Apartment Values and Financing
Valuations of multifamily apartments are continuing to rise. Demand for rental units has been the main driver of this, however the low interest rate environment has compressed Cap Rates too. Options for financing the development of, or investment in, an apartment property are increasing, which has also contributed to rising values.
Apartment Market Values
The multifamily apartment asset class is on a long winning streak. It has been consistently a top performer within commercial real estate. Following the financial crisis and deep recession, single-family and condominium developments came to a standstill, as buyers became more cautious and also struggled to qualify for residential mortgages. The beneficiary of this has been multifamily apartment rentals.
Primary markets within the United States are at effective full occupancy, with vacancy rates of between 3% and 5%. Year over year rental rates continue to climb as demand keeps increasing and new supply lags. Secondary markets are also experiencing similar trends.
Such supply & demand conditions have also translated into high market values for multifamily properties. Cap Rates are at historic lows and continue to fall. In the primary markets of Boston, Los Angeles, New York, Northern California, Seattle, and Washington, the average Cap Rate fell to 4.4% in Q2 of 2014, which equals the low achieved in the last cycle in 2006. For mid-rise and high-rise properties the Cap Rates came in even lower, at 3.9%. If there is any concern that valuations are getting too high, it is not being reflected in the huge demand from investors.
In the secondary and tertiary markets a similar trend is evident. Cap Rates on Garden Apartments came in below 6.5%, and for mid-rise and high-rise properties they were below 5%. Investment demand is also high in these markets due to the higher available yields. The main concern for investors is their exit, that is, will there be an equally active market of buyers when the investor decides to sell.
Apartment Financing with Life Companies
Government Sponsored Enterprises (GSEs), or as they are better known, Fannie Mae and Freddie Mac, still remain the dominant lenders within the multifamily space. Life Insurance Companies are beginning to take a greater scalp of their market share, growing to approximately 10% of the market. As greater uncertainty surrounds the future of the GSEs, Life Companies have capitalized on this uncertainty and also taken advantage of their lending flexibility to win new business.
Some of the advantages of working with a Life Company include the ability to lock your rates on application, compared to waiting for 2-3 weeks with a GSE. Life Companies will also balance sheet the loan, which means they will not sell your loan on the secondary market. This offers advantages to the borrower in being able to talk with the same team that originated and underwrote your loan should any issues arise down the line, such as releasing collateral or restructuring payments. Life Companies can also offer Construction to Permanent loans, an option not available through a GSE.
On the downside, Life Companies tend to prefer Class A properties, in prime geographic locations. They also prefer lower leveraged loans compared to the GSEs, who can go as high as 80% LTV. However their pricing is competitive to the GSEs, and can be better and more flexible. A Life Company can offer Interest Only if the leverage is low enough, which is not possible with a GSE.
Options for multifamily financing are improving and becoming more competitive. If you have a development project, or an investment property, in need of debt financing, equity co-investment, or an experienced development/operational partner, please give me a call.