Problems We're Facing In The Build-to-Rent Industry - EP16

"You say it's a blow and that's kinda how I feel too. But is it really a blow? Maybe it's a blow because it's foreign. It's unknown. That's why I was talking with you guys earlier. Can we get the PUD just because that's what we know? Now we're talking about a condo plat. 

Do we talk about the pros and cons a little bit? Do we jump into that? Is it really a blow? I still feel like it's foreign. It's unknown. But there's still some good opportunity..." - Chase Leavitt, B2R Show

Episode Highlights:

Looking back on this year, the B2R hosts discuss various challenges they've faced as they continue to expand their build-to-rent portfolios. Phoenix has given them the most trouble, requiring that their fourplex development be platted as condos. This is a notable change from their usual investing model.

What does this mean for their returns? How can investors adapt to these changes going into 2022?

Steve Olson: I've been at a conference in Scottsdale about build-to-rent. It was really boring. You guys have been to this same conference, but what was interesting to me? 

I went to the same conference in 2016. And I remember at this conference, there were probably 200 people there and a handful of vendors. Most of the vendors were hard money lenders, ready to charge 12% interest. 

The build to rent space was relatively new at the time. In our day job with what we do together, it's been around since 2011, but really kind of hit its stride in 20 17-18 became a big deal. 

There were 2,000 people at this conference last week. It was absolutely insane. Like everybody talking about a build to rent and, it's the future and where should we be building to rent?  

And that's just creating in my, in my view, a lot of increased competition, a lot of volatility. We'll talk about that in some of the shows. 

The funny thing is that built to rent phenomenon is responding to the massive need for housing in America. And unfortunately, at a time when we have this tremendous need for housing in America, these idiot cities seem to be going the other way and making it more, more and more difficult.  

So we are going to have a gripe session about the city of Phoenix, Arizona today. That is the purpose of the show. I think people at least like seeing the struggle that we've been having, but also understanding it's not unique to Phoenix.  

Before I kind of get into the specifics of the issue, as a matter of context, you know, Phoenix is a huge city. It employs a lot of people and in the Coronavirus, I mean, I don't know if we call it a pandemic anymore. It's a thing that we have to deal with a lot of these governments or whether you think it should be taken very seriously or. 

They are taking it very seriously. And they've got a lot of these mask requirements and you can only go into the office for so many hours. Some people are still working exclusively from home and no matter how you slice it, this equates to it's a lot harder to get things done with a city, especially a big city that was already bottlenecked with a lot of things. 

And you compound that with the fact that there are now record developments happening. People trying to push things through the city. It was already difficult. And now this, you know, they just make it difficult. Okay. So, I don't know who, if you guys want to draw straws or do live rock paper scissors, but what's the obstacle we've run into. 

This is a fourplex project in Phoenix. What's the nature of the problem we've just run into and what have we been? What have we been doing about it? 

Sherida Zenger: So typically we have our project set up as a PUD, a planned unit development. So you're owning a duplex or triplex or fourplex, and you're actually owning the ground below you. 

You have one tax ID number for however many doors you have. Now we're being told, "Hey, this project actually is going to have to go as a condo." 

So what that means is it's going to be individually tax ID per unit, but you don't own the ground below you. You own a percentage of the total ground for the whole project as in the HOA as well. 

So a little bit different, but we're what we're running into is because all of our projects are rental communities, right? So you're not able to have Fannie and Freddie financing. So that then that pushes us into the bucket of a year. You have to be cash or you have to be a commercial loan. This is doable, but on the resell end of it, it's going to make it a little more difficult. 

So maybe we can just talk about that a little bit more and then get into what that means on the flip side of it, for our investors in this specific project.  

Steve Olson: Well, and then we don't necessarily fully know yet what it does mean. We're still figuring that out. It's the uncertainty of the development world. 

Chase. Do you have anything to add to that?  

