Q&A with Berkadia’s Dori Nolan on Multifamily’s “Tremendous” 2021

The year that just closed saw the multifamily investment sales market firing on all cylinders, with activity coming from all investor classes. Berkadia is launching the new year with a 2022 Forecast Webinar, slated for Thursday, Jan.13. Moderated by CEO Justin Wheeler, the hour-long conversation will bring together industry experts from both within and outside the company.  

In advance of the webinar, Connect CRE spoke with one of the Berkadia panelists, Dori Nolan, SVP of client services. Here’s what she told us: 

Q: Looking back at the multifamily investment market over the past year and comparing it to 2020 and 2019, what did you see? 

A: 2021 was a tremendous year for the multifamily sector as a whole. The sector demonstrated tremendous resilience and progress this year. A lot of it had to do with economic trends and demographic trends, such as the resurgence in payrolls and household formation, roaring back and growing across the country. As a result of all the good things we’re seeing, apartment leasing reached a new high. We witnessed strong rent growth, occupancy growth and retention rates. That propped up the sector as a whole and spurred investor demand and transaction activity. 

We saw suburban and secondary markets see the most growth in renter demand and investor demand, but we’re also starting to see investors and renters return to urban primary markets. So cities, where they were pretty stagnant in 2020, really started coming back to life in 2021. We’re expecting them to see more momentum in 2022 and beyond. A lot of that is around the return to office; as more companies require their employees to come back to work, the cities will rebound too. 

The Sunbelt markets continue to lead the way in terms of performance, in rent growth, occupancy levels and retention. Markets like Dallas/Fort Worth, Phoenix, Salt Lake, Atlanta and Houston have all benefited from this inward migration, a lot of corporate relocation which has led to job growth and strengthening of multifamily as a whole in those areas. Fundamentals in urban multifamily properties are expected to reach pre-pandemic levels in 2022, and we’re already starting to see several of those markets surpass pre-pandemic performance. 

There’s a lifestyle renter out there. This lifestyle renter could definitely afford to own a single-family home, but they choose to rent to maintain a more flexible lifestyle versus own. We expect that cohort to steer a big portion of all rental demand for the foreseeable future, and that is a favorable trend for the new luxury units that are being delivered in both urban and suburban locations. 

The Millennial is starting to age out. A few years ago, they were younger and wanted that 24/7 lifestyle and were more focused on urban environments. But as they’re starting to have families and starting to think about schools, you’re seeing that while they still favor renting over owning, they’re moving to more urban edge locations or inner-ring suburban locations. They don’t want to give up the city completely, but they’re more focused on other things. 

Q: Are you seeing new factors come into the equation as analysts underwriting investment opportunities look at ROI?  

A: First and foremost, commercial real estate plays a key role in an institutional investors’ portfolio, because historically commercial real estate provides a hedge and a protection in an inflationary period, but also offers great diversification. Where we’ve seen institutional investors historically allocate anywhere from 10% to 14% of their assets under management to real estate, we’re starting to see that they’re under-allocated to real estate, so they’re not meeting those thresholds. Therefore, they’re allocating more capital to real estate to meet their benchmarks and how they’re weighted to one asset class versus another.  

So multifamily continues to show great resiliency during the pandemic and it continues to be a top choice in real estate for investors. When you look at the NCREIF property index, which has been tracking real estate performance for 30 years or so, you can see that multifamily has proven to be a safe and defensive income-producing investment and it’s been one of the top-performing investments compared to other asset classes. So, we’ve seen investors pivot and shift from, say, office and hotel into multifamily. That’s not to say that what has happened in the past is what will happen in the future, but it can demonstrate and illustrate that multifamily has been a good performer overall. 

Given where we are in the marketplace, with values at an all-time high and cap rates still relatively very low, we’re seeing that investors are reducing their investment return thresholds to compete more aggressively to fill the multifamily bucket. Despite what we’re seeing in terms of declining cap rates and rising values, it hasn’t really dampened investor demand. They have more of a long-term view of the sector, given how strong the fundamentals are and that they know it has a special place in their portfolio composition.  

Q: Are investors more interested in acquiring new, core product versus value-add or development? 

A: Investors have had steady interest in acquiring existing properties, be that core, core-plus or value-add, versus developing. If it’s core, it’s probably more stable and income-producing that doesn’t need a lot of repositioning. Or, if it’s a value-add play, it may be an older asset where they can reposition or renovate to compete more competitively in the market and create value.  

With investors that are looking at value-add opportunities, we’re seeing them take more of an adaptable approach, where that value-add program can be implemented any time during the hold period. It doesn’t necessarily need to be implemented on day one to make the investment work. It’s more of an entrepreneurial-type approach, where they feel that there’s enough market momentum, given the location of the asset, that they can do what they need to do to remain competitive and serve their clients and be a preferred asset in the marketplace. 

