The multifamily investment landscape continues to be robust, as demand for housing is still high and capital availability is not an issue. Despite the recent increase in interest rates, things appear to stay on track. The only change noted by advisors and bankers so far is an unsurprising slowdown in transaction volume.
In the interview below, Ernie Katai, executive vice president & head of production at Berkadia, discusses how multifamily lending has evolved over the past year and how investors’ needs are changing.
How has the multifamily financing landscape changed over the last 12 months?
Katai: The multifamily financing landscape is constantly evolving, and the market uncertainty brought on by rising interest rates and persistent inflation has slowed the volume of deal transactions significantly in the second quarter and into the third quarter of the year. According to our “2022 Mid-Year Powerhouse Poll,” 75 percent of Berkadia’s investment sales advisors and mortgage bankers agree that the rate of production has slowed since January.
In response to market pressures, some lenders have cut back on lending activity or have proceeded cautiously by requiring borrowers to put more capital into deals. Higher borrowing costs have forced some buyers to pull out of deals or to press pause in an effort to wait out rising interest rates, which result in lower property values.
However, investors still have a lot of capital to invest and multifamily demand continues to outweigh supply. Additionally, multifamily continues to be one of the lowest risk asset classes in all of commercial real estate, boasting strong operating fundamentals despite continued economic uncertainty. Therefore, we’re still seeing a healthy pipeline of deals.
How have borrowers’ needs changed?
Katai: Today, borrowers need the most updated data on rent growth as it is paramount to understanding where performance is expected to be on both existing portfolios and potential acquisitions. In these times of market uncertainty, rent growth most directly affects a buy/hold/sell strategy. Therefore, having the latest market data, especially concerning rent growth, is at the forefront of borrowers’ minds.
Additionally, borrowers who have historically and frequently borrowed with floating-rate vehicles need to be prepared for the uptick in debt service costs—both current and anticipated—which has already started to make a heavy impact on escrows for future interest rate caps.
Do the tighter underwriting standards seen in retail or office also apply, in any form, in multifamily?
Katai: Tighter underwriting standards seen in the retail or office space don’t necessarily apply to multifamily. The multifamily industry does not track as closely with the broader economy like office or retail. Multifamily also has not suffered as directly from post-pandemic low occupancy—office—or high inflation—retail. Office tenants tend to pick up and move very frequently and it takes landlords much longer to fill a vacancy in those spaces than it does in multifamily. Because of this, investment in multifamily properties tends to be less risky than office properties as multifamily vacancies are more quickly filled than office vacancies.
What fluctuations should we expect to see on this side of the capital markets as we move into 2023?
Katai: The multifamily sector continues to perform very well despite market uncertainty, and we believe it will continue to be a “favorite” property type among lenders going into 2023. Another sector that continues to gain momentum is single-family rental and built-for-rent.
As of June 2022, we’ve completed $650 million in SFR and BFR transactions, despite these properties being more difficult to finance than traditional multifamily housing. Though agency lenders have become a bit more friendly to this asset class, Freddie Mac and Fannie Mae don’t currently offer financing solutions for SFR scatter-site portfolios, though they do offer debt solutions for BFR properties with some contingencies. This has opened a gap for other capital sources such as institutional investors, banks, life companies and others to become active in the market and forge new and creative financing solutions to support the heightened demand for this booming sector.
What capital options are becoming less attractive as interest rates rise and what are the financing alternatives to turn to?
Katai: In our “2022 Mid-Year Powerhouse Poll,” we asked Berkadia’s investment sales advisors and mortgage bankers which strategies they expected institutional investors to be most interested in. Over 74 percent of respondents agreed that debt funds would hold the least interest with institutional investors, 48 percent agreed that core plus funds would hold the most interest, while over 40 percent agreed that value-add funds would hold the most interest with institutional investors.
How are you and Berkadia preparing for further interest rate increases?
Katai: We’re going to our clients with solutions for the short-, medium- and long-term. As a full-service debt, equity and disposition enterprise, we’re constantly consulting with our clients on the best moves for them, allowing them to process all options given their appetite for acquisition, disposition or long-term holds.
Not being able to predict where and when interest rates will change, we continue to arm ourselves with market research and data so that we are prepared to help our clients navigate any situation. Additionally, having a deep understanding of our clients’ investment strategies helps us to provide the best variety of options to them as they navigate where interest rates will be in one, three or five years from now.
Following record-high investment in 2021 and 2022, the numbers are expected to drop in the remainder of the year in 2023 as well. Do you agree with this forecast?
Katai: Last year was a record year for Berkadia, handling $68 billion in transaction volume. As of June 2022, we’ve handled $32 billion in total transaction volume, putting us slightly off pace from last year’s numbers. Despite consistent market uncertainty throughout this year, we are still on track to have our second-best year ever.
Throughout the summer, we saw production slow as investors across the U.S. grappled with rising interest rates, persistent inflation, higher cap rates and increased construction costs. That said, the industry is resilient and boasts strong operating fundamentals despite continued economic uncertainty, further proven by the high and stable demand we are seeing from investors and renters alike, across key markets.
We remain cautiously optimistic for the latter half of 2022 and 2023 as we have weathered these storms before.
What is one thing investors need to keep in mind when it comes to building a multifamily investment strategy in these volatile times?
Katai: During times of market uncertainty, working with advisors who have historical expertise in navigating volatile markets is critical when building a multifamily investment strategy. Our clients rely on Berkadia producers’ localized experience in each regional market across the U.S. to complete value-add transactions.
Additionally, industry advancements in technology have allowed our investment sales advisors and mortgage bankers to deliver the best results for our clients. Being able to access real-time updates to market-specific data informs the team with actionable insights that help them to best advise their clients—even if that means losing out on a deal because it is not the best investment for their business.