“This is Like My House”

Recently, National Housing & Rehabilitation Association hosted its Summer Institute at the tranquil St. Julien Hotel and Spa in downtown Boulder, CO. While questions about the current Trump administration’s impact on the affordable housing industry dominated the discussion, there were also valuable talks centered on new building practices that exemplify the industry’s history of resilience and innovation.

One of the more intriguing panels was “Leveraging LIHTC for Single-Family Rentals,” which explored the growing practice of building affordable single-family home rental communities using Low Income Housing Tax Credit (LIHTC) dollars and other industry-standard funding sources. Known by various names, such as Build-to-Rent (BTR), horizontal apartments, and single-family rentals, these developments differ from most multifamily construction by focusing on standalone or duplex structures to provide a product similar to traditional LIHTC apartments with a more home-like feel.

“Ultimately, what we’re talking about is affordable housing—rentals—that just have either bigger homes with backyards (sometimes single-family, sometimes they’re townhomes) that are actually not that much different” from traditional, high-density affordable multifamily apartment buildings, remarked moderator Eleor Cohen, managing partner at Cohen Liuzzo.

Though “build-to-rent” evokes certain negative industry practices, such as “buying 700 homes from homeowners and then just turning them into rentals…, that’s really not what this is,” Cohen stressed. “This is an opportunity to use a different type of product, giving families who don’t have the money to either buy or rent market-rate homes, but now they get a home with backyards to bring up their families. So, it’s just another tool in the toolbox.”

Build-to-Rent Picks Up Steam
Benjamin Taylor, vice president and project partner at Lincoln Avenue Capital (LAC), stated that the BTR model originated within the market-rate space in Arizona’s Phoenix Valley around 2008. At the time, a dismal housing market, combined with relatively inexpensive land and construction costs, and an abundance of undeveloped space, led to the practice of building entire communities of single-family homes not to sell, but to rent.

Since then, the practice has expanded into various parts of the country, particularly taking hold in Sun Belt communities in Texas, the Carolinas, and Florida.

Although BTR is still primarily used by market-rate builders, affordable developers have adopted the practice in recent years, filling a desirable niche in the LIHTC market. About three years ago, Taylor said his team realized BTR’s potential for high-quality affordable housing. “We saw this development happening, and we saw a lot of land being marketed down in Phoenix, because we’re very active down there. A light bulb clicked on and we said, ‘hey, if the market-rate guys can do it, why can’t we?’”

Taylor recognized the potential for BTR to serve large families, who are often neglected in the typical affordable housing stock. “You are effectively disincentivized to have a large family if you are in the lower income brackets,” Taylor said, noting that most LIHTC developments simply don’t offer the space that families with multiple children need to be comfortable. “Three- and four-beds generally in our space are not super common, and this product lends itself well to providing that type of housing.”

Mike Hemmens, managing director for West Regional Markets at Citi Community Capital, concurred. “It’s a single-family home,” he said. “For large families that have pets, dogs, you have a place for the pets to hang out, for the kids to play a little bit. You have more space, more room, which families need.”

Still, outsiders have occasionally been skeptical, said Taylor. “Some municipalities view it as a workaround to zoning code,” he explained, noting that some municipalities utilize single-family zoning to guarantee for-sale homes, not rentals, and that those locations push back against what they view as “horizontal apartments.”

“We run into that infrequently, but that is definitely a criticism we will hear,” he said.

Rodrigo Dorador Madrigal of Dominium said that it views the zoning question as a “value proposition to cities. We can diversify their housing stock.” In those locations, Dorador said, “they see it as a big plus.” He also said that many cities “are developing their own zoning code for this build-to-rent style.” For example, “in Arizona, where you have very little land zoned for high-density multifamily, there’s a ton of land where you can rezone it to lower densities of ten to 12 units per acre. So, it has just opened up the pipeline for us in Arizona, and we’re starting to look in other states as well.”

Ultimately, cities are generally pleased with the product, since there is very little difference between LIHTC-supported BTR and typical single-family homes. “This is kind of like my house,” said Taylor.

“The Amenity is the Rent”
One major barrier to BTR is the sheer amount of land required to make it work. Discussing LAC’s first BTR project, the Ranches at Gunsmoke, Taylor noted that a substantial amount of land was needed to make the project work. “We have normally done a ton of garden style,” Taylor said. “That’s around 20 to 22 units an acre. And these were ten to 12 units per acre. So, we need almost twice as much land to do the same amount of units.”

Given the roughly analogous floor plans and building needs, Taylor said he and his team were surprised that this style of building proved to be overall more cost-effective than traditional garden-style apartments. “It is cheaper to build the same square footage projects and unit size BTR than it is a garden style deal.”

