Multifamily Finance — Insights

Several Innings of Play Left in the Multifamily Market

Grace Huebscher, Kristen Croxton, and Brian Sykes

The multifamily market has several good years left to go—that is the consensus view from investors, industry observers, and agency officials who participated in Capital One’s recent industry survey at the RealShare Apartments West conference in Los Angeles.

The optimistic picture emerging from the survey has some interesting nuances that could shape the way investors look at the market through 2018.

Perspectives on the Market’s Future are More Divided than Ever

Every year, we ask participants at a number of industry conferences whether they plan to be net buyers or sellers in the coming year. For the second year in a row, RealShare Apartments  attendees were more than twice as likely to describe themselves as net sellers rather than buyers. That view is hardly surprising, supported as it is by the tremendous investor interest we’ve seen in multifamily over the last few years, and it is, of course, a main reason that cap rates are as low as they are.

Much more revealing, we feel, is the decline by eight percentage points, from 43 percent to 35 percent, of those who have adopted a neutral stance on the market’s future—who believe their buying and selling will essentially cancel each other out. This difference was split evenly between the bulls and bears. In other words, there are more people this year who feel they have clarity on the market’s future, but they don’t agree on its direction.

We can see this divergence of opinion playing out in the market.  One camp of knowledgeable investors are increasing their presence in multifamily. A good example is the Blackstone Group’s $5.3 billion purchase of Stuyvesant Town-Peter Cooper Village.  Members of this group tend to invest internationally, and they see multifamily as a low-volatility investment with attractive returns compared to other global options.

On the other hand, some companies who have been long-term holders are interested in divesting their holdings in noncore markets. They see high valuations as an inducement for selling because they are not sure how long these prices are going to last. A good example is Equity Residential, which recently sold a 73-property portfolio to Starwood Capital Group for $5.4 billion. Sam Zell’s rationale was that his firm was capitalizing on healthy valuations to redirect its focus from suburban markets to downtown urban centers.

Not Much Movement Is in Store for Interest and Cap Rates

Recent positive job reports have precipitated a slight bump in the 10-year Treasury note, but it doesn’t seem likely that interest rates will move substantially when the Fed releases the brakes on them. There are just too many global forces holding them down. It’s clear that at some point the Fed would like to see rates more closely approximate historic norms, but, barring some unforeseen event, this is unlikely to happen in the near future. Any slight uptick in rates will certainly affect how investors evaluate their financing options and property valuations, but it is unlikely to have any effect on acquisition activity as a whole. We have seen, however, that the prospect of a rate hike has caused many investors to accelerate the timing on refinancings, and we expect this trend to continue.

Given this situation, RealShare panelists largely agreed that cap rates have generally hit bottom, although in some West Coast markets they could drop another 25 bps. Many of the same factors that are checking the rise of interest rates will exert the same dampening force on cap rates, keeping them from rebounding. We see them stabilizing, rather than increasing substantially.

To a certain extent, lower cap rates are shaping market activity, favoring larger firms like Blackstone or Starwood that can use their size to achieve economies of scale. Accordingly, an unusually large number of mega-transactions have been completed in the last 18 months.

Supply and Demand Remain in Equilibrium

The market’s future depends in large measure on supply and demand maintaining a healthy balance—and if the respondents to our RealShare Apartments survey are any indication, the outlook for the multifamily market looks good for the next few years. Almost three-quarters said that supply and demand were in balance or that one only slightly exceeded the other.

Admittedly, supply is running ahead of demand in some markets, like Austin and Washington, DC, but we expect that to be temporary. The demographic and financial trends all suggest that demand will stay ahead of supply for the near future in many markets. Not only are millennials finally moving out of their parents’ basements and baby boomers converting their homes into retirement nest eggs, but the number of renters of all shapes and sizes is growing. Household formation is up, and with housing prices rising and mortgage lenders remaining very selective, a higher-than-usual percentage of those new households are renting.

One of the implications of this sustained demand strength is that rents—even after several years of solid growth—will continue to rise, albeit likely at a slower pace. Many Western markets are at or above their pre-recession peak, and developers asking premium rents are leasing up Class A multi-hundred-unit properties at a rapid pace.
 
At the same time, there is ample financing available to support an active and expanding market. The agencies have a healthy presence, as do the banks and life companies.  Borrowers seem to have gotten the message. This year as last, 46 percent of our RealShare Apartments respondents told us that they expected to secure most of their financing from the banks, though the number of those who identified agencies as the source for the bulk of their funding grew by four percentage points. Our poll also revealed that the percentage of lenders turning to CMBS dropped significantly, from 8 percent last year to just 3 percent this year.

One area in which the supply-demand equation is out of equilibrium is affordable housing, especially in the major urban markets. The agencies are really trying to step up their activity in this space to help address this imbalance.
 
Seventh Inning or Extra Innings?

Taking all these facts together, many at RealShare see the market continuing to do well at least until 2018. When we asked conference participants what they thought could slow the market, there was no real consensus: they were evenly split between global uncertainty, interest rates rising, overbuilding of apartment units, and sustainability of continued NOI growth. In other words, there is no sign of conviction that any single factor could derail the market.

This response corresponds to the answers we’re hearing from our customers and colleagues when we ask what inning this multifamily market is in. The general consensus is that we’re at the top of the seventh with a few good innings ahead of us—but a number of market participants feel the strong multifamily market could go on for extra innings.


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