Since May of 2020, when Denver started to thaw out from the mandatory stay at home ordinance, the city has seen an influx of new residents who made a lifestyle change mid-pandemic.
Denver has also seen corporate relocations or expansions from companies that want to follow talent.
Since Denver’s for-sale housing market couldn’t keep up with that demand, the multi-housing market has gone from pandemic pause to double-digit rent growth and record absorption. And those fundamentals have resulted in a rush of capital being deployed into the market.
The daily conversations with capital and robust deal flow has enabled the JLL Denver Debt & Equity team to learn the hot buttons for both debt and equity providers in the multi-housing development space. It also gives us insight into the multi-housing construction financing market. Every multi-housing development deal we closed, or plan to close in 2021, will have a different lender or investor.
Multi-Housing Development Equity
Capital providers have been inundated with requests from developers across the country, but Denver remains a targeted market for these groups, allowing project shortcomings to be overcome. The first thing an investor or lender is going to review is development cost basis. The further vetted development costs are (i.e. 100 percent CDs, IGMP, shovel-ready opportunities) the more favorable capital will view an opportunity.
Hypersensitive to low basis deals, capital wants to actively pursue urban or suburban deals yielding north of a 5.75 percent yield-on-cost. Rising construction costs and softening rents have made that yield-on-cost threshold more difficult to achieve; however, given the low interest rate environment fueling existing properties to trade at a lower capitalization rates, capital is becoming more accepting of lower development yields so long as the spread between un-trended yield on cost and market capitalization rate is still somewhere between 125 and 200bps.
Capitalization rate compression is also a factor of capital wanting to invest in Colorado multi-housing properties, with any given marketed multi-housing sale achieving 10-plus offers. This cap rate compression, and the spread between development yield and cap rate, has also brought forth a build-to-own strategy that a lot of capital is implementing.
Given our unique position, we have great insight into the hot buttons that investment committees need to overcome:
- Increased construction costs reducing returns, mitigated by an ultra-competitive investment market driving prices to record highs for existing product, preserving a comfortable development basis despite increased costs
- Seasonality in the Denver Market that temporarily throttles absorption and rent growth, mitigated by historic data showing strong rebounds following the holiday lull
- Supply in specific neighborhoods, mitigated by detailed absorption analysis forecasting absorption across the entire development pipeline and ability to grow rents in tandem with competing supply coming online
- Unchartered territory for underwritten rents, mitigated by aligning the highest achieved rents in the competitive set on a floorplan-to-floorplan comparison.
As for capital contributions, both debt and equity providers like to see the developer have skin in the game. While 95/5 and 90/10 equity splits, or 75 percent LTC financing, is still available in the market, it will come at a higher cost of capital. There is no tried-and-true formula for an equity development waterfall structure, but JLL has had success negotiating the initial preferred return, an inclusion to return any developer cost overruns, and more accretive GP promotes.
Multi-Housing Construction Financing
It’s not a surprise given the lower last dollar lender basis, but the debt side of the capital stack is even more liquid than the equity side of the capital stack. The below table illustrates construction financing available in today’s market, as determined by the JLL Denver Debt & Equity team.
Not noted in the above table is the construction loan take-out underwriting that is universal across all lender types. At projected stabilization, a cash-neutral take-out loan should size to at least a 1.25x DSCR utilizing a stressed interest rate of approximately 100 bps to 200 bps above current market rates to ensure that agency lenders can refinance the development.
Today, the metro-wide Denver multi-housing pipeline is comprised of some 30,000 units under construction and nearly 60,000 units planned. While the fate of those planned developments is still not a guaranty, there is confidence within the industry that most of them will get capitalized and eventually break ground. The capital markets are liquid for multi-housing development, and the JLL Denver Debt & Equity team has seen more capital providers enter the market fueling competitive terms for developers.