With so much uncertainty on the near-term horizon – inflation concerns, the potential for additional interest rate hikes, a volatile stock market, and conflicting forecasts on the depth of the recession – where are the smart money investors in the housing space placing their bets? In our recent “State of CRE 2023” Walker Webcast, we sat down with executive VP of research and securities Ivy Zelman, executive VP of Investment Sales Kris Mikkelsen, and senior managing director of Capital Markets Aaron Appel to gauge where the housing investment market is headed. The trio provided a deep dive into the market before speculating on what they believe will be winning strategies for investors.
In our recent “State of CRE 2023” Walker Webcast, we sat down with executive VP of research and securities Ivy Zelman, executive VP of Investment Sales Kris Mikkelsen, and senior managing director of Capital Markets Aaron Appel to gauge where the housing investment market is headed in the new year. The trio provided a deep dive into the market before speculating on what they believe will be winning strategies for investors.
The panel began with an analysis of what has proven to be the hottest segment of the housing sector – single-family-rental properties (SFR) and build-for-rent properties (BFR). Fueled by scarce inventory, high interest rates, and record-high home prices, SFR/BFR has become the darling of investors since the market segment saw an explosion of growth over the past few years.
As limited housing stock and intense market competition have capped the growth of SFR portfolios, investors have increasingly been turning to BFR for opportunity. However, even that segment may be losing some momentum.
“The capital formation and the capital deployment (in BFR) continues. But it's largely centered in the build to core strategy, and we've seen large institutional investors continue to deploy capital (into this space). But it's really to build and own this durable income stream for the next 8 to 10 years.”
Transaction activity for BFR has slowed precipitously since the beginning of 2022, as the majority of transactions were in the forward take out structure and inventory has been slow to deliver. Whereas stabilized cap rates for forward take out structures in the fourth quarter of 2021 and the first quarter of 2022 were in the low-to mid-fours, stabilized cap rates now need to be in the six to mid-six range to attract investors.
“There is very, very little transaction activity (going on right now),” says Mikkelsen. “I feel like there are transactions on stabilized, cash flowing, existing communities at market prices, and then you've got distressed home builders selling to opportunistic builders in the forward space on the other end of the spectrum, but there’s very little acquisition activity in between those two poles right now.”
Zelman agrees that the build and hold strategy will most likely continue for investors, primarily due to the severe shortage of affordable for-sale housing. “There is more of a directional play for build-for-rent by many developers (as opposed to) for-sale,” says Zelman. But the BFR market is facing its own self-inflicted headwinds in the form of land pricing, where developers consistently overpaid for land in the rush to bring product to market.
“There’s no question that lot inflation has just soared. At the peak, we were seeing lots in some markets doubling in value,” says Zelman, who is also CEO of the housing industry research and advisory firm Zelman & Associates, a Walker & Dunlop company. “We do a land development survey quarterly, and we saw lot inflation approaching 35-40% nationally, with many markets seeing double that. And the land developers in our survey indicated that a good 40% of that inflation was due to the build-for-rent capital chasing the asset class.”
Fortunately, lot inflation has slowed to approximately 10 percent, and Zelman expects that it will continue to moderate, given the weaknesses in the current market. In contrast to the 2008 Great Financial Crisis (GFC), however, “builders have been much more prudent tying up lots via option in smaller bites than they did in the GFC,” says Zelman. “They're going back and dealing with the developer that they're optioning lots from, and they're either walking away and taking impairments on those deposits – those options that they have locked in right now – or they're deciding they don't want them and they're re-trading them at better values.”
So where are the smart money folks placing their SFR bets?
Zelman opines that with M&A activity in slowdown mode (deal volume in 2022 declined 13% and deal value fell 32% versus 2021, according to a recent report by the Boston Consulting Group), some large institutional investors are acquiring the assets of smaller firms. “I think that smart money right now is taking advantage of the weaker players in the market that are not well capitalized,” she affirmed, citing a recently announced deal that exemplifies that trend.
In early December 2022, D.R. Horton, the largest homebuilder by volume in the United States, acquired the operations of Riggins Custom Homes for $107 million in cash. The deal with the Fayetteville, AK family-owned business included approximately 3,000 lots, 170 homes in inventory and 173 homes in sales order backlog. “So I think that there's no question that (institutional investors) will capitalize on those companies that are not well positioned,” said Zelman. “They have too much leverage and will take advantage of what would be good locations. It would be what smart money is doing today, I think.”
Appel believes that savvy multifamily investors will be taking the long view and will invest outside of the SFR market. “I would say that the smart money should be looking to be able to buy multifamily housing at break-even leverage, based on right around where today's rates are, and to lock in seven-year financing, with the ability to get out after five,” said Appel. “It's just a waiting game, really, if you can buy it at break-even leverage in good rental markets where there are going to be demand drivers and eventual employment drivers back on the horizon – with some level of supply constraint – I think you're going to be a huge winner five or six years from now.”
With so much uncertainty in the economy (complicated by supply chain issues, elevated construction labor and materials costs), the investment landscape for multifamily properties continues to be a complex one. With 85 years of insights into all the complexities of the market, Walker & Dunlop’s team of advisors can help both borrowers and investors plan their next big project. Reach out to our team to discuss your specific needs.
For additional insights into the multifamily properties market, watch the Walker & Dunlop “State of CRE 2023” webcast in its entirety.