Lenders See Clear Skies Ahead
- Feb 05, 2016
Last year was tumultuous in a lot of ways, but multifamily deals wasn’t one of them. The outlook for 2016 is roughly the same: lenders want to lend, borrowers want to borrow, and barring a meltdown in the U.S. economy, a lot of deals still pencil out for both parties. Not even small, steady rises interest rates to follow the Fed’s action in December would likely be enough to slow multifamily deal momentum.
“U.S. multifamily fundamentals remain very favorable,” said Jeffrey W. Adler, vice president of Yardi Matrix. “With rents forecasted to grow more than 4.5 percent in 2016, forecasted solid job formation of more than 200,000 per month, and new forecasted completions of approximately 335,000 units, multifamily should remain a favored asset class.” Adler added, “While new development deals should face greater scrutiny as new supply impacts high-end rents and absorption, there is significant upside in value added redevelopment acquisitions that should continue to attract both debt and equity capital in most Southern and Western markets.”
According to Marcus & Millichap Capital Corp. Senior Vice President William E. Hughes, “Multifamily is still the darling among lenders, with maybe a little less luster going forward in some markets, as more inventory comes on line. Even so, not much less luster. The demand for multifamily isn’t going away.” Hughes added that while there will be plenty of available capital, underwriters aren’t throwing caution to the wind. “This cycle hasn’t been frothy. Standards have been maintained and that’s sustaining the market.”
Lending standards will remain high, agrees Jason Bressler, Mesa West vice president of originations at the firm’s Los Angeles headquarters. “Lenders will continue to focus on the underlying fundamentals.” The GSEs are setting the tone, and currently they underwrite 10-year apartment loans at rates ranging from 4.3 to 4.7 percent, and leverage of up to a maximum 80 percent in select instances, Hughes explains. Also, portfolio lenders are offering similar loan-to-value ratios (LTVs) with rates from 3.85 to 4.5 percent. Floating-rate bridge loans for stabilized properties are issued at LTVs of 70 percent and spread 250 to 400 basis points above Libor. For value-add deals, 80 percent LTV (60 to 65 percent of cost) and rates 350 to 500 basis points above are the norm.
The main reason 2016 is primed to continue lending strength is that multifamily fundamentals themselves are still exceedingly strong. According to Marcus & Millichap data, about 268,000 apartment units were absorbed nationwide in 2015, the highest level in ve years, despite the rush to devel- op new properties. Overall vacancy is down from 4.5 percent at the end of 2014 to 4.3 percent at the end of 2015, and rent growth has averaged more than 5 percent last year. (Axiometrics Inc. likewise puts average oc- cupancy at a strong 95.3 percent as of Q3 2015.)
Demographic trends are also highly favorable for the apartment sector, with Millennials still entering the workforce en masse and forming households, and older adults down- sizing from owner-occupied housing. The employment-to-population ratio for 25-to-34-year-olds, when households tend to be renters, is at an all-time high. Higher down payment requirements, limited construction of starter homes, and tight mortgage underwriting continue to suppress single-family home purchases, thus delaying the transition from rentals to single-family homes.
“The multifamily sector will continue to be the favorite for balance sheet and capital market lenders,” said Warren Higgins, head of mortgage banking at Berkadia. “Supply and demand remains in fairly good balance, and the improving economy is bringing younger people out of their parents’ basements and turning them into multifamily renters. There’s going to be very little movement in the occupancy rate in 2016, even with the full pipeline of new product being delivered.”
Indications by the GSEs suggest that mul- tifamily debt levels this year will match 2015 levels, said Higgins. Overall, the Mortgage Bankers Association forecasts $225 billion in originations in 2016, roughly the same as in 2015. Also, the conduit market, while experiencing pricing volatility, isn’t expected to see any retraction in the new year.
“Given the amount of debt capital available in the market, we don’t expect any major changes for lenders,” said Bressler. He expects continuing interest in the sort of deals that Mesa West completed late last year, which included providing the joint-venture of the Bascom Group and Oaktree Capital Management with $46.8 million in first mortgage debt for the acquisition, renovation and stabilization of Axis at Nine Mile Station, a 336-unit multifamily property in Denver.
A portion of the three-year, non-recourse financing will be used to help Bascom implement its value-add investment strategy, which involves repositioning the asset, according to Mesa West principal Steve Fried, who headed the origination along with associate Seth Hall. “Bascom has the experience to unlock the underperforming property’s upside potential and narrow the current rent gap with competing properties,” said Fried.
None of this is to say that the capital mar- kets will be precisely the same this year as in 2015. “Credit tightening isn’t likely in gateway cities and urban markets,” explained Higgins, “Still, with the new supply that has come on line over the past few years, older properties in secondary and tertiary markets will be subject to closer scrutiny. These properties will take the brunt of any downward value pressure as cap rates rise in response to interest rates.” Higgins added, “Rising interest rates will potentially have the greatest negative impact on debt service coverage and valuations.”
“Rapid rate rises would be injurious, but if they move slowly, they won’t be a problem,” noted Hughes, who doesn’t expect rapid rises this year in any case, and maybe not even the total 100 basis point rise for the year that some prognosticators are predicting. “As rates go up, there will an adjustment in cap rates, but the spread between 10-year trea- sures and cap rates is still pretty favorable, and that isn’t likely to change. It’s going to be a good year for multifamily lending.”