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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   August 2013

What’s Ahead for the Multifamily Market

The apartment sector remains strong but not without its challenges

In the past few years, multifamily has become the darling of commercial lending and the shining star among still-struggling commercial property types. Many commercial mortgage brokers may wonder what the future holds for the apartment sector, particularly with the current challenges facing development, construction and financing.

Industry professionals share concerns over increasing costs of land and building materials as well as a shortage of specialized labor. According to a survey from the National Association of Home Builders and Wells Fargo, more than three-fourths of the builders expect building-material prices to be one of their significant problems this year; 51 percent of surveyed builders expected cost/availability of labor to be a significant problem; and nearly half of the builders expected cost/availability of developed lots to be a significant problem.

Considering that housing starts are expected to total 1.1 million units (700,000 single-family and 400,000 multifamily) this year, increasing costs also are expected to continue. In addition, as a result of a prolonged economic downturn, much of the qualified construction labor pool has moved to new career fields, leaving a labor shortage.

Because of several years of strength in the multifamily market, there are now some concerns that this property sector may be headed for tightening. Today’s astute developers work diligently to understand the demographic of potential apartment customers, one that will have many options when it comes time to write a monthly rent check. These developers strive to gain a true understanding of the wants and needs of their customers to be better prepared to compete in the coming marketplace. As commercial mortgage brokers work to finance these projects, they must understand the many factors that will affect the multifamily market in the coming months and years.

Debt markets

In the permanent-finance marketplace, it is expected that Fannie Mae and Freddie Mac will pull back, and the commercial mortgage-backed securities market will get more aggressive. In addition, insurance and portfolio funds will continue to offer speed to closing and customization for well-qualified borrowers.

Freddie Mac and Fannie Mae have been mandated to reduce this year’s lending by about 10 percent. This past March, Edward DeMarco, acting director of the Federal Housing Finance Agency, expected “that this reduction will be achieved through some combination of increased pricing, more limited product offerings and tighter overall underwriting standards.”

Considering that GSE portfolios and mortgage-backed securities hold the largest share of the total multifamily debt outstanding — $383 billion or 45 percent of the total multifamily debt outstanding as of this past first quarter — many in the industry see an opportunity to take a larger slice of the pie as private rates become more competitive against agency debt.

Development

Developers face various challenges — from finding land or existing product suitable for redevelopment to a shortage of qualified labor and increasing construction costs. As a result, 2012 new-home construction starts were at their highest level since 2008, but still 43 percent lower than normal levels. With tight new inventory, it is likely to the market will see increasing prices for the end consumer.

Not surprisingly, this past year, 31 percent of permits issued were for multifamily building construction, the highest percentage in the past 20 years. Land constraints in populated urban areas are pushing prices in many cases over manageable risk levels, however. This is causing developers to look for ways to reduce costs through new construction techniques like prefabricated-home construction, brace framing and the configuration of smaller units with more common areas for social interaction.

Consumers

The future of multifamily rests upon the analysis of three generations: baby boomers who work longer before retiring; Generation Y with its early adopters of technology; and Generation X, which is moving out of multifamily and toward homeownership. As baby boomers delay retirement, they likely will be staying in their homes longer, reducing supply for Gen Xers and increasing costs for them to move. As Gen Yers come up and out of living with their parents, they will be searching for affordable, independent living that provides social interaction opportunities.

Cutting-edge amenities will continue to differentiate multifamily developments. For example, some developers implement social programs at new buildings with rooftop gardens, high-speed Internet, multiple social areas, increased guest parking and 24/7 services. These types of features are designed to attract a new era of renters and maximize gross rents.

The growing demographic of multigenerational families presents an opportunity to create new spaces that offer shared and private areas within the unit for extended families to live together, yet apart.

Equity outlook

Because of increased competition, equity funds are finding it challenging to raise and place capital for new assets. In addition to the difficulty of procuring new assets, fund managers find themselves holding onto existing assets longer, for an average of almost six years, up from just three years in 2007.

Assets being sold tend to come in two types:

  • Class-B and Class-C properties: These properties often are sold after a partnership dissolution, when a private-equity company is the next buyer in line after an initial failed sale attempt and recapitalization of existing funds. These assets are typically Class-B or Class-C properties with a potential to add value. Often they were built in the 1970s or 1980s in areas like Atlanta, Baltimore and Tucson, Ariz.
  • Class-A properties: These properties often are 1990s-era assets in Class-A locations marked with relatively strong job growth, like Los Angeles County, Dallas and the San Francisco area.

• • •

By keeping the opportunities and challenges of the multifamily market in mind, commercial mortgage brokers can position for themselves to capitalize on the continuing potential of this sector. Still, minding the challenges ahead can offer brokers — and their clients — a more realistic view of what to expect in their deals. 

Matthew Parrish is the founder of Vesa Commercial, a Los Angeles-based debt-placement company that originates loans for business owners and investors. Previously, he worked in Bank of America’s commercial division and PWC’s audit department. Parrish received his bachelor’s degree in accounting from the College of the Holy Cross in Worcester, Mass. Reach him at m.parrish@vesacre.com.


 


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