Executive Q&A: Lack of Income Growth Looms Large

Marcia Diaz, Head of Originations, PGIM Real Estate Finance. Image courtesy of PGIM Real Estate Finance

Last year was a strong year for multifamily investment and financing and experts predicted strong results in 2019 as well. Job growth and favorable demographics have led to hardy absorption of new supply and the trend is anticipated to continue. Caution is still required, however, as we move ahead in this late cycle economy.

Marcia Diaz, head of originations for PGIM Real Estate Finance, discussed the challenges that might upset the currently healthy fundamentals.

PGIM REF originated a record $18.1 billion in financing in 2018 led by record production in multifamily and core-plus lending. What does this tell us about the multifamily financing landscape?

Diaz: Multifamily continues to be a preferred asset class for investors and continues to attract competitive financing. This is the one asset class where construction financing has been readily available and so we are seeing many new projects being delivered for permanent financing. The abundant liquidity in multifamily helps narrow the gap between buyer and seller expectations, which helps facilitate more transactions compared to other asset classes.

Also, there was a record $6.2 billion in conventional and affordable multifamily loans on behalf of Fannie Mae, Freddie Mac and the Federal Housing Administration. What were the factors behind this surge?

Diaz: Investors continue to favor multifamily as an asset class which has contributed to many multifamily transactions as well as new development. The GSEs continue to provide very competitive financing options for multifamily acquisition loans as well as take out financing for stabilized new developments.  These favorable conditions combined with the strength of our originations platform and strong relationships resulted in increased GSE financing at PGIM REF.

How do you think that multifamily lenders will benefit from the Fed’s “patient” approach to rate hikes?

Diaz: Low rates lead to more financing opportunities as investors can make more deals work with lower cost debt. Real estate owners don’t like volatility. If the debt market is volatile, they tend not to transact. So, a “patient” approach is good as it creates more stability in the market.

Tell us about the impact of an economic slowdown on your business strategy. Will the cost of debt rise?

Diaz: The cost of real estate debt may rise in an economic slowdown if spreads increase in response to corporate spreads widening and/or a decrease in lenders, as some nontraditional lenders may leave the space to seek other investments. At PGIM REF, we have been a consistent presence in the market even in downturns and would enjoy an environment with less competition and higher yields.

The supply of new apartments is expected to peak in 2019. How will this translate into the multifamily financing environment?

Diaz: The easy answer is that more new apartments will translate into more financing opportunities. However, in certain submarkets, the new supply may impact rents and ultimately values, which would lead to stricter underwriting guidelines for the impacted submarkets. As newly constructed apartments projects get delivered, if absorption is slower due to the new supply, there may be more opportunity for bridge lenders who will need to provide interim financing while properties stabilize. That said, vacancy rates are still under 5 percent, even though they ticked up a bit with all these recent deliveries.

We still see strong demand for multifamily, with increased household formation, Millennials moving out on their own, Baby Boomers transitioning from large homes and healthy job growth. So, while we’ve seen a record number of deliveries, the fundamentals tell us these new properties should get absorbed into the market.

What are PGIM Real Estate Finance’s business focus points in 2019?

Diaz: We are always focused on core and core-plus lending opportunities. We will continue to have a primary focus on multifamily, bulk distribution warehouse, neighborhood grocery anchored retail, office buildings in primary markets and seniors housing. For select cases, we will lend on hotels, self storage and student housing. 

What are your expectations regarding the multifamily financing sector going forward? What challenges are anticipated to arise?

Diaz: Some multifamily submarkets will experience oversupply, which means lenders will have to be selective about where to make their bets. If we head into an economic slowdown, lenders will need to underwrite/anticipate declining rents, slower absorption and, at some point, cap rate expansion. One headwind we had seen was a lack of income growth, which could hurt rental growth potential. This could impact the viability of value-add apartment transactions and high rent Class A construction deals.