Chase Leavitt: I don't. I think that was everything that I probably would've said. That was, that was great. Okay.  

Steve Olson: Yeah. Okay. This is unique. And the fact that you know, most people that do a build to rent project have total ownership of the project itself. You are Sally, the investor, you built a duplex in your town in Iowa, right? 

You own that. That was your build for rent deal on the opposite end of that spectrum. You know, as long as we're doing the Phoenix thing, the national builder Taylor Morrison. Has launched this company called Christopher Todd communities. So it was kind of the flagship of build for rent and they do, they do really nice communities. 

I'm in the Phoenix area. I think they're, I think they're expanding out of Phoenix. We'll have to check on that cause that's something worth following what they do. Nice single-family, detached developments, right. Where somebody feels like they live in a home, but they, they are renting a place and it's this kind of bridge between. 

Renting from a single-family landlord and living in a class, an apartment complex, it's this hybrid. So that's the other is that Christopher Todd communities is the owner of the entire community. So what we've done typically in our day job, fig fourplex investment group is different. We, we build and develop this and we sell the entire community off as like 30 different fourplexes that doctors and lawyers and dentists all come in and they own. 

Directly that's different than if you invested in a Christopher Todd community, right? Because you don't get to decide when to sell, but if you own a fourplex, you do. So the only way to maintain control over a build-to-rent community that has fractionalized ownership like that is through a homeowners association, which is usually a dirty word in the Mon paw investor world. 

In a homeowners association like Sherida. You own the unit, you own the ground under it. You own above in the air. You can sell it whenever you want to. You can encumber it. You can do all those kinds of things. Investing in syndication. No, you're at the mercy of the sponsor of the general partners. 

They are deciding according to their, their PPM, what they're going to do with this, this investment. And you, you have to abide by those rules. You can squawk and say, I want to sell, I want my shares out. Maybe they'll indulge you, but they don't necessarily have. Right. So in this case, the city of Phoenix gave indications to our development team. 

"Yeah. You can do fourplexes". And so when you get to the final approvals and we'll know you can't, and by the way, that's a screw up on our end. Right. Our team should have definitely done the due diligence on a known beforehand. They may disagree. Maybe it was impossible to know this. I don't, we don't know, but we are where we are and you frequently end up there in the development role world. Don't you. Something comes out and now, now the facts have changed and you have to problem-solve. That's why I get paid in real estate as you solve problems. 

So now the designated zoning C3 within the city of Phoenix allows for a condo. And chase and I were talking earlier, he's like, well, you got to find out why they're wanting to do that. And I was saying, it doesn't matter. It's what the zoning says. And they allow for, I mean, they could allow for a zebra farm in the zoning, we don't know. 

Right. They created what they created. 

Sherida Zenger: We also said, we could wait and go back to the city and maybe take another year and get this zoned as a PUD and do our townhomes. Like we normally. But at this time, we're not wanting to do that. We don't, we want to get this project out the door. So we're just kind of dealing with the blow, doing the best that we can put the right people in place. 

But that is another option. But we also could say, Hey, let's go and wait another year and try to figure this out. And they could come back and say, actually, we just want it as a condo. It's a condo. That's what we're doing. That's how you're going to have to do it. So we're kind of just dealing with the blow. 

Chase Leavitt: And you say it's a blow and that's kinda how I feel too, but is it really a blow? Maybe it's a blow because it's foreign. It's known, that's why I was talking with you guys earlier. Can we get the PUD? Just because that's what we know the townhomes. So now we're talking about a condo plat. 

Do we talk about the pros and cons a little bit? Do we jump into that? Is it, is it really a blow? I still feel like it's foreign. It's unknown. But there's still some good opportunity.  

Steve Olson: How's it different? Tell us. 

Chase Leavitt: The difference that I see is from an exit standpoint, it creates some flexibility where if you get a fourplex, you're going to have four individual units. And if it's zoned as a condo plat, you have four different condos. They are built and look like townhomes. So we're thinking, oh, is that beneficial? Can you sell them off individually? And you can.  

