The single-family build-to-rent housing industry has experienced a lot of turbulence this year, and the uncertainty has not fully cleared.
In March, the Senate added a provision to the federal housing bill to force major single-family housing investors, defined as those owning 350 or more homes, to sell to individuals within seven years. That disposition requirement essentially turned off the tap for investment in the single-family build-to-rent sector for a time, according to Lauren Rico, partner at global law firm DLA Piper, who represents institutional investors in commercial real estate transactions.
“Removing [the forced disposition requirement] from the law is obviously a huge win for the industry, and I think it is creating more optimism,” Rico said. “Anecdotally, I talked to some clients, and I said, ‘Do you now view this as a possible asset type for you to invest in? Is it part of your strategy?’ And clients are saying, ‘Yes,’ they've taken some comfort from the bill and the changes that were made.”
However, Rico cautions, “That does not mean that it's not without a host of legislative uncertainties.”
With the 21st Century ROAD to Housing now law as of July 11 with build-to-rent housing excepted from the 350-home limit, investors and others in the SF BTR industry are nonetheless grappling with a brand-new and still ill-defined regulatory landscape where they will likely face increased scrutiny.
Those who are buying existing single-family homes to add to a rental portfolio will likely consider buying new construction now, according to Roger Ashworth, head of research and data at New York City-based investment firm Saluda Grade. Defining the ownership rules around what counts toward the 350 units is going to be critical.
“If you're an institutional investor, a [limited partner], I think all those controlled rules need to be really looked at very closely because they're fairly prescriptive, and there's not a lot of wiggle room, so they need to make sure that all the ownership structure is ‘all prisoners accounted for,’” Ashworth said. “You have to make sure about what fits in and what doesn't into that 350 limit.”
‘A massive, massive amount of paperwork’
Implementation is the next hurdle now that the bill is law, and there are a lot of open questions, according to Brandon Rios, partner and co-lead of DLA Piper’s Congressional Investigations Practice.
“What is implementation going to look like? What does compliance even look like? We don't know. The bill doesn't spell it out,” Rios said. “This is an entirely new regulatory compliance regime on an institutional investment class that hasn't existed before in this space, and that is always hard to do.”
In terms of details about day-to-day business compliance — like whether reporting will be through online portal forms, quarterly audits or yearly or biannual reports — “we haven't seen anything about that yet, and Congress didn't prescribe it,” according to Rios.
There's no guidance regarding consequences for failing to do the reporting, according to Rico, and although the stated consequences for purchasing a home that is not permitted under the act can be quite high, it’s not clear how they will be applied. For example, if you buy an extra 200 units, “is that 200 violations or one violation if you buy it in one portfolio?” Rico asked.
Another area of uncertainty is regarding institutional investor- and developer-adjacent businesses, such as online housing brokers, according to Rios.
“[Those businesses are] purchasing houses in bulk and then reselling them, but they're only holding them for 20 days, 40 days, you know, ultimately not much time,” Rios said. “They don't view themselves as an institutional investor. They're not trying to make a profit over the long-term gains of the property. ”
Some of these undefined terms lend themselves to continued uncertainty and could change from administration to administration, said Rico.
“In the short-term, while I do think that investors are feeling better about reinvesting in BTR, bringing it back on the table, they're going to price that legislative risk into the transaction costs, and it could mean that it's simply harder to make a deal because they're going to account for that risk somehow,” Rico said.
Regardless, it’s clear that some large firms are going to have a major administrative burden, per Rico.
“There's a lot of reporting guidance and annual HUD filings for notice of portfolio-wide ownership tracking that you might have to do [when] creating a build grant program. What does that mean, what does that look like? There's no guidance,” Rico said. “It has the potential to be a massive, massive amount of paperwork I think for some of these larger institutional investors.”
Outstanding questions, risk
Some key definitions in the BTR section are unclear, according to Rico. One of those is the definition of a single-family home, namely what “structure” means for the purposes of the law.
“The bill has defined the single-family home as a structure, but it has not defined what structure is, and there's no legislative reference for what structure is,” Rico said. “A single-family home on a single plot in a neighborhood that's unconnected to another structure, that's pretty clear. But townhomes, that’s another question.”
Build-to-rent townhomes, some of which contain three and six housing units, are in a legal gray area, according to Rico. What is considered a single-family home is a “considered legal position, it's not a settled or official definition,” according to Rico.
Another key question is how an institutional investor is defined. There's language about entities acting in concert with other entities that is going to be subject to the regulatory guidance needed from the Treasury, according to Rico. If an entity is trying to stay below the 350-home limit in order to avoid being qualified as an institutional investor, there are two ways to read it.
“If you read it broadly, acting in concert between parallel funds and sidecar vehicles and co-investment structures that might even be independent but managed by affiliates or advisors that are affiliates … that might put smaller vehicles into large-investor status,” Rico said. “But if you read it narrowly, then you could actually have genuinely, truly coordinated programs that are sort of split across different entities and not qualified as institutional investors.”
Purpose-built rental housing is likely to fall under the definition of BTR housing and the safe harbors that the bill has set forth, “but that doesn't mean that the work ends there because of all the additional reporting and investor portfolio management and that kind of activity that's going to come behind it,” according to Rico.
People in the housing industry and housing activists should be watching these deliberations very carefully, and “expressing their voices and be prepared to make the case for their specific scenario of how the agencies should interpret these definitions,” Rios said.
What investors can do
Although current owners are grandfathered in, they should nonetheless engage in “very careful planning on a go-forward basis to make sure that [they fall] within the boundaries of these exceptions and limits,” Ashworth said. For example, “there's some parts of the accepted purchases [section of the law regarding build-to-rent] that are a little loose.”
Investors need more clarity in order “to eliminate kind of an additional underwriting cost in the deal or to account for not knowing what's going to happen and how these words are going to be interpreted,” Rico said.
Since a big question for institutional investors is what constitutes a single-family home, Rico suggests stress-testing potential investment projects to see if they’re likely falling under the act.
“If it falls outside the statute, fine. But what if it doesn't, and we have to make sure that we then comply with the requirements in case retroactively, we are forced to justify our investment,” Rico said. “Unfortunately, until we know, I think you have to analyze your program under both and be prepared to comply if your interpretation is not the winning one.”
For example, keep site plans, unit configurations and fact-specific records in order to support the argument being made, Rico said.
Rios said it’s important for companies to build an audit trail as if they’re advocating to a regulator.
“What companies can be doing right now is building the record and saying, ‘we think we fit into this definitional exception, here's all the steps we've taken that align with that view,’ so that when the agency regulatory process opens up, they can say, ‘look, here's why this makes sense,’” Rios said.
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