherida just said, you know, the cold waters, the hot, hot waters, the cold, right? The door doesn't shut all the way the window is stuck over here.
These things don't mean that you hired a bad builder. Now they could, right. But new construction needs time to be broken in. And so a tenant is coming in and they're breaking that property in. Yeah, you can expect some warranty items, but other things are just part of you got to get the property settled down.
I've noticed there can be kind of a little bit of a break-in period for the first couple of months. And then it really chills out for quite a while on new construction. Have you noticed that chase?
New Construction vs Existing: Should there be a difference in rents?
I know it can all very just depend on the property because a lot of times when you were talking to existing in your mind thinks Oh, this could be an older property 1990s 1980s but What if you buy existing that was just built 1-3 years ago? So depends on what we mean by existing. That can vary as well. Location. Quality. I think a lot of things play into that.
Do properties built in 2021 lease for more than something built in 2015?
What about all things being equal? Would you expect a new construction property built 2021 to lease for more than something built in, say, 2015? Same neighborhood, similar square footage. I don't I don't know if there's a right answer. I'm curious. I want to explore that.
I would think yes. But it depends on the property manager to they might get a little more competitive with the new construction to get at least up and stabilized.
What is stabilized mean?
Stabilizing an investment property means there is a vacant unit. In the whole community, you could have anywhere between 50-100 units that are vacant or being built, and then they start to get turned over. And your investors want that to get leased up ASAP, or as fast as possible. They want to start seeing that, that income that cash flow,
It's kind of that time period between when it was completed, and getting it fully leased. It's kind of that stabilization time making sure that that property is occupied at full capacity.
Well, that goes to chases earlier comment of when you buy an existing property, you're getting things as they are, right. But when you do build for rent, you're having to get way out of head ahead of what the rents are in that neighborhood. And you might have that peg pretty well, you might at least think so.
Market changes during the build period
But remember, build-to-rent takes a long time. You're probably a minimum of 18 months before you get the idea of when you can actually start leasing units. Can the market change in that time?
Well, and it also depends, are you talking about a single unit? Are you talking about a single-family home? Or a townhome in an area that maybe other units are owner-occupied? Or are we talking about a whole project, right? Because if you're talking about a whole project, yeah, that's gonna take you a lot longer if it's just an infill--infill meaning there's a vacant lot in the middle of some city and Middle America, USA.
When you say the project, we're talking about a large number of doors or units. I talked to an investor the other day, that found a piece of ground, I think this was somewhere in Pennsylvania, and he wanted to put up a fourplex on it. Right.
So his expectation for stabilizing that property, meaning it's now full of tenants, they're paying rent, everything is going the way that you wanted it to go. It was a relatively short period, he thought, you know, within 60 days of being completed, I will be stabilized. And I don't think he was wrong. Right? A four Plex is probably something easy that a local market could absorb.
But if we're talking about 200 units, right, there's a lot of costs beyond just I built this, now you have to have that dry powder that capital to be able to get through that time period. I think that's why if we go from kind of more of the main street, single-family home, four Plex investor, all the way up to bigger units like apartments, your loan to build that is going to be 18 to 24 months, at least, because typically, the lender that's going to come in and pay off your construction loan and replace it with a long term loan is going to want to see 90% occupancy, they want to see stabilization because they're making that loan based on the health of the project.
Not necessarily, you. Although it is a misconception people all the time, I don't have to have very good credit to do multifamily, because it's based on the property, not on me. That's not true. Is it? Now, what is a lender gonna look at that? If it's, if it's, I mean, they're gonna kind of look at you, aren't you? What are they worried about?
Is build-to-rent riskier since you're basing decisions off of a proforma?
A lot of investors view build-to-rent and correct me if I'm wrong. But from my understanding, they view it as riskier. The main reason for this is you are dealing with pro forma or projections because it's not actually done or stabilized. yet so many unknowns are some unknown. But that's why, when you first got on here, start talking about this subject. It's all about the numbers. It's all about doing your due diligence and dialing that in. And the more that you can understand that and look into the numbers, whether it's the rents or the expenses, then that takes away. Not all but a lot of that risk going into that to build her for-rent product.
So you're saying people would view it riskier. And I agree, there's a segment that views it that way.
Why do some investors buy pre-construction and others buy a few years later for a higher price?
Sherida, we do an apartment or a townhome project that's exclusively for rent, right? Oftentimes, we have investors that come and would buy a fourplex or a 20-Plex or something below market value, or at least that's what we represent, right? Why are they doing that? Versus somebody who buys it from that investor years later for much more, why are they doing that? Could you give some color to that?
