Increasing Demand from Renters for Larger Units
As homeownership in Denver becomes increasingly more expensive, we expect demand for larger rental units to increase. This shift is likely to be driven by demographics and the overall cost of housing. In the Western United States, homeownership rates peaked at just under 65% in 2006. The homeownership rate declined significantly in the years following the Great Recession.
Currently the homeownership rate is just above 60% in the Western U.S. The city of Denver has a lower rate; we currently have 310,000 households of which 160,000 are renters, or 52% of total households. Denver’s rate of homeownership is lower than the Western region largely due to the increasing cost of housing. The median home price in Denver has increased from $219,900 to $446,600 from 2009 to 2019, this is an increase of 103% during a time in which weekly wages have grown from $850 to $1,090, or an increase of 28%. It’s becoming increasing difficult for most people to afford to buy a home. The average single-family home in Denver is now just under $530,000. To afford a home at this price, assuming a 10% down payment, $400 for tax/insurance and a 4% interest rate, the monthly payment would be $2,677, or 42% of the metro median income of $76,643. Average Denver metro rents have increased to $1,512 per unit as of second-quarter 2019. This delta demonstrates the significant premium that exists to own a home versus renting. In addition to offering better economic value, renting also offers better flexibility for people who value the ability to move to another metro area for employment opportunities or other lifestyle reasons.
We expect the big drivers of future rental demand to continue to be net migration, job growth and declines in homeownership as price appreciation continues to outpace wage growth. As the millennial generation ages and begins to form families, we expect them to increasingly seek out larger rental units in suburban locations with strong school districts. The demographics of this group are attractive. Single-family renters are more likely to be higher earners with a median income of $60,000 compared to $47,000 for multifamily renters; they are older with 63% over 35 years old versus 49% of multifamily renters; and they are more likely to be parents, 40% versus 17% of multifamily rentals.
Denver’s single-family rental vacancy rate is currently 3.2% compared to a second-quarter 2019 stabilized apartment vacancy of 5.2%, much of this is driven by the challenges associated with delivering this product as compared to traditional higher-density multifamily. Some key considerations for this type of product include the quality of the school district, thoughtful floor plans with flex space if possible, pet friendly, privacy and security. Developers that will benefit from this demographic are likely to be those that focus on delivering three-bedroom units, townhome units and purpose-built single-family homes for rent in the locations that families desire, where nearby single-family home prices are more than $500,000.
In order to build larger units, developers are not able to maximize the density of a site. This leads to the challenge of finding attractively priced land at a cost basis that allows for the lower-density, larger units at an acceptable yield on cost. Developers for this type of product are typically competing with single-family, for sale builders, who can pay more for well-located land. A recent survey of build-to-rent single-family communities across the country discovered the following. Build-to-rent product typically leased up at a rate of nine units per month, stabilized occupancy of build-to-rent is 97%, the median size of these deals is 125 units, they achieve a rent premium 5%-plus over equivalent sized apartments or one-off single-family rentals, they have a lower operating expense ratio of 28% versus 34% for traditional multifamily, they have turnover rate of 30% versus 35% in traditional multifamily and there is a support for stabilized 5% cap rate valuations.
Some considerations for this type of product include finding the right property managers, focusing on small individual lot sizes, delivering moderately sized homes, offering garages and providing amenities that appeal to families. This industry is in the early stages with only a handful of operators delivering the product with any material scale. In future years we expect more groups will enter this market. Many current apartment owners can leverage their existing platforms and marketing strategies. We expect many of these groups will view adding some component of build-to-rent to their existing portfolios as a hedge against softness that will occur during the next downturn.
Delivering this product is not without its challenges. These include obtaining entitlements from local planning boards that are unfamiliar with the concept, delivering product in a timely manner given ongoing labor shortages, developing reliable proformas with very little existing rent comp data and finding land at the right cost basis in attractive locations. This product has caught the attention of large private equity groups and is likely to become more prevalent and competitive in the future. We plan to continue to watch how these assets are received by the market. In the meantime, we continue to pursue larger units to further diversify our portfolio.