The institutionalization of the US single-family home market is one of the major themes of the covid-19 era. During the past year, billions of dollars have been committed to acquiring portfolios of rentable homes and even developing whole for-rent communities from the ground up.
Brookfield has taken this trend further down the housing supply chain with its acquisition of the Newland Real Estate Group, a California-based planned community developer.
The transaction gives the Toronto-based firm, which already had a large residential lot bank portfolio, a nationwide platform for acquiring and entitling land, Adrian Foley, Brookfield’s managing partner of real estate and president of development, told PERE.
The deal was executed with balance sheet capital, though the firm is exploring options for folding it into a future vehicle for investors. Brookfield declined to share how much it paid for Newland.
The acquisition nets Brookfield control of 35,000 lots throughout the country. It can either sell the option rights to those lots to other homebuilders or develop them directly. Combined with its existing land holdings, the mega-manager now has control of 80,000 lots in the US and 30,000 more in Canada.
Foley said Brookfield is capitalizing on what it sees as dwindling expertise in the land business while bringing some consolidation to a highly fragmented market. “We’ve been in the land business for 34 years and we see a depleting supply of knowledge and capital to go with it,” he said. “The number of groups excelling in land is diminishing while demand for lots, especially land-light lots, is on the rise.” Land-light lots refer to lots for which development rights have been sold.
New housing starts hit 1.7 million units on a seasonally-adjusted annual basis in March, according to Federal Reserve Economic Data, the highest rate since 2006. That surge follows a run-up in homebuying and household formation during the pandemic. But momentum is already waning. New starts fell below 1.6 million in April and are expected to have been lower in May, despite continued demand for new homes. Along with rising labor and material costs, a scarcity of land has been blamed for this slowdown.
The bank is open
Brookfield is looking to address this issue by bringing institutional scale to lot banking.
Underpinning this strategy is the gravitation of the top homebuilders toward a ‘land-light’ business model, in which they hold no land on their books but instead pay cash for the option rights to lots held by third-party groups. The advantage is that keeping their balance sheets free of stagnant land results in a higher price-to-book multiple for listed homebuilders and therefore a more favorable return on equity.
While this trend has taken place, many of the biggest listed homebuilders have significantly increased their output, Foley points out. For example, DR Horton, the nation’s leading homebuilder, increased its closings from 45,000 during the fiscal year 2017 (before it began its transition to an asset-light strategy) to 65,000 in fiscal year 2020. During the company’s March earnings call this year, chief executive David Auld said he expected the share of lots developed from option rights to increase from 75 percent to more than 80 percent over time.
Foley said the rising output on the homebuilder front has not been matched on the land side of the industry. “It’s incredible, the growth in the last 10 years, and we’re going to see significant growth by only a few groups on the land production side, as well,” he said. “We think we’re a prime partner for those other groups to join.”
Brookfield is also able to option its own lots to bolster its development pipeline. As part of the acquisition, the manager has also acquired Newland’s 5 percent general partner stake in 15 of its 20 master-planned community projects under development. “The Newland acquisition is not only scalable but existing assets are phenomenally located in fast-growing markets,” Foley said. “They are early- to mid-phase investments so there are opportunities to lean in and add value.”
There are good reasons for the fragmentation in the residential land sector, according to one executive in the space who requested anonymity to discuss the Brookfield-Newland deal.
Deploying billions into land would leave you with an unsustainable amount of assets under management.
Most groups that specialize in lot banking tend to be smaller outfits focused on specific markets or regions where they know local governments and the nuances of their building and zoning requirements. This granularity and variability of the entitlement process is what keeps developers from simply acquiring land directly. “It’s rare to buy acreage, sit on it and sell it,” he told PERE. “You have to work it to what an end user needs.”
The executive sees the lot banking sector getting slightly more competitive, especially with groups such as Angelo Gordon looking to establish a presence in the space, but he expects it to remain largely dispersed. Forestar Group, a subsidiary of DR Horton that trades under its own ticker, is the lone example of a listed residential lot development firm with a nationwide mandate.
As far as the union of Brookfield and Newland, the executive sees the transaction as a win-win for the parties, both of which he considers “old mainstays” with deep knowledge of sector. But while he sees opportunity for a scale player in lot banking, he notes there are limitations on just how large the new platform can grow.
“Deploying billions into land would leave you with an unsustainable amount of assets under management,” he said.
The residential land sector is not an easy one in which to operate. Bob McLeod, the former executive chairman of Newland, told PERE that a lack of investment capital is what sent his firm looking for an equity partner in early 2020. After that process began, Brookfield approached the firm with a buyout offer, he said.
“The business that we’re in is extremely capital intensive and Brookfield brought a new dose of capital to continue our work for the next 10 years,” McLeod said.
Newland has been no stranger to institutional capital during its 53-year history, but its sale to Brookfield is its first dalliance with private equity. Its prior equity partners include American General – an insurance company that has since been absorbed by AIG – the California Public Employees’ Retirement System and Hunt Realty Investments, a Dallas-based real estate company.
With all the capital sloshing around looking for a home, if there’s another way to play it, the groups that think outside the box are going to be more successful.
McLeod, now an executive on Brookfield’s land investment team, touted the firm’s multiple pools of capital as an advantage to the transaction. “Brookfield brings a kind of flexibility to the capital,” he said. “They really have several options, which is another benefit to our relationship.”
SFR in focus
More than 10,000 of the lots, or roughly one-eighth, of Brookfield’s newly expanded portfolio are likely to be developed into purpose-built single-family rental homes, Foley said. If that rate of production holds true, it would far outpace the broader market average. As of the end of the first quarter, purpose-built rentals had just 4 percent market share of newly development homes over the prior 12 months, according to the National Association of Homebuilders.
Brookfield is one of the private real estate managers that made a substantial entry into the single-family rental space last year. It acquired Conrex, a landlord with 10,000 rental homes throughout the US, and launched a $300 million vehicle to invest in the space.
“The single-family rental business is here to stay,” Foley said. “It’s got its moment of glory today, but we think it is a 20-year play, not just a popular 2020-2021 investment, mainly because of the household formation we’ve seen during the pandemic.”
Brookfield is not alone in this conviction. Mark Owen, a managing director for the capital advisory Evercore, said demand for single-family rental strategies is so strong that institutional investors have reached out to him to see what options are available, a reverse from the typical flow of his business.
Many investors were waiting to see how single-family rentals held up during a downturn, Owen said, and were impressed by the sector’s performance during the height of the pandemic. He said firms like Brookfield will benefit from few other groups employing lot banking strategies to capitalize on the demand for the property type.
“With all the capital sloshing around looking for a home, if there’s another way to play it, the groups that think outside the box are going to be more successful,” he said.