California’s suburbs have long attracted renters by offering a quieter and more affordable lifestyle. Demand for this lifestyle has exploded since the pandemic — and investors are taking notice.

Build-to-rent homes, which are single-family residences (SFRs) built for the express purpose of renting, provide an outlet for this market force. Frequently, these homes take the form of rental home communities which tend to cluster in low-density areas. The majority — 61% — are located in suburbs, according to RENTCafé.

In the fourth quarter (Q4) 2021, build-to-rent homes comprised 26% of properties bought by SFR providers, according to the National Rental Home Council. In comparison, this share was just 3% in 2019.

In 2020, a record-breaking 49,000 rental SFRs were built across the U.S., surpassing the previous high of 47,000 in 2003, according to the Joint Center for Housing Studies.

Build-to-rent homes are an attractive option for renters unable to save up a down payment. The pandemic escalated demand for more space and privacy, both of which these homes promise. Renting a home also gives occupants greater flexibility to move than they would have as homeowners.

Knowing this, California investors are pouring build-to-rent communities into their portfolios. But high land prices, low returns and a stringent approval process threaten the success of these communities. Skeptics point to the state’s worrying population trends and expanding rent control ordinances as reasons why the bustling national trend won’t survive long in California, according to the Orange County Register.

Others are more optimistic, convinced a convenient location near jobs, shopping centers and highly-rated school districts are all it takes to attract renters.

But the real benefits driving this trend are those to investors, including:

  • lower maintenance on new homes;
  • builder warranties typically included;
  • less tenant turnover than traditional apartments; and
  • higher rent appreciation.

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High costs bring risky yields

The old adage of “location, location, location” comes at a price.

In California, land costs frequently make up the lion’s share of a property’s total value. 69% of an average California home’s value is derived from the price of its land alone as of 2020, according to the American Enterprise Institute (AEI).

The cost of vacant land in California’s densely populated coastal regions runs higher than in less dense inland areas.

For example: in Los Angeles, 74% of a SFR’s value is derived from the price of its land. The share is 72% in Orange County, and 70% in San Francisco.

In Sacramento and Riverside on the other hand — inland areas with more available land for development — the share is a lower 57%.

Two main factors account for these variations in land costs:

  • homebuyer and renter demand, which tends to fluctuate based on how desirable the area is, including access to jobs and amenities; and
  • government regulations over land usage, including zoning, permitting and environmental review processes.

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But it’s not just the cost of land that build-to-rent investors need to weigh.

Building costs are also high in California, due to:

  • local permitting fees;
  • building materials; and
  • labor costs.

The state’s high cost of living forces contractors to pay laborers higher-than-average pay. Building materials are also more expensive in California due to the state mandating more stringent construction standards and energy-efficient materials. Permitting fees, which vary by location, tend to be extremely high in California — nearly four times the national average.

Thus, the high cost of land and building fees in California makes new building projects an expensive and risky investment.

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Even renters need housing

As the cost of housing rises, as it did significantly in 2021, homeownership increasingly eludes renters. Thus, the long-term culture of renting will continue.

California’s homeownership rate is hovering around 54% as of 2021, compared to the national average of 65%. Historically, California’s homeownership rate tends to lag about 10 percentage points behind the national homeownership rate, a trend which continues today.

With a low homeownership rate, rental property will continue as the standard — the only alternative to traditional homeownership.

California’s relatively young and mobile population tends towards renting. Gen Z and Millennials are finding it increasingly difficult to enter California’s housing market. They’re often hobbled by student debt and stagnant wages. Without down payment gifts from the bank of mom and dad, they will need to save up for their own down payments — a task that can take as long as 70 years in some parts of the state.

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A severe lack of residential construction has led to major price gains for homes in all tiers. There’s simply not enough housing to go around. An overwhelming 93% of firsttuesday readers reported experiencing a housing shortage in the markets they serve.

As many as 205,000 residential units were built in 2005, at the height of the Millennium Boom. In 2021, roughly 117,000 residential units were started. Despite the growth of its population since 2005, California is building about 90,000 less housing units than it built then.

Build, baby, build!

The solution is simple: build more housing.

But getting to that solution is a challenge.

Not only do builders of new residential construction contend with the expenses for land and building costs, but they are further restricted by zoning laws, which impact land use, parking, lot sizes, building heights and permitting costs and times.

Build-to-rent homes certainly add to California’s depleted inventory. They also cater to renters and younger generations with budding families who want more space — a highly desired commodity in today’s market.

But will it solve California’s inventory shortage? Not likely. Though they have grown in popularity, these types of homes currently make up only a small share of single-family residences, according to the Joint Center for Housing Studies.

By choice or by necessity, many renters will continue to eat high housing costs to remain in California. If they must rent, they might as well have a backyard.

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