But we are seeing some investors starting to look at ground-up development in strong locations. Where we’re seeing that most is in markets where the pricing has become so frothy, where assets are trading at a major premium to replacement costs. But we’re still woefully undersupplied. So, the number of new apartments that we expect developers to construct over the next few years will be significantly less than half of what was started in the years prior to COVID. The average number of apartments delivered over the past 10 years has been about 271,000 units annually, where the demand has been roughly 285,000 new units. Therefore, net absorption across the country has been very strong, and we expect that as new units are delivered, they will be quickly absorbed into the market and the supply-constrained profile of our apartment markets is expected to continue. 

While you’re seeing new development, construction costs have increased, and supply chain shortages have impacted some developers’ interest in trying to determine timelines. In addition, legislation overlays have played a major role as well. You may have found a great site and are ready to put a shovel in the ground, but with the red tape to develop it sometimes takes several years to get a project started. That’s been a major challenge as well. 

Q: On the subject of development, the build-for-rent single-family market has been active. Do you see that gaining further momentum as we go into 2022?

A: Yes, very much so. A year ago, we predicted that the single-family rental, build-for-rent sector would transition from a niche asset class to a full-fledged asset type as investor interest skyrocketed. That actually came to pass. In 2021, $30 billion of debt and equity entered the single-family rental, build-for-rent space, with more commitment. So, we don’t see that slowing down anytime soon. And we’re seeing investors pivot into the space that had been having trouble filling other types of capital buckets and finding other opportunities. You’re seeing major homebuilders like Lennar and DR Horton that have made the building of single-family rentals a key component of their business models, while investors like KKR and Blackstone are allocating a lot of capital to the space as well. And then there are the REITs like Invitation Homes and American Homes 4 Rent that have been in the space since the GFC.  

So we’re seeing a lot of crossover between single-family rental, build-for-rent and multifamily developers, investors and third parties. But this makes sense, as these groups can handle the life cycle of the renter, from leasing an operating an urban apartment building to a suburban single-family rental community. 

As home prices continue to climb at a faster clip than the average median household income, these are playing a pivotal role in the preferences set by the pandemic. So the Millennial is a prime cohort to move into a single-family rental, because their demands and their needs are changing. This product is a great solution for somebody who’s looking for more bedrooms or more livable space, or a garage, or a place to work from home or even a yard. 

Q: Another watchword that we saw come into prominence during 2021 is ESG. As it relates to multifamily investment, how have you seen the ESG movement make an impact? 

A: ESG is very important, and commercial real estate investors have been progressively considering ESG when underwriting investments and operating properties. But I think the ongoing pandemic and the demands of the capital have spurred the need to make some ESG initiatives and further adoption. This is important at every stage of the property lifecycle, from development to acquisition, financing, operating and selling. 

When it comes to multifamily, many investors are classifying affordable housing to meet the criteria of an ESG investment, therefore institutional investors have been looking at investing in affordable housing and generally helping underserved communities that will generate positive long-term outcomes for residents and investors. We at Berkadia are energized about this heightened awareness and attention and doing the right thing, and by the continued impact that we think we’re going to see from investors instituting ESG measures across the country. 

Q: We’ve heard a lot about how capital that was on the sidelines in 2020 has come back into the game. Aside from the institutions, what types of investors have been active? 

A: I think every investor type was more active in acquiring apartments in 2021 than they had been before. The private investor was the main source of capital, and that group ended up comprising 65% of all apartment purchases, making it the sixth consecutive year that private investors accounted for more than 60% of all activity. They’re definitely the leaders of the pack, and following that would be the institutional investor, who remains really enamored by the asset class. 

Institutional investors made approximately 23.5% of all apartment purchases in 2021. What’s important there is that they were also net sellers, but they ended up acquiring more apartments than what they sold in 2021. So, while they were selling apartment assets and booking the returns, they were also then turning around and buying and often in the same markets.   

Another cohort that we’re following is the cross-border investor, and they were a large net purchaser of apartments in 2021. They look at U.S. real estate, and multifamily in particular, as a really sound asset-class, and want to deploy more capital accordingly.  

And then the REITs came back to life. The REITS were trading at a discount to NAV in 2020, and started coming back to life in 2021. REITs usually perform well during an inflationary period, because they’re able to raise rents and make distributions and so forth, and in 2021 they ended up buying more than they sold. So, while every investor type was pretty active in terms of who acquired in 2021, the private investor continues to lead the pack.

Click here to register for the 2022 Forecast Webinar.