Higher interest rates and economic uncertainty continue to slow multifamily transactions.
“The speed and scale of the Fed rate hikes is unprecedented, which has created such volatility. We’re not going to see transactions occurring until we have a consistent cost of capital,” said Mona Carlton, senior managing director, capital markets, at JLL, during the Multifamily Executive Conference at the end of September. “In April and May, the 10-year Treasury stabilized in the 3.5% range, and transactional activity went up 32%. The LPs that we speak to on a daily basis, until there is clarity on the cost of the capital, I don’t think they’re going to jump back in.”
Interest rates are definitely causing a disruption for multifamily borrowers, said Ricardo Rivas, principal and CEO of Allied Orion Group. “What we call the triple play, we have taxes, insurance, and interest rates—those are the three things affecting most operators. The only way to turn this back around will be with rents increasing, which affects affordable housing.”
Rivas said with taxes this year, in particular, when the collectors are assessing properties using the prior year values, it will be a matter of protesting and getting adjustments for next year, creating a cash problem in the meantime.
Allied Orion Group sold everything two years ago and is rebuilding its pipeline.
“We are building two projects of 11; the other nine are on hold because we’re trying to get some financing. We are trying to pencil the deals. We own the dirt, we have the capital committed; however, we can’t find the debt currently,” he said.
According to Rivas, in order to end the disruption and go back to deals penciling out, rents are going to have to go up; taxes are going to have to go down; insurance needs to either stabilize or go down again to the levels seen before; and the Fed needs to stop hikes and lower rates.
While transaction volume is down, the speakers on the State of the Capital Markets panel said opportunities do exist to get deals done.
Stephanie Wiggins, head of production, agency lending, at PGIM, said people will transact at a higher level, especially those borrowers that must do something, if you have a loan maturity or an interest rate cap renewal.
“What we’re seeing instead of looking at traditional terms and executions, they are looking at buying down five-year money and paying up for flexible prepayment. In their minds right now, better times are coming. Stay alive to 2025, and so they are just buying themselves some flexibility,” she said.
Carlton added that life companies are providing a five-year fixed-rate loan with the flexible prepayment on the back end. “People think in 2025, 2026, 2027 that things will stabilize, and they want to be able to get out of those loans and sell them. So life companies are a good source,” she said.
While production volume is down for government-sponsored enterprises Fannie Mae and Freddie Mac this year, Carlton said the mission-focused agencies will lean in if you have a mission deal.
She added that debt funds have made a comeback, saying, “There’s ample capital anxious to deploy, but it’s expensive.”
Carlton noted that people think banks aren’t lending, but that’s not the case as well.
“We do a lot of production volume, and 30% of it year to date is with banks. It paused 12 to 18 months ago, but local and regional banks have stepped in,” she said. “They are lending, but it’s very relationship-based, and they want all of your business. It’s there, you just have to wait for it.”
According to the speakers, there is not as much liquidity in construction lending.
“As a non-bank lender, we are doing construction loans in the current market that are expensive. They are 9% to 10%, very selective, but they are nonrecourse, which justifies some of the cost. At a 9% to 10% rate today, it’s hard to make the construction numbers work,” said Vic Clark, senior managing director at Lument. “If you can find a construction loan and you can get a deal going in the current market, by the time you bring it to market, let’s say two years, it will probably be one of the best times to bring new units to the market. After this year, there will be very minimal new construction deals coming on the market.”
Wiggins and Clark both noted that the Department of Housing and Urban Development’s Federal Housing Administration Section 221(d)(4) program is the best construction loan you can get, if you’re willing to be patient and go through the pain of a lengthy process.
“On a HUD deal, it’s 60 to 70 basis points (bps) lower than the agencies and another 25-bp discount if it’s green,” Clark said. “With HUD, never give up.”
Distressed Asset Opportunities
The panelists agreed that they haven’t seen a lot of distressed deals for now but are anticipating them.
“We really haven’t seen it, but what is definitely coming is significant defaults that are probably six to 12 months away. There was a period at the end of 2020 and all the way through 2021 where all of us lenders put out a lot of aggressive floating-rate money,” said Clark.
Carlton added that over the last few weeks of September that she has started to see some scale on the distressed properties. “I think it’s the tip of the iceberg. They are good assets with loans that are highly leveraged and were made when SOFR was 5 basis points instead of 500 basis points,” she said. “Borrowers don’t know what to do with these properties.”
She cautioned the audience, “If you think you’re going to have an issue, speak to your lender earlier rather than later.”
Rivas added that his firm is ready to take advantage of distressed opportunities. “We know how buyers borrowed, and we know that they are coming to maturity and they have an issue because the math is the math,” he said. “We are raising the capital. We have the dry powder. We are waiting to see when and if that will happen. We haven’t seen it just yet.”
While the short-term outlook isn’t rosy, the lenders remained relatively optimistic.
“The thing that gives me some comfort is that we have smart people in this business and who have been in this business a long time,” Wiggins noted. “We have seen the cycles. We will get through this.”
Clark said he’s grateful to be in the multifamily business. “There’s always capital for multifamily; it may not be perfect, but it just keeps rolling and providing opportunities. People have to live somewhere. There are still good things happening,” he said. "I think we have another year of pain, but we’ll all get through it. Batten the hatches, and then we’ll be in store for good times again.”
Carlton concluded: “Our space has so much liquidity. We have a lot of capital available. Multifamily is always going to be a good stable property type to invest in.”