Well, if you're buying it pre-construction, you're getting, for the sake of what we do, you're getting it at a wholesale price, right? So they're able to get in with less skin in the game. And then they're able to take advantage of the equity.
Whereas the builder, if you're buying something else, the builders, the one that's going to be taken advantage of the equity or the owner of that property, if you're buying an existing, they will have taken up some of that equity. So you're really buying it up retail if you're buying existing versus buying the new construction model. So there are pros and cons to that some people like to take advantage of that.
Build time takes a lot longer. So some people say, Hey, I don't want my money sitting on the sidelines, I need that income right now. I want that cash flow. So I want to buy existing, and they're willing to pay a little bit more for it because they know they're getting something that again, is stabilized versus something that is projected and could take them quite a bit of time. I know when we work and talk with investors, we say in our project, specifically plan on six months for it to be fully leased up, right.
That's the best-case scenario, but sometimes it's faster. Sometimes it's slower.
Even if you look at it, segueing somewhere a little bit different. You go to syndication. They'll tell them to plan on 12-18 months before you see any kind of return once it's completed. So every you know, we're talking about a bunch of different options here.
Well, I don't want to name-drop, but whenever somebody says they don't want to do something, that means they're about to do it anyway.
I've been on the podcast for the Real Estate Guys--Robert Helms, and Russell Gray. And they do a great job, I highly recommend their show to everybody reading. And they always say, "no investor left behind".
I think we're probably guilty that some use a word that investors may not understand. Sherida said, and we're going to kind of make this our thing everybody's witnessing, and we're making it a thing right here and right now. Right? The No, no investor left behind the component.
What is a Syndication? Why do investors prefer to get into syndications?
In a syndication, you invest in a partnership. You're taking a share of a company that then goes and buys an apartment building. You're not gonna see any returns for 12-18 months, at least, because the operator (the person that you invested with that's kind of leading the project) has a lot of work to do.
In apartments that are existing, oftentimes, that's referred to as a value add, they go by an old, dilapidated building, we're gonna go put a new carpet, new countertops, kick out the deadbeat tenants raise the rents by 100 bucks a door, that thing's worth a lot more all the sudden, but that just doesn't happen overnight. That's a complicated process.
So if you invest it into that syndication, they syndicated the capital, they're not gonna be ready to pay you any kind of returns or any cash flow until that process is really settled down, right? You get to take a little bit lower risk in that case, because you have a piece of a very broad and diverse asset.
With 200 units, what are the chances that you're not going to have cash flow? At any given time, over those 200 units, you're gonna have a vacancy rate. You're gonna have a certain percentage of tenants that are not paying you rent, right? Well, when you're the only owner of a property, you get to feel all of that vacancy, right.
So that's why a lot of people like to go into syndication because it's just a more even-keeled experience, right? those bumps get smoothed out through the syndication model. But if you buy what we would call fee simple, built around a real estate, that means you're the owner, just like the house that you live in, you probably own it fee simple. You can buy it, sell it mortgage it, it's your property, but you feel all the bumps when something like that happens because it's 100%. Your problem because you're the only owner, right?
Exactly. I think that's also the advantage of doing something where you're getting multiple doors versus one door, right? So if you buy just a single townhome or a single-family property right, if you're going into getting a duplex or triplex or fourplex something of that nature, you're not filling that pinches much when you don't have one tenant paying, versus if you own one door, and one tenant doesn't pay. You're next on the line for all of it.
You have multiple streams of income to service that debt, those taxes, the carrying costs associated with the property.
Thoughts on Build-to-rent Single-Family
So that's interesting, right? Because we were talking right before we started recording today about that model of assessing what you are going to do on build-for-rent because you just gave an advantage to multifamily.
Somebody could come back and say well, a big advantage of single-family is I have a higher exit price. You might. We were just talking about doing some townhomes. Should we do them as rental townhomes? Or should we sell them off to Bob and Susie, the owner-occupied homebuyer? Can we sell at a higher price to Bob and Susie?
For owner-occupied? Absolutely. But we can't because the investor, if you would sell or hold the property as an investment, you're looking for yield, and you're gonna have to build cheaper. You're gonna have to be in at a lower cost, in order for that to be worth you.
But Bob and Susie don't care, they just want a place to live. And they're looking at the local market. So somebody who does a build-for-rent on single-family, I have a, an investor client that's doing this a lot in Florida right now, if you do a build for rent on a single-family home, and you rent it out, great, you rent it for a few years, maybe the tenant leaves, you do have an interesting fork in the road there, do I want to keep renting it out, or Wow, has the market really gone up so much, that I can make a really healthy pop here if I just sell it to the homeowner.
