By Fred Matera, CIO, Redwood Trust A lack of affordability will lead to near-term weakness,…
By Brandon Turk
Build For Rent (BFR), building new single-family homes from the ground-up for the specific purpose of renting to tenants, is a rapidly expanding real estate asset class. It is born out of growing tenant demand for increased privacy, greater room options, larger outdoor areas, and now, a comfortable place to work from home.
This demand has sparked a major shift in new development projects. As a result, multifamily developers and traditional build-for-sale homebuilders realigned their strategy to enter the single-family rental (SFR) space with their eyes set on stronger returns and increased renter stability.
Several different strategies have emerged from the BFR boom. One strategy that is gaining traction is the sale of newly built rental homes upon receipt of a certificate of occupancy to institutional aggregators. As institutional investors entered the SFR space, they brought with them a demand for portfolios of newly built single-family homes.
This demand is commonly met through mutually beneficial partnerships with home builders. This partnership decreases the risk for the builders as they pre-sell the homes, while the investor acquires high-quality SFRs in bulk, without spending the time or resources to acquire each home individually.
Whether you are eyeing a similar exit plan or are looking to first finance your BFR project, here are some helpful financing tips to consider.
Besides interest rate, loan amount, and recourse options, two other important factors should be considered when evaluating construction financing options: 1) Lock-out / Prepayment penalties and 2) servicing.
Lockout / Pre-payment Penalties
Sometimes a lender’s and a borrower’s interests diverge: a borrower is motivated to deliver homes and pay off the loan quickly while the lender would prefer to keep the loan outstanding a little longer to earn more interest.
This misalignment of incentives causes some lenders to structure loans with lockout periods (a period of time when a loan can’t be repaid) or prepayment penalties (fees charged if a loan is repaid too early), which are in essence success penalties that are punitive to the borrower when a project is completed/delivered ahead of schedule.
If you plan to sell units immediately upon receipt of certificate of occupancy, make sure that your lender allows you to pay down the loan without penalty.
Construction Servicing Team
Who will you be speaking to for draw requests, release of homes, and miscellaneous issues that come up during the loan term? As expected, adding a middleperson (aka external servicing team) will most likely increase friction, reduce efficiency and lead to potential funding delays.
For example, if you are requesting to reallocate funds from one line item to another, you might be hit with the typical response of “That is not what the loan agreement states,” and thus begins the long journey of dealing with your lender through an intermediary. When lenders have an internal servicing team, there is generally a greater level of communication, flexibility, and a stronger overall relationship.
Lenders are in the “relationship business” and are more inclined to help their clients overcome issues that arise during the loan term. This will keep the project moving efficiently and help you reach project milestones.
As new institutional and retail investors enter the Build For Rent market, I expect to see many innovative strategies that will continue to improve the BFR model. It is certainly an exciting time to be in the real estate industry.
I hope this article was of use to you. Whether you are developing BFR communities, renovating multifamily apartments, or growing your SFR portfolio, I want to hear from you!