Despite benefiting from steady debt financing and being universally bullish on new apartment development fundamentals, multifamily builders remain skittish over the impact of macroeconomic trends on job creation and land and constructions costs.
“We’re very bullish about those projects that are about to break ground, and we think they'll deliver well into this vacuum of supply and demand,” said Greenbelt, Md.–based Bozzuto Development president Toby Bozzuto, who spoke this week at the 2011 Multifamily Executive Conference on the panel "Dirty Deeds: The Return of Development and What the Boom Means." “I am very concerned about the future because we are not exactly sure when new job growth and household formation are coming, and there is a lot of supply from all of us on the table being put into the marketplace.”
Indeed, Bozzuto and his fellow panelists, Atlanta-based Wood Partners CFO and COO Joseph Keough and Arlington, Va.–based AvalonBay Communities executive vice president of development Steve Wilson, all reported 2011 deliveries of thousands of units in new apartment construction, with thousands more expected in 2012.
“For us, you go back 18 months and those were the first signs of positive job growth, which tend to show up at the property level about six to nine months later. You also simultaneously have 18 months where no one was building, and a third opportunity in construction costs, which, depending on market and product type, have dropped as much as 25 percent, which is pretty significant,” said Wilson. “So you have job growth, no supply, and discounted construction costs, which makes development so much more compelling.”
Multifamily developers with strong sponsorship pedigrees have been fortunate to find attractive lending terms from banks even as they begin to question the broader impact of long-term high unemployment and a spread compression between apartment acquisition and new construction. “When we began to pro forma our deals in 2010, we penciled in for 35 percent to 40 percent equity and figured the debt would follow,” Bozzuto said. “We also anticipated that there would be large personal recourse that we did not want to be associated with. What ended up is that we're getting 75-25 and 70-30 loans, and the recourse is benign compared with what it could have been. We're working with multiple banks and aren't having an issue finding financing.”
Also helpful on the debt side is product type among the panelists, which is all Class A, institutional-quality assets in the top 20 MSA, high-barrier-to-entry coastal markets, noted Keough. “Nationally, in nearly all of our markets, the supply-demand ratio continues to be fantastic,” Keough said. “Unfortunately, land prices are getting out of control, and the spread between buying and developing is closing too much. It’s not at 150 basis points or greater today in some areas.”
Compression in development spread due to asset pricing and land and construction costs might be temporarily overcome by lower yield expectations, but likely the expected surge in apartment development will pause as markets and pricing realign back to additional spreads. “Do you continue to chase cap rates down with your spread and look at building on a 6 percent return relative to a 4 cap rate?” questioned Bozzuto. “We don’t think we do, and that might curtail our activity in the next several months or so.”