Another year has come and gone as multi-housing investors eagerly move into 2017. The last year will be remembered globally for unexpected market shocks and uncertainty following surprising voting results at the polls in both the U.S. and the U.K. The stock market began 2016 with a 10 percent drop in the first three weeks of the year, and many speculated if commercial real estate (CRE) allocations would be scaled back due to the numerator effect: A portfolio imbalance where CRE allocations become overweight due to the asset class’s performance relative to equities and fixed income. In May, Brexit caused investors to take pause and move to the sidelines. Nevertheless, equity markets rallied through the summer of 2016 and surged again following the surprising U.S. election with the Dow reaching record highs, north of 19,000. Given this volatility, investors are taking a more cautious “wait and see” approach with respect to many deals on the market. That being said, there continues to be record amounts of capital raised and ample liquidity as we progress into 2017.
From a pricing perspective, 2016 was a year of discovery. While core and select value-add transactions were the most sought after trades, core-plus transactions continue to be in the midst of price discovery as many buyers struggle to underwrite a clear path towards rental growth. Bid-ask gaps widened, and some sellers were paralyzed, pondering whether this was a new normal or merely a temporary slump.
The outlook for 2017 has many investors eager to get back in the game, targeting selective, late-cycle or counter-cyclical markets with proven stability and a stronger possibility of outsized rental growth going forward. With a new administration and one party controlling the House, Senate and Oval Office, investors are eyeing the impacts of deregulation (e.g. Dodd-Frank) and the potential for a long-term federal budget. Increased federal spending, whether debt driven or otherwise, will bolster employment and GDP growth, which will help mitigate oversupply and lack luster rental growth concerns.
The big question on most investors’ minds centers on the rise in interest rates and the potential impact to cap rates. While the overall cost of capital cannot be ignored, especially on transactions heavily dependent on leverage, HFF’s research has found that historically cap rate movement is better explained by the availability of capital rather than the movement of interest rates. For instance, historical trends indicate that the more than four percent 10-year Treasury environment of 2007 did not slow transaction volume or cap rate compression. Additionally, the average loan to value today is significantly lower than it was in the previous cycle.
Currently, there is unprecedented liquidity in the commercial real estate sector and, as volatility around the globe continues, U.S. real estate stands to benefit from the attention of foreign capital. Furthermore, should the U.S. enter into an inflationary period, commercial real estate, and, specifically, multi-housing will continue to be the darling of the investment community.
Looking at apartment transaction volume for 2016, volume ended the year down 1.5 percent relative to 2015 driven by a decrease in entity transactions. In 2016, mid/high-rise apartment cap rates decreased 20 BPS year-over-year to a national average of 4.8 percent, while garden apartment cap rates decreased 23 BPS to 5.85 percent. This compression between asset classes illustrates the increasingly competitive landscape for higher yields, specifically suburban value-add deals. While the New York metro remains the largest market for transaction volumes, non-major markets such as Dallas, Atlanta and Denver have experienced higher velocities than the likes of San Francisco, Boston, Chicago, Los Angeles and Washington, D.C.
A wave of debt maturities will occur between 2017 and 2018, with more than $205.2 billion in loans coming due. Of the $205.2 billion of maturities, $12.7 billion, or 12 percent, of these loans are multi-family assets. Given the uncertainty within the debt market, it remains to be seen whether owners will be able to recapitalize the existing debt or be forced to sell. Investors will be keeping an eye out for these opportunities as maturities come due.
Oversupply continues to be a concern in the majority of markets, deepening the apprehension of flat rent growth. That said, absorption exceeded expectations in 2016, resulting in a national vacancy rate of 5.1 percent.
Meanwhile, the construction pipeline is beginning to dwindle as developers plan fewer 2018 deliveries. Construction costs continue to rise, which, coupled with the aforementioned flattening of rents, is creating further pressure on investors’ returns. In addition, construction lending for apartments has significantly diminished due to the perceived “bloat” of existing loans on lenders’ balance sheets and increased scrutiny by regulators. Of the banks still quoting construction loans, loan-to-cost has lowered, recourse has increased and spreads have widened. However, this “self-regulation” of the construction markets is considered a good indicator of market stability. The select projects that are capitalized in the next twelve months should experience a path to rental growth delivering into a markets with limited new supply.
In summary, 2017 prospects for multi-family transactions seem much brighter than 2016, as the overall fundamentals seem to favor rent growth. Buyers should begin underwriting rent growth, shifting their approach to become more aggressive towards new opportunities that come to the market.
Walter Coker is a managing director in the Washington, D.C. office of HFF. He is primarily responsible for originating investment sales and equity placements on multi-housing assets throughout the Washington, D.C., metro area. Since joining HFF in July 2011, he has completed more than $1 billion in equity joint ventures for nearly 7,000 units and capitalized more than $3 billion accounting for 12,500 units in total this cycle.
Prior to HFF, he was the co-head of Cushman & Wakefield Sonnenblick Goldman’s Washington, D.C. debt and equity platform, where he closed more than $6.5 billion in debt and equity placements. Prior to that, he worked in Spaulding & Slye’s Structured Finance Group and in Walker & Dunlop’s debt and equity groups.
Brian Crivella is a director in the Washington, D.C. office of HFF. He is primarily responsible for originating investment sales and equity placement transactions throughout the United States. Since joining HFF in July 2011, he has completed more than $1 billion in equity joint ventures for nearly 7,000 units and capitalized more than $3 billion accounting for 12,500 units in total this cycle.
Prior to HFF, he was the co-head of Cushman & Wakefield Sonnenblick Goldman’s Washington, D.C. debt and equity platform, where he was involved in more than $6.5 billion in debt and equity placements. Prior to that, he worked as a leasing specialist on the General Service Administration’s National Broker Contract Team at Jones Lang LaSalle.