Millennials Drive Growth in U.S. Land Deals

The largest living generation in the U.S. will fuel demand for single-family homes and suburban land deals, experts say. Consequently, investors are urged to take another look at land investments.

Land investment in the U.S. has been a nascent niche over the past few years thanks to major demographic shifts and strong fundamentals, and demand for land is only going to grow, according to GPs targeting the strategy.

“The best part is the macro-level story,” says Tom Shapiro, chief investment officer for Los Angeles–based GTIS Partners. Pointing to five key trends, he says “record affordability, supply gap, demographics, the return of credit, and relative value” have made land strategies a real estate asset class worth paying attention to once again, following the dramatic loss of value in the wake of the financial crisis.

“Housing starts are at a World War II pace when we had half the population we do today,” Shapiro says. “Historically we created 1.2M households a year for the past 40 years, but during the downturn that number got cut in half. Now it’s come back to the norm.” Shapiro suggests that growth could exceed past trends.

Indeed, Stephan Elieff, president of the real estate development firm SunCal, argues that the case for land investment is more compelling than ever, with talk of millennials—those aged 18 to 34 in 2015—moving wholesale to urban areas only, “overestimated.”

“If you look at it, there are a number of things that will swing in favor of land,” says Elieff. “People have overestimated urbanization. Once people get to a certain age, they are right back in the suburbs. They want kids, and they worry about schools and having backyards.”

Already millennials have surpassed the oversized baby boomer generation, according to the U.S. Census Bureau—a fact that will further drive household formation, says Elieff. Taken with job growth, rising rents, and increased access to financing, demand for new single-family homes, not least from first-time buyers, will only grow.

“There’s an absolute lack of supply,” says Tony Avila, managing principal and co-founder of the residential private equity real estate funds Encore Housing Opportunity Funds and ResCore Property Trust. “That’s why you have [existing] housing prices going up so precipitously.”

With a finished lot presenting one of the biggest development constraints, Avila sees opportunities in delivering the right land to homebuilders. According to Elieff, the key is to focus on areas “where it’s not easy to add supply or where there are barriers to entry.”

It’s a theme that may sway investors who have overlooked land in their portfolios since the last real estate cycle.

“Concern over pricing of certain assets has certainly made people more open– minded towards land strategies,” says Shapiro. “Some investors did invest in land before the last downturn. The issue was that land was highly leveraged, and when the market moved away, investors got burned.” Instead, he says, investors can benefit from “convexity inherent in land. Since land is a derivative of home prices, you don’t need to leverage land to create high returns.”

Avila, Elieff, and Shapiro, whose firms have transacted together in this space, see significant benefit in land for both development and entitlement, as well as finishing lots by adding foundations of infrastructure, such as sewers or roads, for homebuilders to eventually purchase.

Each of the men also highlights the plethora of distressed deals that were available over the past few years as partially finished projects lay dormant, available at significant discounts. Hybrid deals can also prove fruitful, they add, such as developing portions of lots and parceling out the remaining parts to builders at healthy premiums.

As investors face the increasing portfolio performance pressure, land plays present a unique opportunity.   

“This is definitely opportunistic,” says Avila. “If you buy a core apartment today and rents fall, you are going to lose money. We are developing new apartments with approximately a 200–basis–point buffer between the development cap rate and market cap rate. I would encourage investors to sell core apartments and invest in developing apartments and to take advantage of the cap rate arbitrage.”

Despite the potential upside, land investments and single-family home strategies are not on many institutional investors’ radar. “They don’t fill a particular risk bucket, which is ironic, since the single-family home business is larger than all other asset classes combined,” says Shapiro.

In terms of market timing, land prices have already risen, but the cycle may be kind to new entrants.

“Many people ask me what inning we are in,” adds Elieff. “It’s market–dependent, and for some markets the game hasn’t started yet. Certain markets, such as Manhattan, San Francisco, L.A., and Orange County, have come back and surpassed the previous peak. For areas such as the Inland Empire in Southern California or suburban Chicago, it’s early innings.”