Connect Apartments Transactions Series: Inside the $1-$20M Deals

By Dennis Kaiser

Transactions in the $1 million to $20 million range remain the multifamily sectors’ cashflow kings. A group of six experts at 2018’s Connect Apartments in Los Angeles discussed the requirements of today’s small-balance borrowers, how capital sources are meeting these needs, and what lenders are doing to accommodate these deals that account for one of the largest share of multifamily transaction volume.

The Transactions Series: Inside the $1-$20M Deals panel was moderated by Marcus & Millichap’s Tony Solomon, who kicked-off the discussion by asking the panelists to assess the current state of the market.

Money360’s Gary Bechtel noted that lenders are seeing the 10-year treasury compress spreads as interest rates increase. He predicted there will be “a time when they can’t compress any more. Getting the coverage is constrained LTV-wise, which will impact the loan process for borrowers,” he notes.

Walker & Dunlop’s Gabe Weinert says spreads from agency, CMBS and life paper lenders has experienced 20 to 30 BPS of compression in the last 12 months. But “underwriting has also loosened, since there’s so much capital chasing deals,” he says. Given that there’s roughly $120 billion in agency allocations that need to be placed, “it is a great time to be a borrower,” he said.

Comparing this year to last, Greystone’s Jason Gaffner, expects agency lending to hold at similar levels. Both Freddie and Fannie combined for about $36.5 billion last year. He noted one of the new twists to agency lending is the introduction of green programs, which favor environmental-friendly practices implemented by borrowers. Those incentives help make loans more affordable, in some cases it could amount to a 40 bps discount, he says.

On the construction lending front, Parkview Financial’s Paul Rahimian notes there is considerable activity with unprecedented demand. Yet, construction costs are the difference between a project making sense or not today. “It is getting harder to underwrite” construction, he says.

Walker & Dunlop’s Weinert added, that in his view, “land prices need to come down to make proformas work, sometimes by as much as 20% to 30%.” And Rahimian pointed out that since labor and material costs are not likely going to decrease, the only factor that could potentially go down is land costs.

Thorofare Capital’s Eddie Prosser noted that multifamily is likely to remain a favored asset class status given to it by the ratings agencies. Having multifamily on the books is good for bond holders, he says.

But the lending competition is stiff, too. Walker & Dunlop’s Weinert says there are 100 debt funds in the bridge space now, all underwriting to get in the market. The question he poses, is will it “come back to bite them similar to what happened to CMBS lenders the last time when the music stopped?”

Parkview’s Rahimian says interest rates are a “huge factor.” In his view, keeping the U.S. Treasury under 3% is key, because once it exceeds that point, it could spell trouble for the U.S.

A central investment strategy across the multifamily sector has been value-add plays. A trend Thorofare Capital’s Prosser is watching is how quickly deals can get done in consideration of tenant buyouts. He warns there could be some issues if local NIMBY’s delay the process by causing an issue for a land deal or organizing tenants.

Still, rents have outpaced expectations, says Walker & Dunlop’s Weinert. He notes on the last 10 deals they’ve done, rents have been 10% higher than initially thought, a trend he is seeing across the board. And Thorofare Capital’s Prosser doesn’t see that abating soon, given the rising employment numbers, which should “support rent growth,” he says.

One trend to watch is the out-migration to secondary and tertiary markets, notes Marcus & Millichap’s Solomon. He says they are seeing movement out of the coastal markets into other states. That was confirmed by Money360’s Bechtel, who says they are seeing interest in states like Texas, Nevada, North Carolina and Tennessee.

For Thorofare Capital’s Prosser, places that offer “access to mass transit, that’s a premium today and the future,” he says, since lower vehicle expenses translates into more income in pockets for rent. He indicates that’s what’s helping drive their interest in markets like Dallas, Fort Worth, New York, Chicago, Seattle and the Bay Area.

The multifamily rental sector appears to be positioned for a longer runway, notes Money360’s Bechtel. He believes that since the for-sale market has under-delivered product, there’s just not “inventory there to backfill demand. The 25- to 35-year-old resident profile has no place to go,” he says. Greystone’s Gaffner concurred, indicating there’s “no place to go and it is a place for rent to go up.”

In terms of an overall market perspective, panelists noted that given the strong market fundamentals, and economic picture, multifamily is expected to remain an in-demand product type for both tenants and investors (including international capital) for the coming 12 to 24 months. Multifamily simply represents the safest asset class for the foreseeable future,” says Parkview’s Rahimian.

For comments, questions or concerns, please contact Dennis Kaiser