SPECIAL REPORT: Multifamily Conditions are Showing Significant and Rapid Improvements Across the Board

Dallas–The environment for apartment development may be starting to appear attractive again. Presenters at a recent webinar sponsored by the architectural firm of Humphreys and Partners Architects LP said market, financing and acquisitions conditions in the apartment industry are strongly bouncing back.

“I think in part the market is recovering very, very quickly, and much more quickly than anyone has been expecting,” said Greg Willett, vice president of Sales-Research & Analysis at M/PF YieldStar‑Market Analysis. The webinar, organized by Humphreys and Partners, was entitled “Mid-year Industry Update for Apartment Development.”

Webinar presenters agreed capital for construction financing is flowing once again. Whereas last year, Federal Housing Administration (FHA)-insured financing was pretty much the only game in town for multifamily construction financing, traditional sources of construction financing have begun to returning to the multifamily market in 2010.

“We are seeing construction banks getting back to the bread-and-butter and construction lending mode, especially for markets that are justifying new construction,” said Cameron Cureton, associate director at HFF (Holliday Fenoglio Fowler). “Most banks have the liquidity to lend again.”

Mark Humphreys, CEO of Humphreys and Partners, noted that his architectural firm’s projects have shifted from as much as 90 percent financed by HUD insurance in 2009, to about 60 percent FHA- financed today. He said as much as 40 percent of the projects are resorting to conventional capital sources for construction financing. Humphreys added, though, that the size of the conventionally financed construction projects are much smaller.

Cureton said that construction lenders today require substantial equity, asset quality and deposits from developers. He said loan-to-value ratios are in the 50 to 70 percent range, recourse is still assumed, and the loan size limitation is about $20 million to 25 million generally. Pricing, he said, is still inefficient, at 300 to 350 basis points over LIBOR and floors at the 4.5 to 5.5 percent levels.

“Construction financing will remain difficult to obtain,” said Cureton, and will be limited to pretty much the best in class. “But the wind is behind our back” and the construction financing picture will only improve going forward for the multifamily business, he said.

Perhaps banks are responding to the improving apartment market conditions. Net apartment absorption in the country’s 64 largest market turned positive in 2009, according to M/PF YieldStar. Moreover, in the first six months of 2010, net absorption—at 250,000 units–has already exceeded the 110,000 units in all of 2009, said Willet. Resident retention rates have also increased across the board, he added. “Most operators are telling me they are getting 60 percent-plus renewals,” he said.

Willet said the unemployment numbers may be understated, and that also renters of the shadow market inventory are returning to apartment homes as more of the shadow inventory begins to go into foreclosure. Additionally, parents are more willing to guarantee leases for their children, and roommates are beginning to “decouple” and search for their own apartments.

Apartment occupany is beginning to bounce back “very, very quickly,” said Willet. Occupancy, in multifamily housing which bottomed in the fourth quarter of last year at a bit less than 92 percent, has increased sharply in the last two quarters to a preliminary 93.9 percent in the second quarter. The cities with the strongest occupancy levels are El Paso, San Jose, Pittsburgh and New York. The weakest occupancy levels are seen in Jacksonville, Houston, Phoenix and Atlanta. Willet projects occupancy levels will top out at more than 95 percent by mid-2011.

Willet projects that rent growth would be substantial though not at double-digit levels this year, reaching 4 to 6 percent in 2011-13. The reason rent growth would not be stronger, he said, is that it is still cheaper to buy homes than it is to rent in about half the country, and unemployment remains high.

Ron Davis, vice president, originator at Johnson Capital, outlined the loan features and eligible product types for FHA-insured financing for new multifamily construction or substantial rehabilitation. FHA-insured financing is non-recourse, and provides rollover construction and permanent financing and fully amortizing loan terms of up to 40 years. The financing program also imposes no income restrictions, he noted.

Davis said that FHA allows for any style of multifamily housing, with a preference for transit-oriented deals and workforce housing. Energy-efficient features are a plus. The FHA offices looks favorably on projects other than the typical suburban garden apartment, with features “that set the properties apart,” he said.

Davis noted that FHA’s new guideline will include the lowering of leverage from 90 percent to 83 percent, and an increase in working capital requirements from 2 to 4 percent. Projects that are in process and which have been submitted will be exempted from the new requirements. For this reason, developers should try to submit their projects before the new rules come into effect. “If you have a deal now, we really need to be talking now,” he said.

As far as permanent financing, Cureton said that Fannie Mae and Freddie Mac are also no longer “the only game in town.” The life companies have shored up their balance sheets and now back in the market, pricing just above the GSEs. And CMBS financing is looking as though it can become a future capital source for multifamily, though there has not been any deals yet.

At the higher 75 to 80 percent leverage levels, Fannie Mae and Freddie Mac are still most competitive sources of financing for multifamily housing, said Cureton. “No one can touch them.” But at the 65 percent level, life companies are becoming very competitive with the GSEs. Interest rates for Fannie Mae financing can be 4.5 to 5.5 percent for five, seven or 10 year fixed rate mortgages, he said. The market is also seeing interest-only financing, and mezzanine products that can take the leverage to up to 90 percent, he indicated.

Cureton also commented on the acquisitions market. In the past few months, sales prices are getting closer to replacement costs, he said. “We are seeing the buy side of the market drastically improve. Cap rates are compressing significantly as buyers focus more on IRR and discounts to replacement costs,” he said.