Orlando, Fla.—Thomas Sittema, CEO of Orlando, Fla.-based CNL Financial Group, recently talked to MHN about the recent capital markets trends and how they will affect the multifamily industry.
MHN: What are some of the capital markets trends you’re seeing?
Sittema: Clearly the overall capital markets are actually pretty robust. The public markets are quite active and solid. From a real estate standpoint, there’s a little bit of a tale of two stories. When you look at Gateway City’s trophy assets vs. secondary and tertiary types of assets and markets, if you had an office in New York City you’d have 50 bidders, and if you had an office in who-knows-where, you’d have a hard time getting people to close, unless it’s a pretty distressed level, so it’s a very different story, different market, depending on the sector you’re in and the geography you invest in.
MHN: What about multifamily?
Sittema: Well, we historically at CNL haven’t been that active in the multifamily space, but we like the fundamentals in that business today, and we’re about ready to announce our third apartment development transaction, where we are an equity partner with a development operating partner. We like the early-stage apartments because of the demographics and the growth and performance in that sector, and like most real estate sectors, there has been little to no construction. There have been 30-50 year lows in terms of construction activity. Given the stability and strength of the multifamily market, early-stage apartment development in the right sponsor-operating partners is a good investment today.
MHN: Do you think this will continue?
Sittema: Nothing continues forever, but I do think it will continue for a season. Our timeline, which will adjust as market conditions warrant adjustment, but we think for a 12-18 month window, to do early stages of apartment development is a good investment today. We’re embarking on that strategy, and we’ll revisit our investments at the end of the year and early part of 2013, and pause for a season just to make sure everything is where we think it is and as we had underwritten it to be. We think that a window is clearly a great opportunity, and the concern always with development is you go from one extreme to the other, from having no construction activity and 50-year construction lows to pretty robust development pipelines fairly quickly. So you have to monitor the construction levels. But at this stage, the rate of development seems to be sustainable for a season.
MHN: Do you have any other concerns with respect to the real estate industry and multifamily?
Sittema: I’m paid to have concerns! I have concerns in a lot of area. It’s hard to know where the economy is headed. We clearly feel like we’re moving in the right trajectory. However, we started last year on the right trajectory, and we hit a wall in the middle part of the year with Washington budget impasse, which threw cold water on the idea of a recovery. We feel that has transitioned here in the last 60 or 90 days. The European situation seems to be stabilizing a bit, and clearly we’re encouraged with Bernanke coming out saying interests rates are going to be sustainably low for a season. For real estate that’s a good trend given the debt capital intensity in our sector.
From a concern standpoint, you’re not seeing tremendous absorption in a lot of sectors, so we’re monitoring that carefully. For any acquisitions, we’re being reasonably prudent in terms of lease assumptions and rental-rate assumptions. While the capital markets continue to strengthen, it’s a bit irregular. You don’t really see the emergence of the CMBS market today like what we had thought a year ago.
MHN: What is the industry outlook?
Sittema: People always talk about real estate relative to where it was in 2006 and 2007, and I would argue that those were not years of normalcy. Those were years of frothiness. I don’t think about what markets were like at ’06 and ’07 levels. I think back to ’03, ’04, ’05 levels, and in some sectors I think we are back in those areas. The trends are generally positive in almost all sectors. You clearly see the economy strengthen. We obviously have to add jobs, and we’re starting to do that. Unemployment is 8.3 percent—still too high—but at least we’re trending in the right direction. Sustainably low interest rates will help any type of real estate recovery. The capital markets have reemerged, and they’re very strong. The bond market and the equity market for real estate companies are doing very, very well. I think the outlook on the whole is quite positive. It’s not crazy positive like ’07—thankfully—but it clearly is trending in the right direction.
When a market gets really heated as in 2007, it’s amazing how much capital is available and how little real equity needs to go into a deal. With the power of leverage and relatively low cost of debt, you can make a lot of things pencil from a real estate standpoint. When you have to put in substantial levels of equity in apartments and development deals, such as is the case today, you have to be more disciplined in your underwriting or you don’t get the returns you need from an equity perspective. Additionally, there are a lot of sponsors and development companies that blew up post ’07, and if you have a spotty track record and some blemishes, it makes it more difficult to access capital today. As we look at development, we’re clearly being very disciplined on our underwriting—we’re not aggressively trending rents. We’re not playing any games with underwriting growth assumptions and exit cap rates and that sort of thing. So it’s just a return to sound fundamentals in real estate investment, and that’s a good thing for the market.