As co-living properties are gaining in popularity, developers should be aware of how financing differs from the traditional multifamily deals. The operational differences between traditional multifamily and co-living impact how lenders underwrite the assets, and those difference tend to fall into three categories.
First, most co-living apartments rent by the bed and offer residents a full-service experience, folding the economic value of those services into the monthly rent. Many co-living owners include furniture, internet, utilities, and cleaning in the monthly rent. While this is convenient for renters and a bargain because it is cheaper than renting a studio alone and reduces the headache of splitting costs with roommates, in aggregate, the unit rents are higher than traditional multifamily, which can be a challenge for lenders.
Second, co-living apartments carry higher expenses. In addition to increased reserves for furniture replacement and costs for cleaning, the building often will need to carry more leasing and management staff. A 100-unit co-living property may operate more like a 200-plus-unit building from a leasing perspective because leases are signed by the bed. Renting by the bed also leads many owners to provide tenant “matching” services, which entails developing and enforcing roommate policies, maintaining tenant conflict management, and potential tenant relocating if a match is not successful— all of which can require a higher level of management staffing.
Last, permanent lenders generally want to see more operating history, relative to traditional multifamily, before providing a long-term loan. Since the traditional apartment market is liquid with relatively ubiquitous data, lenders will regularly provide traditional apartment owners a long-term loan at stabilization or with only a few months of history. Conversely, on a co-living project, most permanent lenders will want to see 12 months or more of operating history. And when it comes to banks and debt funds financing co-living construction and adaptive-reuse projects, the lenders are at a minimum looking for substantial prior traditional multifamily development history in similar submarkets and a detailed explanation how their co-living project will execute and compete in the market.
Co-Living Challenges
Because pure co-living apartments are relatively new, operating and sales data can be scarce. This is a challenge for lenders and owners both in terms of benchmarking performance and establishing value. In situations where there is a lack of peer competitors, by-bed rents are typically compared with similar studio and one-bedroom apartments since this is the analysis most renters will perform. On the expense side, some lenders will benchmark costs against student housing or underwrite to a minimum expense-to-income ratio that is a few hundred basis points above typical apartment metrics.
Additionally,while co-living solves many challenges for renters from both a cost and ease of transacting perspective, it also simplifies the moving process. If a tenant does not own furniture or significant household items, and can be easily matched with roommates, a lot of the inertia of moving is removed. Therefore, owners and management companies really need to bring their “A” game to retain tenants and ensure they compete on more than price.
Lender Response
Lenders are mitigating risk by using more conservative underwriting metrics and requiring more operating history. In some cases, lenders will underwrite rents to traditional apartment levels, which results in a lower NOI. However, this method does not work well for many co-living projects, which often have large concentrations of units with four or more bedrooms that are not commonly seen in traditional multifamily. Lenders will also use cap rates that are 25 to 50 basis points higher than traditional multifamily sales when determining value.
Co-living presents new options for renters, but its financing differs significantly from traditional multifamily financing. Understanding those differences—and what lenders need to know—will help borrowers make the most of this emerging segment.
