The trend toward urban-infill, transit-oriented development (TOD) has informed the strategies of many multifamily developers and financiers over the past five years. And rightfully so. The TOD story is certainly a compelling one, especially given the rising Gen Y populations in many cities and the push toward walkability and sustainability, not to mention the ever-climbing price of gas.
There will always be a need for suburban, garden apartments, as well, though it’s safe to say that TOD has performed better and has a sexier image with many institutional investors. But while equity investors continue to favor urban TOD, developers are having a more difficult time finding construction debt at leverage levels that would make those deals pencil out.
Behringer Harvard’s focus has been on urban infill TOD in core locations since its beginnings, but recent trends are making the company shift gears. BH has moved its strategy away from acquisitions to new development over the past 18 months, given how far cap rates have fallen for core acquisitions. But it’s also starting to rethink the markets where it will focus its development efforts.
“When I look at the difference between cap rates in the core urban TOD product and what you’re seeing in the suburbs, I’m starting to go the other way, especially on the development side,” says Mark Alfieri, chief operating officer at Addison, Texas–based Behringer Harvard Multifamily REIT 1. “On suburban sites, you see yields in the 7 to 8 percent range. On the core infill, you’re really building to a 5, 5.25 percent, maybe, and that’s getting dangerously close to acquisition cap rates.”
Many urban TODs were the first deals to get capitalized and out of the ground during the early stages of the development cycle as financiers flocked to the core. And even given today’s rising cost of land, labor, and materials, equity providers continue to favor TODs. But finding debt financing is growing a bit more difficult in the core, a bit easier off the beaten path, says Derek Ramsey, CFO of Charleston, S.C.–based developer Greystar Real Estate Services.
“We’re in an interesting situation now, where anytime you have a suburban, higher-yielding development, you can pull out a dozen lender term sheets, and the work has to happen on the equity JV side,” says Ramsey. “And it’s reverse for the infill TOD locations—usually we have strong interest from equity but a difficult time pushing the leverage to a point where we could get the returns we need for that equity.”