Q&A with Berkadia’s Dori Nolan on Multifamily’s “Impressive Resilience”

After wrapping up a tumultuous 2020 with record-breaking sales in December, Berkadia is getting 2021 underway with a 2021 Forecast webinar, slated for Thursday, Jan.14. Moderated by CEO Justin Wheeler, the hour-long conversation will bring together industry experts from both within and outside the company. Connect Commercial Real Estate spoke with one of the Berkadia panelists, Dori Nolan, who as SVP of national client services is focused on growing the firm’s reach among institutional investors. Here’s what she had to say:

Q: We’ve been seeing an uptick in fundraising. Do they have specific investment targets at this time?

A: We’ve seen record-breaking private-equity fundraising in the past few years. We’ve been tracking it pretty closely, and $83 billion was raised in 2019, and up until the second quarter of 2020, $23 billion was raised and was on pace to match 2019, but with the pandemic, it slowed down.

Commercial real estate plays a really interesting role in an institution’s portfolio, because real estate actually hedges risk and provides portfolio diversification. So I think that’s one of the reasons you see institutional investors select real estate at the outset. When they look at their portfolio allocations, usually they’ve allocated anywhere from 10% to 14% of their assets under management to real estate. But what they’re finding is that they’re under-allocated to real estate. So they’re trying to dedicate more capital to real estate to meet their benchmarks in terms of how much they’re weighted toward one asset class versus another.

The two asset classes that we found to be resilient once the pandemic emerged were multifamily, which is what we’re really focused on, and industrial. Multifamily has shown impressive resilience during the pandemic, and that’s driven by a few things. First of all, the low interest rates that we’re witnessing today, as well as the long-term income growth and liquidity characteristics of multifamily itself.

Also, when you look back over time with the NCREIF Property Index, you can see that multifamily has generated attractive risk-adjusted returns over the past 25 years. This gives those institutional investors the comfort that the future’s not indicative of what happened in the past, but it’s a good leading indication that it’s a safe, defensive, income-producing type of investment.

Everyone needs a place to live, right? We’re seeing population and household formation increase. That’s only going to drive more need for housing. Not everyone can, or wants to, own a house, so renting is an excellent alternative and it provides a lot of flexibility and mobility, too, for those that don’t want to be tied down. We’ve seen that with the Millennials; the Millennials are aging now, so they’re moving out of city centers and into more suburban locations because their lifestyle preferences are changing. They’re getting older, they’re having children, they’re interested in identifying good public school options for their children. They want to be close in, so the inner-ring suburban locations are benefiting from people leaving the urban centers and moving out for various reasons.

Q: What did investment activity look like in 2020?

A: We had a strong first quarter for investment sales at Berkadia leading up to the pandemic, and that was driven largely by the insatiable appetite for multifamily. Then things slowed down once the pandemic set in. A lot of the institutional investors moved immediately to the sidelines. It’s not uncommon for them to be the last ones in and the first ones out. That’s largely their behavior; it’s patient, defensive capital.

So investment activity in April through the end of May was pretty slow and sluggish given the uncertainty surrounding valuations and rental collections. The only deals getting done were the deals that were already accounted for earlier in the year. But we woke up one day at the end of May and things changed. We started to see more clarity and confidence emerge, and I think that was driven by collections. People were unsure about how resilient the multifamily sector really was, but once they could see trendlines about how collections were holding up, in that 90%-plus range, they felt pretty confident that this was more of a temporary phenomenon or extraordinary situation and that long-term, even with this disruption, things would hold up pretty well. So we started seeing more activity coming into the market. The sellers were a little concerned because they didn’t think there was going to be a big discount to valuation. So it was a matter of educating those sellers and buyers on pricing and valuation. Over the summer and through the end of the year, we began to see values bounce back to or above pre-pandemic levels.

Ninety percent of the deals that Berkadia closed during the third quarter were with 1031 exchange buyers and private, more opportunistic investors. We were seeing the institutional investors tracking investment activity but still on the sidelines. Now we’re seeing them come back in. One of the things I ask is, what are your investment parameters? What do you target in terms of size and returns? For the most part, they’re looking at more core and core-plus right now, small appetite for value add. But when I look at what they’re projecting in terms of their target returns, they’re still targeting pre-pandemic return metrics. They haven’t adjusted their risk profile to consider what transpired and what we’re living through in this pandemic. So that’s comforting to me that things haven’t really changed.

They’re emphasizing core and core-plus because they look at it and think that it’s income-producing, generating stable cash-flow, and there’s not a lot of heavy lift in terms of creating value. “If we purchase and operate, it should perform in a measured way, and we don’t need to do a lot of improvements to make this investment thesis work.” The value-add that I’m seeing interest in is more adaptable value-add, where it could be implemented at any time during the investment hold period. It doesn’t need to be implemented on day one in order to make the deal work.

Q: Are private investors more likely to pursue value-add where they need to do the value-add from the beginning?

A: I think so, because they’re more entrepreneurial and more opportunistic by nature, and they’re more nimble. Given their cost of capital, for the most part, they’re looking more in that core-plus/value-add space than they are in the core arena.

Q: Do you anticipate that the momentum of the second half of 2020 is going to continue into 2021?

A: I think transaction volume is going to increase. There’s been so much pent-up demand for multifamily, and we started to see the wheels turn faster in the latter half of the year. We had a record-breaking December, closing $1.9 billion of investment sales activity. That’s a big month for Berkadia. I think that’s going to carry through, because now we’re seeing congruent trendlines and there’s more clarity and confidence over the past six months. The rollout of the vaccine is going to provide even more comfort and confidence that we’re getting past this and getting back to more of a normalized marketplace.

One of the themes that we’re going to hear more about in 2021 is single-family rental. People are going to gravitate more toward the suburbs and will want to live in lower-density properties, more horizontal than vertical. I also think it’s critical that we address the affordable housing crisis. This is the 800-pound gorilla in the room. The third theme for this year is hotel conversions to multifamily. As the hotel sector continues to languish and struggle as a result of the pandemic, we’re going to see more hotels converted to multifamily.

For comments, questions or concerns, please contact Paul Bubny