But the tricky part is, is if you go to sell it off individually, that person coming in most likely needs to be an investor, not an owner occupant and needs to be a commercial loan.  

Steve Olson: Correct. When we've talked about the difference between a conventional commercial loan, a lot on the show. So we're not going to dive into that now, but there are clear advantages to conventional.  

Chase Leavitt: There's a little flexibility there. I think the blow is we know the Fannie Freddie loan, the 30- year fixed loan. 

Maybe it has better terms, better rate going versus the commercial loan. But as we looked into the commercial loan, there's, there's still some opportunity there.  

As we put that into our proforma, plug the numbers, look at the cap rate in the cash. We're still at a six cap. 

Sherida Zenger: Yeah. I mean, it's still performing just fine. It's a great investment either way. I think again, like you said, yeah, I'm using below and maybe it's just because, as you said, we're, that's what we're familiar with. That's what our district is familiar with. So yeah, there could be some positives to this. I think just the big thing is in the past, we've been able to resell these and use that Freddie and Fannie financing. 

And we're not going to be able to at this point, because you can only have. I don't know what the exact number is, but 50% of the project has to be owner-occupied. The other half can be investors. Our projects are all investor-owned. So, you know, as far as, I guess, as tenants rentals. So yeah, so that makes that's where it's a little bit difficult, but I don't know. 

I mean, maybe there's a silver lining in this. I know we talked a little bit about, Hey, maybe somebody can come in and eventually just buy through the entire project. I mean, you know, one individual investor could eventually buy everybody out. I don't know.  

Steve Olson: There's another component that we have to deal with too, is that this is located in a federal opportunity zone. 

The funny thing was we had to go break the news of this to our investors. You know, most of them have understood things happen. Some have been less understanding, you know, you've got to give bad news to your clients sometimes. What we're trying to figure out here is many of the investors in this project, we're going to use commercial financing anyway. 

To take advantage, and I'm not giving any legal advice here. This is Steve's understanding of it. To take advantage of a federal opportunity zone, you have to buy land, and then you have to put into the land improvements or construction value at least equal, if not more than what you paid for the land. 

That's easy on a PUD. It's very clear what your land value is. That's a little less. In this case, right? Because with a condo plat, you own a share of the common of the condo association. We're trying to figure out like, what, what does that mean from opportunities on regulations? It wouldn't surprise me if it's not very clear. 

Opportunity zone stuff is relatively new and literally, nobody has fully realized one yet because it has that ten-year timeline. We're going to have to spend some money with some very specialized attorneys who unfortunately I don't think are going to give us a very satisfactory answer, but we have to do it because many of our clients wanted to use commercial financing. 

Because when you close in an opportunity zone, you buy that land. The silly thing is, is you have to buy that land. And then you have to use an opportunity zone business. So your opportunity fund, which is an LLC that you designate as a, as a fund, then funds your opportunity zone business. So you can get it. 

That person can't use Fannie and Freddie because Fannie and Freddie have to be the name of John DOE with his social security number. And the opportunities business cannot be John DOE it's John DOE, LLC tax EIN is so on and so forth so that doesn't infect those people from financing, but does it affect the viability of the opportunity zone? 

That's the million-dollar quite literally the million-dollar question.  

Chase Leavitt: So stay tuned. We'll look into that. We'll look up some Opportunity zones references that we know we'll call them and yeah, we can probably do another episode and give some feedback.  

Steve Olson: We give some feedback on that. It's a good idea. So yeah we'll get into it when we talk about OZ's and taxes and especially 1031 exchanges, we have an episode coming up on 1031 exchanges because they can be unique in a build-for-rent community. 

I have a quote in my office by John wooden, that things turn out best for those who make the best of the way things turn out. 

Sometimes things just happen and you got to deal with it.