You take that option off the table when you go five units and up unless that person wants to get commercial financing or something. But that's what's unique about a fourplex.
Owner-Occupying a Fourplex (House Hacking)
What about fourplexes and how they merge with owner occupancy? Where do the two worlds come together?
So a fourplex or four units are nice because you can still take advantage of the 30-year fixed conventional loan. That's what most homeowners are used to is that 30-year fixed. It gives you a more favorable interest rate.
Because you live in it, the interest rate you're going to get is lower than if you didn't live in it?
Not necessarily, it's whether you live in it or not. With four units or four doors, or lower. When you when we start talking to the five units or more, the bigger apartment complexes, your financing is going to change.
You have to go commercial at that point. Doing the four doors or less or being able to go residential, Fannie or Freddie.
No investor left behind. What is that? What does that mean?
Those are the different loan types/programs that you are allowed through your lender. Lower interest rates than something that's on commercial. It's more of a conventional loan, like Chase was saying, you're going to do a 30 year fixed on something like that. Which makes it I think, more affordable for some people.
The true 30-year fixed, that loan could be given to an investor, that's not going to live in the four Plex or the triplex or the duplex or the home, right, one to four units. What if that investor wants to live in one of the units has that changed up?
It does change it up, but it has to be a duplex. And at that point, they can do 20% down? If it's anything over most lenders are going to require 25%.
A lot of people talk about this house-hacking concept. They don't want to get commercial financing or they don't or they want to put less money down so they think if they go buy this duplex and move into one side I can put a very small amount of money down move in and live there for X amount of time and then move out and just keep the loan. Which is a really really great loan--low downpayment and the lowest possible interest rates.
Some people I think get into trouble with that. That's called loan fraud. If you say I'm gonna move into it and you never do. Not the most sustainable business model, although it doesn't stop some people from trying.
Okay, and I like the house hack idea. But why not house hack multifamily? A fourplex, duplex, or triplex? That's a great idea.
Absolutely. It works well, and they're out there. I mean, for whatever reason, people builders put up a ton of fourplex is in like the 70s in the 80s. And then they stopped for about 20 years.
I'd be interested to figure out why they did that. What was the reasoning behind that? Did people want more land and so they wanted that's where they went single-family or what was the thought behind that?
Every city I've gone to, every market I've ever analyzed, they all have these little pocketed neighborhoods. You can tell this was built in the 70s and 80s, those boxy-looking style for plexes or garden-style apartments. They just built him like crazy and then they stopped.
Know what to check into it.
Best/Worst Markets for Build-to-Rent Investing
We have time to get into another question. What markets should you consider for build-to-rent? Is there a right answer?
There's a lot of great options in my opinion. The more you do your homework and understand each market, there's a lot of opportunities. I would say pick where you feel comfortable.
For me, I started here in Utah, and luckily, Utah's a hot market. But that's where I first started because it was in my backyard. The more I started to research Idaho, Arizona, and Texas the more I saw a lot of similarities to my home market. And with that, a lot of opportunities. A good place to start is where you feel comfortable.
I think you also want to be aware of how landlord-friendly a place would be. If you're going to be a landlord, you want some protection on your side.
There are definitely states you want to avoid. Want to pick on states?
Massachusetts, New York, California, Washington, Oregon, Connecticut, Maryland. I'm not saying you can't make money in these states (and there are more states we won't get into), but they're not known to be very landlord-friendly.
When we talk about to build for rent, it's the local building code and the inspections and everything that you have to deal with.
If I said those states and you're, you're sitting there going, Hey, that's mean. You actually know it's true if you live in one of those cities, and you own property.
Now, it doesn't mean that you can't make money, it actually doesn't mean that you can't make a lot of money. There's that saying in business that if it were easy, everybody would do it. Right? And so if it were, so people want to live in those places, is their tenant demand? Right? I think that's the ultimate key. Yep.
Do people want to pay rent is rent going up, you can usually figure things out from there, it might be harder, and it will pick on Massachusetts, it might be more difficult. That doesn't mean it's not possible. And it doesn't mean it's not profitable. But what you said for somebody who maybe is going to go outside of their backyard, because I agree, it's easy to know and operate in your own backyard.
But if you're going to go outside of it, it probably makes sense to be somewhere that's landlord-friendly, and, and has some of those laws on the books that are more favorable. Because when you're doing it from afar, you need everything in your favor that you can possibly get.
