Should real estate investors consider built-for-rent (BFR) properties?

Is the new home premium a cost too high? Are real estate investors better off buying existing homes with lower prices? Or, should they consider a new housing product, newly-constructed built-for-rent (BFR) properties.

According to the Census Bureau, the median new home price was $335,300 in November. In comparison, the National Association of Realtors reports that the typical existing home had a median sale price of $310,800 during the same month. That’s a difference of $24,500.

“We all like discounts and bargains and no doubt there’s a cost differential between new construction and existing homes,” said Rick Sharga, Executive Vice President with RealtyTrac, a leading source of investor leads and real estate data “Is the purchase of a new home worth a premium of almost $25,000? The answer  is more complicated than just a comparison of purchase prices.”

Ownership costs

Dr. Natalia Siniavskaia, Assistant Vice President for Housing Policy Research with the National Association of Home Builders (NAHB), argues that “buyers can afford to pay a 36% premium for a new single-family detached house, compared to the one built before 1960, simply because it is new and has lower operating and maintenance costs.”

Looking at data from the 2019 American Housing Survey (AHS), she says that “on average, annual costs of running a home amount to close to 5% of the home’s value but the rate tends to decline for newer homes. This fraction exceeds 6% for homes built before 1960. With newer homes, costs per dollar of value tend to decline. Home owners of single-family detached homes built after 2010 spend an equivalent of 3.2% of the home’s value per year on operating their newer homes.”

Operating costs do not represent the full expense of ownership. According to Siniavskaia, “operating costs” include property taxes, insurance, maintenance and utilities. Mortgage expenses are not seen as an operating cost though it’s hard to understand why given that property owners surely write monthly mortgage checks.

New construction versus existing homes

If a new home is bought for $335,300 and the operating costs amount to 3.2% of the home’s value per year then the typical annual expense will be $10,059. Buy an existing home built before 2010 and the annual operating cost will be 5%. Given an acquisition cost of $310,800 the annual operating cost will be $15,540. So the cost of operating the newer home is $5,481 less.

If we add in mortgage costs the numbers change. If we assume a VA buyer and 100% financing at 3%, a property bought for $335,300 has a monthly mortgage cost of $1,413.64. For the existing home priced at $310,800 the monthly cost for principal and interest is $1,310.35. That’s a difference of $103.29 a month or $1,239.48 per year.

Subtract $1,239 from $5,4,81 and the newer home saves the owner $4,242 annually in this example. Tax benefits are extra for both properties. In essence, the higher price for a new home is recaptured in about six years.

Not apples versus apples

For investors comparing new versus existing properties raises several considerations beyond acquisition prices.

  • For flippers, it might seem as though operating costs are not an immediate issue. The idea is to buy and sell as quickly as possible. However, operating costs can be a strong selling point, especially for buyers with fixed incomes. For this reason operating costs are important even to flippers.
  • Operating expenses are a big concern for investors who want to buy and hold. Generally, all utilities and some maintenance items will be paid by tenants. What remains are the responsibility of the owner.
  • Location is important. Older properties are often closer to central business zones, shopping areas, and cultural attractions than newer properties.
  • Existing properties may have landscaping that took years to evolve
  • Buy an older home and you’re likely to find smaller closets, bigger living rooms, and formal dining areas. Newer architecture tends to favor more openness. Notice the fix-up programs on cable TV? Tearing out walls is a basic staple when working with older properties.
  • Newer homes are more energy efficient and that translates into monthly savings.
  • Newer homes are often located in communities that include amenities such as pools, clubhouses, and other common areas.
  • As the buyer of a new property you can determine its colors, design, and features. With an existing home you’re dependent on the taste and preferences of past owners.
  • Buy a new home and there are home warranties, system warranties, and appliance warranties that can offset large initial costs. With existing homes limited warranties of some type may or may not be included in the sale.

Built-for-rent properties (BFR)

Rather than look at the question as one of existing homes versus new properties, perhaps the issue for investors is different. Why not new single-family construction for investors designed specifically for use as rental real estate?

There are, in fact, such properties, what are generally known as “single-family homes built-for-rent” (SFBFRs) or simply “built-for-rent” (BFR) housing.

It turns out that BFRs differ from typical new homes. According to NAHB, built-for-rent homes are generally smaller and have fewer bedrooms, fewer bathrooms, a one-car garage or no garage, and are often joined together as townhouses.

Such properties sell. In the third quarter, say the home builders, about 14,000 BFRs were started. That’s not a huge number – it’s only about 4.5% of the new home market – but it only includes units builders expect to retain. The real market is larger. According to NAHB, “this class of single-family construction excludes homes that are sold to another party for rental purposes, which NAHB estimates may represent another two percent of single-family starts.”

In rough terms builders are selling about 6,200 BFRs to investors every quarter. Given that such homes are smaller and have fewer bedrooms they must be priced lower than nearby units designed for owner occupancy. Alternatively, they are new construction. They come with the warranties, better energy efficiency, fresher designs, and the lower operating costs associated with new homes.

“For investors,” said Sharga, “it means that the debate is no longer new versus old, it’s new versus old versus built-for-rent (BFR). BFRs represent a new wrinkle in the marketplace, one worth investigating, especially for those who want to buy, hold, and potentially save money on maintenance and operating costs every year.”

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