An Advantage of Build-to-Rent Developments

Government procurement, mortgages and pyrite

There’s a certain Irish distaste for apartments or houses being built to rent. “Build-to-Rent” developments are seen as a missed opportunity for young people to own their own homes.

However, there’s at least one advantage to developers building to rent. Developers are are incentivised to build something that lasts.

This advantage is recognised by governments and companies when they tender out large projects, say for power generation or desalination. There, it’s known as BOOT (build own operate transfer). The project developer Builds, Owns, Operates for a period (maybe 15-30 years) and then Transfers ownership. Governments and businesses know that “build-only” projects (often called Engineer Procure Contract, EPC) can be risky because developers are incentivised to minimise build cost, not total cost of ownership (including maintenance). Governments/Companies could choose to set standards for the building, but that can be a brittle approach because it can be easy for developers to game. Aligning incentives through a build-own-operate approach can be a more robust solution.

The “Irish defective block crisis” (see wikipedia) provides an example of the perils of a “build-only” approach. Irish homes – largely in Donegal and Mayo – were built with materials that later crumbled. This left homeowners and, by virtual of political pressure, the Irish taxpayer to foot the costs of bad development standards and regulation.

The mortgage industry provides yet another window into the dangers of a build-only approach. Having issued mortgages to homeowners, banks often package up and sell on those mortgages to investors. In return for an upfront payment to the bank, the investors collect the future mortgage payments. This reduces the bank’s incentives be careful who they give mortgages to. The risk of default is no longer theirs if they have sold that package of risks and rewards on. The re-selling of mortgages was not an insignificant factor in causing the housing crashes over the last decades – particularly in the US. As a partial solution, regulators now often require banks to maintain a portion of mortgages they issue on their loan books – i.e. a build-own-operate approach.

All of what I say above is not to discount the benefits of owner-occupied residences. There is merit to the argument that owner-occupied homes are better maintained. My urge is to be a little less critical of developments that are “Build-to-Rent”.