Why builders are turning to rentals instead of buyers

[UNITED STATES] In an unexpected twist of the housing market, homebuilders across the United States find themselves sitting on a substantial inventory of unsold homes. As of September 2024, there were 108,000 finished homes for sale, marking a staggering 48% increase from the previous year. This surplus comes at a time when the overall housing market remains tight, with the total number of available homes for sale at the end of October 2024 being about 21% lower than in October 2019.

This paradoxical situation raises a crucial question: Why are these newly built homes not being snapped up by eager buyers in a market that has been characterized by low inventory for years?

The Perfect Storm: Affordability Challenges and Market Uncertainty

The answer lies in a complex interplay of factors that have created a perfect storm for potential homebuyers. Keith Hughes, an executive at the housing research firm Zonda, explains, "Buyers may not be flooding the market, but there are fewer homes out there, too". This scarcity has contributed to sustained high prices, even as builders accumulate inventory.

Mortgage Rate Volatility

One of the most significant hurdles for potential buyers has been the volatility in mortgage rates. After a period of decline over the summer, rates for 30-year loans spiked by almost a full percentage point in just one month. This rapid increase has left many would-be homeowners hesitant to commit to a purchase, fearing further rate hikes that could significantly impact their long-term financial obligations.

Affordability Gap

The affordability gap between buying and renting has widened to historic levels. According to data from John Burns Research and Consulting, purchasing a starter home is now about 45% more expensive than renting, far exceeding the historical average of 15%. This stark difference has forced many potential buyers to remain in the rental market, unable to make the financial leap into homeownership.

Market Uncertainty

General economic uncertainty has also played a role in slowing home sales. With conflicting signals about the economy's direction, many potential buyers are choosing to "sit on the fence" rather than make a significant financial commitment in an unpredictable market.

Builders' Strategies: Adapting to Market Realities

Faced with this challenging landscape, homebuilders are employing various strategies to manage their growing inventory.

Incentives and Downsizing

Rather than slashing prices outright, many builders are offering substantial incentives to attract buyers. Lennar, one of the largest homebuilders in the country, reported that their average sales incentives per home reached $48,100 from June through August 2024, up from $36,400 a year earlier. Additionally, some builders are opting to construct smaller floor plans to cater to cost-conscious consumers.

The Rental Market Pivot

Perhaps the most significant shift in builders' strategies has been their increasing focus on the rental market. This approach takes two main forms:

Selling to Investors: Builders are forging relationships with companies that specialize in purchasing and managing single-family rental homes. For instance, Invitation Homes, which manages over 85,000 rental properties, plans to purchase nearly 2,500 homes from builders in the next couple of years.

Build-for-Rent Communities: Some builders are developing entire communities of single-family homes intended for rent rather than sale. D.R. Horton, the nation's largest homebuilder, reported having about $800 million worth of single-family rental property on its balance sheet, consisting of 3,140 homes and 1,900 lots for future construction.

The Rise of Single-Family Rentals

The pivot towards rentals reflects a growing trend in the housing market. Adam Stern, founder and CEO of Strata SFR, a real estate brokerage focused on single-family rentals and build-to-rent homes, notes, "I think investors are more or less saying to themselves, we're providing a solution here for builders, and that solution is inventory management and getting out of inventory that otherwise they're having trouble selling".

This trend is particularly pronounced in Sun Belt markets like Nashville and Dallas, where new construction is most plentiful. Data from Forecasa, a real estate analytics firm, indicates that investors purchased 3% to 5% of homes sold by builders in the past three months, up from about 1% a year ago.

The Impact on Potential Homebuyers

For those aspiring to homeownership, this shift towards rentals presents both challenges and opportunities. On one hand, it may mean fewer opportunities to purchase new homes directly from builders. On the other hand, the increase in single-family rental options provides an alternative for those who desire the space and amenities of a house but are not yet ready or able to buy.

Long-Term Market Implications

While the current situation may seem dire for potential homebuyers, experts caution against viewing it as a long-term trend. Selma Hepp, chief economist at CoreLogic, describes the current market as being "in limbo," stating, "It's sitting on the sidelines. It's waiting".

The housing market's future will likely depend on several factors, including:

Interest Rate Stability: A stabilization or decrease in mortgage rates could reignite buyer interest.

Economic Conditions: Improved economic certainty could encourage more people to enter the housing market.

Supply and Demand Balance: As more existing homeowners decide to sell, it could free up inventory and potentially ease price pressures.

The current state of the housing market, with builders holding a significant inventory of unsold homes while potential buyers struggle with affordability, reflects the complex and often counterintuitive nature of real estate dynamics. As builders adapt their strategies and investors play an increasingly significant role, the market continues to evolve.

For now, the American dream of homeownership remains elusive for many, with renting becoming an increasingly attractive – or necessary – option. However, as John Burns of John Burns Research and Consulting suggests, this situation also represents a new category of buyers that could help builders manage inventory during market downturns.

As the market continues to navigate these challenges, potential homebuyers, investors, and industry professionals alike will need to stay informed and adaptable to the changing landscape of American housing.