From a capital markets and investment perspective, last year was one for the history books for the apartment market. Apartment transactions rose to an all-time record of $150 billion in 2015, according to Real Capital Analytics, toppling the previous year’s record. Total units sold surpassed 1.2 million for the first time ever. And the average price of new apartment homes set yet another new record, at $136,130, while cap rates correspondingly fell to all-time lows.
Given these historic highs, the collective outlook for 2016 from the outset has been more measured despite confidence that apartment demand fundamentals will remain quite positive. Back in January at the NMHC Annual Meeting, most investors expected to be busy closing deals during the first half of 2016, as they worked through some spillover from late 2015 and agency lenders had a lot of headroom under their lending caps. But the view into the second half of the year is a little less clear.
Part of what’s driving a conservative outlook is the economy’s painfully slow climb back from the Great Recession. Now in its 82nd month, the expansion has far eclipsed the average length (58.4 months) of expansion following a downturn. The limp-along economy, together with uncertainty over interest rates and turmoil in certain global markets, is leaving industry executives without a sense of whether this is the new normal or whether we should be bracing for the next market swing.
But multifamily’s swift run out of the gate, along with a substantial amount of capital still circling the sector, suggests that deal flow might be more robust than some anticipate.
Multifamily Lending Off to a Strong Start
As predicted, Fannie Mae and Freddie Mac both had a good first quarter this year. Not just good—huge. And that’s perhaps what’s been most surprising. In 1Q 2016, Fannie did $12.6 billion in multifamily lending, putting it 21% ahead of a year ago. And Freddie Mac completed $17.5 billion, putting it a whopping 75% ahead of where it was in 1Q 2015. This puts agency lending already roughly $10 billion ahead of last year’s pace. And brokers confirm that transaction activity is hot.
But what’s happening on the agency side stands in stark contrast to what’s happening in the commercial mortgage-backed securities (CMBS) market, which is drying up at a distressing pace.
Whereas CMBS accounts for 36% of lending in the retail space and 40% for hotels, it now has just a 7% share of multifamily lending, according to some recent estimates—and it could shrink further. Some recent CMBS volume projections for 2016 are as low as $40 billion, which is significantly below the $125 billion that some were forecasting for 2016 at the beginning of the year.
Some Pull-Back in Construction Lending
Construction lending is yet another story. The apartment industry enjoyed a nice pickup in construction activity in 2015. The industry delivered 310,300 units, putting production square in the range of the 300,000 to 400,000 new units the industry needs to build every year to keep pace with demand. And the construction pipeline looks solid into 2017. With a strong pipeline of apartments under construction, deliveries in 2016 are expected to exceed 2015’s levels.
However, in the wake of this new and forecasted wave of deliveries, many banks are pulling back on their construction lending even though absorption so far has kept pace with new supply. Adding to the banks’ cautious approach is a December letter from three federal banking regulators expressing concern over construction lending activity and new capital requirements that have led many banks to tap the brakes.
According to the most recent results of the NMHC Quarterly Survey, the Debt Financing Index stands at exactly 50, representing mostly unchanged conditions in the debt market. However, two-thirds of respondents indicated lower bank construction financing availability, with 40% reporting slightly lower availability and 26% reporting significantly lower availability. Moreover, for construction loans for which they had gotten recent quotes, 60% of respondents reported receiving slightly less-favorable terms than six months ago, while an additional 12% reported significantly less-favorable terms.
A Lot of Investment Capital on the Sidelines
On the equity side of the equation, the market remains liquid, as investors continue to be attracted to the apartment market’s fundamentals. However, they’re being more selective. Rather than looking to just have a toehold in the sector or a specific geographic area, investors are zeroing in on their targets, getting deep into the details of the individual assets and how they perform relative to other options in the market.
And given the new supply coming on line, moderating rent growth and the hefty price tags attached to multifamily assets, many investors are seeing more yield opportunity in the value-add space. This more-disciplined approach is also reflective of the uncertainty in markets abroad. Following some positive changes to the Foreign Investment in Real Property Tax Act (FIRPTA), more foreign investors have entered the mix.
In fact, last year, foreign investors accounted for roughly $70 billion in commercial real estate (CRE) investment in the U.S., or nearly 20% of all CRE investments, according to an analysis by HFF. This compares with a historical average of between 8% and 10%. This surge in foreign capital investment makes multifamily more susceptible to the fluctuations in global markets like Europe and China.
The flip side to this more-conservative investment trend is that there’s an estimated $139 billion in so-called dry powder waiting to be deployed. Once investors feel they have a little more clarity as to which way the markets are moving domestically and globally, there’s likely to be a lot more transaction activity.
So, by most measures, the outlook is pretty positive—even when compared with the monster year for transactions that was 2015. This is noteworthy because a number of massive deals—Blackstone’s $5.3 billion purchase of Peter Cooper Village/Stuyvesant Town in New York City, Lone Star Funds’ purchase of Home Properties for $7.2 billion, Clarion’s buyout of Gables Residential, and Brookfield Asset Management’s buyout of Associated Estates—contributed to an overall volume boost last year. So, while we might not see as many mega-deals this year, there’s likely to be a healthy level of activity.