One more thing about the backyard comments. There are certain cities and places in my home market of Utah, I wouldn't go to. So it could be very specific within that state as well.
Well, you do. You're the majority of your investing in Utah. So why wouldn't you go to those places?
Just like what you mentioned, the man for rentals or for and also employment rates as well as their high employment rates? And what are the vacancy rates going to be? Those are two key indicators that I look for, that you'll want to study in each market that is specific.
So the three of us once upon a time, when was this when we took our trip to Texas, remember that? Did we look at duplexes? Yeah, that's like six months ago, yeah, beginning of the year. I know in the COVID era, nobody knows when things happened. I can't remember it's all a blur.
We saw some good-looking products, some of it in the core of San Antonio. And the rest kind of out in what I felt like was the sticks. And I know some investors that have purchased there. They seem happy. And but the jury is still out. Right? When things are going good things are going good. Right? You can invest almost anywhere and look like a genius. But when things aren't going so good. You find out what you really have. And that's what I want to see.
With those particular duplexes that we saw that were out in the middle of nowhere. I kept thinking, well, who are these people who are clamoring to pay rent out here?
Where do they work? What are they doing? Yeah, right. There's a lot of questions behind that. How far are they willing to commute? I mean, there's, yeah, there are things that play into that. Right. Are they willing to commute a little more, because the rents are less? Yeah. But is that something you want to take on risk-wise?
Yeah, well, and it's exactly why are they willing to do it and the developer had their reasons. Some of them made sense. Others I had issues with, we're not going to know. Now you might be a really careful investor, you might say, Well, I'm not investing there then because I don't want the jury to be out.
I want to invest in an urban core, where I know no matter what, there's going to be a huge likelihood that there will always be tenants. There will always be businesses, and that's great, but it comes with a cost doesn't it. You want that certitude with tenants. It's going to cost you cheap. Land out in the middle of nowhere, anytime.
So there are two questions involved there. Yeah, like what you said, Will it rent? And most of the time, it's Yes. Unless it's in the middle of nowhere. But that will probably rent too. The next question is how much is it going to rent for? Once you understand those two things, then you can pencil in the numbers and see what are the cap rates going to be cash flow and see if it makes sense or not?
Everything rents at a price. But is that price going to eat you alive? Exactly right in the build for rent world, your financing, and all of your projections are based on a certain rental price. So you've got to have some elasticity at that price, you've got to know hey, look, I've seen units running for $1200 a month.
That seems like that's very easy to do around here. But I'm going to hit the market with 50 of these that are kind of a similar floor plan. Maybe I should plan on like, you know, a $1,000 rent special for the first year and build all my models off of that. Because if you outperform it, then good for you. But if the project success lives or dies by you having to hit that in the first year, this is not the right deal for you. I don't think
When I think that's why when we're analyzing projects, putting a performance together, we're looking at it saying, What's a conservative viewpoint, right?
Like we want to be conservative, we're not projecting market rents that are going to be in a year, we're looking at what's current market rent right now. And maybe going even a little bit below that, in some cases, or right in between where you know, the high and the low is, and what we feel product-wise, you know, how our product fits in that.
And we've been fortunate because we've been in a really good rental market, where a lot of times are less, what, five to eight years, the rents are typically 50 at least or sometimes even 150 to $200 more per unit, which makes the numbers that much better.
It's all about looking at the comps and seeing what surrounding similar rental properties are ready for being conservative. I like that. Go do your due diligence. Yeah. And then understanding. Okay, what's being built? What's coming in taking it a step further as well?
Well, it's very tempting, and I've seen this happening lately. I mean, what about when the music stops? If you've been investing the last five to eight years, you that's that rising tide lifts all boats, right, no matter what you built, the rent was probably higher when the unit was completed than what you thought it was going to be when you projected it.
And I've started to see a few people starting to go I didn't work occurred market rents, but I think they're going to be here in a year, and everything is built on what they think is going to happen in a year. That's a hard position to be in because you're trying to make a deal work. And, you know, I've sometimes I've found myself going down that path a little bit. I think you got to be careful about it. Yeah, definitely.
That's funny, I actually looked up a property yesterday in Idaho for a client, and they had a current mark, or their current rents right now, like 950, 955, and then in another column, they had projected rents of 1325. So I sent the gentlemen an email to the listing agent and just said, Hey, can you please explain? He has yet to get back to me. So that'll be interesting to see why he thinks that those market rents are totally different than what the current rents are. But that's a significant jump.