According to Taylor’s analysis, the project was at least ten percent less expensive to build than a garden-style complex with the same unit sizes when compared to a garden-style deal that LAC closed two months after the Ranches at Gunsmoke. The garden-style build cost $242,000 per unit, while the Ranches at Gunsmoke cost $212,000 a unit, Taylor said. “In my eyes, we are building a better product for more cost efficiency. So, in our book, it’s a win-win.”

Dominium’s Saddleback Village BTR project enjoyed similar savings, with Dorador noting that costs came in around ten percent lower than they would have for a typical three-story walkup style complex. “That’ll make a dent in the pro forma,” Dorador said.

Other cost savings stem from the fact that developers don’t need to incorporate extra amenities to market and lease BTR units. “For us, with this type of product, the amenity is the rent,” said Dorador. “We don’t have a fitness center; we don’t have a pool. It’s just a single-family home subdivision.”

“When we looked at the rent advantage between our affordable product and similar market-rate BTR, it was off the charts. It’s much more of a rent advantage than comparing affordable three-story to market-rate three-story,” Dorador continued, since rents for single-family homes are often much higher than those in apartments, even if square footage and layout are the same. “We’re just delivering so much more value to the tenants at the same housing cost.”

Such desirability meant that they could be more aggressive in the underwriting terms. For example, the project’s syndicator—Walker & Dunlop—originally wanted to underwrite for a seven percent vacancy and use other “conservative guidelines” when assembling an investment team. “We had to work through it with them and say, ‘This is way more desirable. Look at the rent advantage.’”

“A Bowl of Spaghetti”
Both developers noted the care that must be taken during a project’s planning stages to prevent costs from ballooning and ensure projects remain feasible. For example, on the Ranches at Gunsmoke, Taylor detailed how contractors had to wait nine months before pouring a single foundation, as each unit required individual utility lines to be laid before any other construction could take place. “One of our civil engineers called it a bowl of spaghetti,” Taylor recalled.

Counting duplexes as one building, “we have 144 buildings on this property. Each one has an individual water, sewer, and electrical line. And it’s a ten-foot separation. So, you are running utilities next to each other all over the place. It’s a very complicated utility and civil grading exercise.”

This delay in laying the foundation poses a risk of cost overrun, as components, such as lumber and HVAC equipment, are purchased approximately two to nine months after they would be on a typical vertical LIHTC project. “Our risk was: ‘Are costs going to go through the roof in the next nine months?’”

This is particularly important due to the waiver of Performance and Payment (P&P) bonds, two types of contract surety bonds that guarantee quality construction and payment for contracts and subcontractors, respectively. Typically used on public projects, P&P bonds are a staple of LIHTC construction, as investors and lenders appreciate the security that such a financing structure can provide for a deal. In general, contractors with experience building LIHTC projects are comfortable with P&P bonds.

However, for BTR construction, P&P bonds are far less common, as builders on these unique projects are typically single-family general contractors and thus accustomed to a vastly different set of rules and regulations. More common are cost-plus contracts, which can expose the development team to unexpected price increases or liability for shoddy contractor work. A cost-plus contract can “give a lot of people heartburn, especially because of what we went through during COVID. Historically, construction costs have been pretty stable…but during COVID, in Phoenix alone, we saw 25 to 40 percent increases. We were building for 180 a door, and two years later, it was 230 a door.”

Hemmens said that being able to provide this BTR product was worth the risk of foregoing P&P bonds. “We’ve gotten comfortable with no P&P bonds, and we’ve gotten comfortable with a cost-plus contract,” he said. “You have to ensure that you’re comfortable with the sponsor, with the project, with the architect, and with the contractor.”

A Flexible Exit Plan
One final consideration that makes these deals potentially more attractive is the flexibility upon exit from the LIHTC compliance period. One particularly active and helpful audience participant was Caleb Roope, CEO and president of The Pacific Companies, who said that he had done a BTR deal in Montana that was intentionally structured to convert to individual homeownership at the end of the compliance period.

“We’ve sold out of that Montana one, and it was really successful,” Roope explained. “We got the income targeting to a level where home buyers could afford it, but the renters got the first choice to buy.”

Though converting the units into for-sale homes would be a “huge advantage,” Taylor noted that a BTR developer “really has to plan for that ahead of time.” For example, a master-meter electric system—common in LIHTC properties—would need to be broken up into individual meters, and the land would need to be split into individual lots.

Those considerations, coupled with the time it takes to sell a home, dissuaded Taylor’s team from planning to convert the Ranches at Gunsmoke units into for-sale homes at exit. “Not on this one,” he said.

Still, there are other attractive exit options available for BTR owners that may not exist for traditional LIHTC apartment buildings. “We like the optionality of various exit options,” said Dorador.

“We’re not thinking so much about preparing [each unit] for their own lots,” Dorador said. Instead, “we’re thinking about more of a condo structure with an HOA that manages the utilities and all the common infrastructure. There’s a ton of condos like this already out there. “