As a year of mixed returns for multifamily crossed its midpoint, industry experts expressed some optimism about the sector as a whole. At a July 26 MHN Voices webinar moderated by MHN Editorial Director Suzann Silverman, a panel of multifamily investment experts largely agreed that the industry is seeing no shortage of dealmaking and development difficulties brought on by inflation, strict lending and underwriting terms and liquidity stress.
At the same time, participants observed that the sector is proving itself resilient in the long-term. Stabilized, high-demand assets located in fast-growing metros are expected to perform particularly well, while the overall market was projected to remain relatively healthy throughout the rest of 2023.
Persistent stresses
Taking place one day after the Federal Reserve increased interest rates by another 25 basis points, panelists widely agreed that we will face a mild to moderate recession at the end of this year or early next. Jeff Adler, vice president at Yardi Matrix, discussed this within the context of trends impacting real GDP and core and headline inflation, as well as rent growth, which he noted will be key indicators for multifamily for the rest of the year.
Of particular note was what Adler termed “weak” rent growth, which stood at 1.8 percent year-over-year, a 3.7 percent decrease from the rate at the start of the year, and 74-basis-points down from May. At the same time, the metro-specific contexts of these metrics are more nuanced, within markets with large supply pipelines in the South and West such as Austin, Miami and Salt Lake City doing “reasonably well,” and having “great long-term prospects,” according to Adler. At some point, however, they are expected to undergo struggles with absorption, as demand appropriately scales to meet supply.
Deal making and transaction volumes within most metros is still stagnant, due in part to interest rates being at their highest since 2001. Two victims in particular have been deal underwriting terms and liquidity on the part of owners and investors. “I don’t think that it should be a surprise that the dramatic increases in interest rates have stressed liquidity in all markets, even for apartments,” reflected Mary Ann King, co-head of Institutional Solutions at Berkadia.
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The drop in transaction volumes has also affected asset values, which have dropped between 15 and 25 percent, according to data cited by King. In turn, the interest rates and tanked asset values have bled into “a bid-ask spread that has created the liquidity problem,” King said. Compounding on these struggles are a mix of more circumstantial factors for investors, such as imminent loan maturities, expiring capitalizations and large redemption cues which have prompted investors to pull their deals. “Virtually all of the investors pulling deals in the market are prompted by some sort of stress,” King reflected.
Other areas of difficulty are the ability to secure loans for construction, which have added to the supply shortage. “It’s incredibly difficult to source a construction loan,” King said. “Combined with large pipelines and uncertain rent, it’s hard to underwrite, (especially) with so many existing deals selling at discount to replacement costs.”
At the same time, the deliveries, when they come about, will have the potential to yield worthwhile returns. “All of the housing necessary to resolve the shortage has already been identified,” Adler pointed out.
Who are the winners?
Despite the gloomy fundamentals and extant investment hurdles, “most people still believe in the multifamily story, long-term,” said Jon Siegel, co-founder & chief investment officer at RailField Partners.
Within regional banks pausing on lending, save for the most cash-voluminous investments, institutional investors and debt funds have stepped in to take a more “holistic” approach, weighing an asset’s short term-cash flow with value-add opportunities, demographic projections and longer-term capitalizations, according to Siegel. “You won’t know when the market changes until you are in the market,” said Siegel.
Consequently, the biggest hurdle in capital markets has not been towards the availability of capital, but a matter of cost. “There is a lot of money still on the sidelines, but (the amount) is fewer and further between for people that want to execute right now,” Siegel concluded.
As a result, the deals that end up closing often end up significantly in favor of the debt funds, particularly for assets that are in high-demand, according to Melissa Farrell, Head of U.S. Debt Originations at PGIM Real Estate. This has led to a high degree of competition. “Everyone is chasing the same loans; they are very competitive, and the actual loan-to-value ratios have decline.”
As a result of this competition, they still enjoy 60 to 65 percent leverage in some deals with “(everything) based on debt service coverage ratios,” according to Farrell.
Consequently, from Farrell’s perspective, the “majority of what we are working on is refinances, and we are being inundated with requests for shorter-term prepaid loans with flexibility. They have to be something with an increase in cash flow.”
Materially, the most promising sectors are those in the highest demand, particularly in cities with high migration and more limited supply. Adler sees the widespread housing shortage as a particular motivator for the sector’s prosperity. “It is driving both rent growth and regulatory pressures in certain jurisdictions,” he said.
“Build-to-rent, student housing and workforce are the most niche products in the space; people that are getting even more yield will look into those them,” King said. “Student housing has some great fundamentals in the right universities, while self-storage has the resiliency to do rent increases, even when (they) are down,” Adler agreed.
A light at the end of the tunnel
Despite the hurdles towards dealmaking and construction, the long-term outlook remains highly positive. Where the distress is concerned, the problems remain situational, a stark contrast from the existential threats that the office sector of facing. “Multifamily is currently undergoing a period of stress, but there’s nothing structural about absorbing new supply,” explained Joshua Westerberg, director of originations at Mesa West Capital.
“Multifamily is not going through a secular change right now. We are only going through interest rates, and I don’t see anything in the future that will cause increasing distress,” Westerberg predicted.
As for what will lead to this prosperous investment and development environment, the key marker will be capitalization rates matching interest rates, ideally at a time when the funds rate decreases. “We are going to have to find the place where cap rates get to where interest rates are, and you want to have the growth to bridge that gap,” said Sigel.
Adler sees the deals that end up closing as being worthwhile investments, particularly those that get financed through the next two years. Listing the example of deals that were done during the global financial crisis that were financed through 2010, Adler recalled, “For folks that did, the returns were enormous.”