So that's something to be aware of, to absolute. Why is he looking at that? Does he see something I don't see? Or is he just doing this so that he can justify the purchase price?
Yeah, proforma will tell you, they craft that to tell you what you want to hear. So you can get a reputation pretty quickly. If you're doing a pie in the sky performance. I ran into the same thing last week, we're helping a client buy it. This was a four Plex. And the rents the cap rate was mediocre. But it's mediocre in the entire market, in most cases right now. But yeah, we did find one of the units was under rented. That's why it speaks to us to know your market. Right? What what is the market rents because a lot of these, we call them mom and pop landlords get lazy, or maybe there's a bad management company.
And over time, it's very apparent that they're not collecting enough rent on this property. Right. I could move tenants out of here and release that thing for 100 200 bucks higher. That's a tremendous amount of value when we're talking about cash flow. So when you're deciding a market, and I think that's the original question, we asked here, how do you decide which markets are best? It needs to be one that you know, right? You need to be able to look at a deal and say, You know what, those rents are too low. That projection is too high. Nobody's going to rent that. You know, it's a funny market. We talked about this about 18 months ago, we expanded our business operations in Phoenix, Arizona, and looking at lots of land opportunities.
And everybody kept saying go to Buckeye, right if you know Phoenix, You know Buckeye? What is it chase? Probably 90 minutes outside of downtown to get to Buckeye. maybe an hour, maybe an hour, maybe an hour. Yeah. Now it doesn't feel like an hour. It feels like more. Because when you leave the west side of the valley, it's like you're in an old Western movie, right? Yeah, you're on the 10 on your way out to Los Angeles. But it's like there's nothing there. And then all of a sudden Buckeye shows up. And it's there. And there's Home Depot and Lowe's and restaurants and movie theaters and everything. And going Wait, why is this here? Right? I can't figure it out. So people kept saying you need to go to Buckeye.
That might be true. Now I don't know yet. But I said, Well, why do we need to go to Buckeye. And I remember our project Superintendent Mike kept saying, well, this blowing up. Why was this blowing up? I might I don't get it. Why is it blowing up? Well at the time, and like I said, this may be different. It's been a while since I've dived into Buckeye. But people from California could move to Buckeye, Arizona and buy two acres and build on it or just have their own property.
That's why it was blowing up is because it was cheap to live there. But the employment base for tenants that were ready and willing to pay a lot of rent, wasn't there. Right? They could easily go into the city into like surprise and Goodyear and Tolleson and some of those cities right on the west side. That's where they worked. That's where they could also live. So I wasn't ready unless we had rents that were substantially cheaper than in the core of the city. Because what else would incentivize somebody to drive out to Buckeye? At night after they work somewhere, you know, in the logistical area up there along 303? Right. So that's something you have to consider too. I bet it's different now though. We should we should check into it.
Yeah, that's been kind of fun, too. Sometimes just even going when we're trying to analyze a piece of dirt that we have, that we're getting ready to sell out to our investors has been going into some of the other property management companies, or just you know, making phone calls, but driving the area.
No, like we've said a few different times on here. Know the market know the area, go do some due diligence, drive around, ask questions, see who the neighbors are, make a huge difference and look at it from a tenant's perspective. If you're a tenant, are you going to want to drive to this location? Do you feel safe here? Is it close to amenities? You know, we'd like to be close to freeways. One of our inside jokes is is there a Costco or chick fil close? By? If so let's buy it. So Hmm.
And a good example of that is the Fourplex Investment Group's Village on Greenway project in El Mirage, Arizona. If you look up El Mirage, online, it's not gonna have flying colors. But if you actually drive it and go there, take a look at it. It's in one of the better locations of El Mirage in Arizona. That's it. So there's a story to tell with every project, and it helps to look at it.
Before we wrap it up. Another really helpful piece of advice to anybody considering build for rent is one good thing that the age of COVID stupid COVID all right has given us is the city council meetings are all recorded, and they're all online. Now. They're usually broadcast live, you can be sitting in Missouri, and you can watch the city council meeting in Seattle right that night.
And you can see what are the other projects being proposed in the area? What's being built over here? What's being built over there? Because having insight into that makes you look out across that raw land in an entirely different way. Right, you know what's coming. So we kind of talked about don't do projects because of Oh, here's what I think it'll be in the future.
But that's not entirely correct advice, because you got to know what's happening in the future. Right. And if you see a bunch of other developers and office managers making plans that will tell you something about a project you're considering.
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