— By Adam Wolfson and Darryl Kasper of Wolfson Development Co. —
Against a backdrop of recently proposed (though unlikely to pass) legislation aimed at forcing large build-to-rent (BTR) and single-family-rental investors to shed units and convert them to for-sale housing, BTR fundamentals — and the investment case for the sector — remain strong as ever.
While debatably well-intentioned, the legislation mistakes correlation for causation. The BTR sector is indeed benefitting from problems in the housing market. However, these problems pre-dated the industry and are more likely caused by factors such as inflation, high interest rates and limited supply. These forces are at play throughout the United States, but they are especially prevalent in the Southeast, where they align to create what could be the perfect storm for BTR rent growth.
Inflation, Wage Growth Will Drive Rent Growth
Inflation has run rampant since mid-2021 for a variety of reasons, including economic dislocation caused by the pandemic and the subsequent stimulus packages the U.S. government provided in response, as well as high gasoline prices and a supply chain crisis. According to U.S. Inflation Calculator, the annual inflation rate skyrocketed from 1.4 percent in 2020 to 7 percent in 2021, then fell slightly to 6.5 percent in 2022. Notably, however, the annual inflation rate fell to 3.1 percent in 2023.
While inflation certainly contributed to rent growth in recent years, the wage growth we began seeing a few months ago should enable further rent growth given effects on affordability and rent-to-income ratios.
In the late 1970s and early 1980s, many markets saw high single digit, if not low double digit, rent growth year after year — and these were the days of “stagflation” with no real wage growth. Today’s wage growth, which The Fed projects will continue over the next couple of years, provides a more real and more powerful second barrel for rent growth than inflation by itself.
High Interest Rates Create Demand in BTR
BTR obviously didn’t cause Covid-19 or the stimulus packages that followed. Similarly, however, the BTR industry didn’t cause The Fed’s fastest-on-record interest rate hikes. These high rates have had real impacts on the for-sale housing market that are flowing downstream into BTR’s pocket.
While high interest rates make mortgage payments unaffordable, people nonetheless require more space to live and work as their families expand. The rental housing industry is unlikely to be the reason that would-be-buyers cannot afford mortgages after The Fed raised rates 11 times in two years. It is simply the case that rate increases drive would-be-buyers to rent. The BTR industry did not cause these problems. However, it will continue to benefit from them.
The Impacts of Interest Rates on Rental Housing
Many articles that lay out the ‘rent vs. own’ dichotomy focus on the ways in which high interest rates impact home mortgages — as well they should, considering high interest rates will often shift near-term demand in favor of rental housing.
But less appreciated are the longer-term effects high interest rates have on housing supply (both for sale and for rent). Namely, high interest rates impact construction loan availability, developer and homebuilder willingness to take on double-digit interest rate loans and confidence surrounding bridge loans, perm take-outs and the viability of the for-sale market.
Some projects will be mothballed for future cycles, and others won’t be conceived of in the first place, but new supply will be vastly limited. All of this comes against an already supply constrained framework facing an estimated shortage of some 6 million homes nationally.
All told, the high interest rate environment offers a redoubtable one-two punch for rent growth, both demand and supply wise in both the short term and long term. How much supply will be further limited due to high interest rates remains to be seen. However, judging from past cycles, even a year or two of light deliveries can be followed by high single digit rent growth in in-demand markets.
And the markets of the Southeast — particularly Florida — are just that. Per recently released census data, Florida (now with a population of 22.2 million) had the highest population growth of all U.S. states at 1.9 percent. This translates to more than 1,100 new residents daily. Even in the high-delivery, low-rate times of 2021, supply would never have been able to keep up with that.
BTR Rent Growth Thrives in the Southeast
BTR fundamentals are strong nationally, but they are particularly good in Florida. A CBRE report from June 2023 reported that BTR vacancy stood at 4.8 percent nationally, and saw 6.6 percent rent growth in 2022. Tampa led the nation in BTR rent growth, with 13.4 percent rent growth.
BTR in Florida and the Southeast are benefitting dually from strong in-migration trends and evolving renter preferences. Rent growth from the above and other factors can provide a meaningful offset to cap rate increases that might otherwise result from interest rate hikes.
Despite Agency permanent loans in the mid-six percent range today and bank loans in the seven percent range, CoStar marks cap rates for the major Florida and Southeast markets in the low five percent range both today and over its five-year forecast periods. Some of this differential can be attributable to yield curves — which are expectations of where borrowing rates will be a few years from now — but at least some of it is a statement about rent growth.
Another important factor that should help keep cap rates suppressed are the billions of dollars in equity capital that funds have. These funds must either be put to work as tasked with or returned to investors.
And where do these investors want to deploy first? You guessed it: Florida and the Southeast, as evidenced by cap rate spreads. CoStar expects these trends to continue, with average cap rates of 5.2 percent for Florida and 5.4 percent for the Southeast over five-year projection periods, compared with a national cap rate average of 5.6 percent.
The Bottom Line
The factors enumerative above aren’t independent of one another, but interdependent, and capable of strong multiplier effects when combined. With such tailwinds propelling the BTR sector forward, it’s surprising to see some institutional investors sitting on the sidelines waiting for the great ‘risk-off’ to end.
On the other hand, it’s encouraging to see some of the smartest investors jumping in. Warren Buffet and Berkshire Hathaway recently poured hundreds of millions of dollars into U.S. home builders, which are increasingly viewing for-sale and for-rent product interchangeably, and which don’t need traditional construction loans to build. Whether due to factors laid out in this article or others, Buffett’s investment is a significant rubber stamp for the bet on rent growth and housing.
The fundamental trajectory for the BTR industry is well encapsulated by Buffet’s description of how to size up an investment: “Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily understood business whose earnings are virtually certain to be materially higher five, 10 and 20 years from now.”
Looking at the pre-existing supply problem — and the recent policy proposals that the BTR industry had no hand in making — it’s difficult to imagine a world in which there are fewer renters, and in which rents themselves aren’t meaningfully higher over the next decade. These are trends that we can expect to be amplified in the Southeast and Florida.
Adam Wolfson is the CEO and Darryl Kasper is head of investments at Wolfson BTR, an affiliate of Wolfson Development Co. Based in Miami, Wolfson is a real estate investor, developer and fund manager that shifted to a nearly exclusive BTR focus in 2017. The company currently has almost 2,000 BTR units in development.