GSP Principal David Rifkind's report from the Apartment Leadership Roundtable last week at the AFT Apartment Conference in Fort Lauderdale, Florida:
GSEs (Fannie, Freddie, HUD) accounted for 81% of the multi family financing market in 2009 and likely to be similar in 2010. Life Companies have a total allocation for 2010 of approximately $60 billion, only a small amount of that will be for multifamily, this will make a small difference in the total capital needs of the multifamily market. Banks: not likely to meaningfully expand exposure to multifamily this year. CMBS: lots of optimism, still too early to tell. Potential problem with CMBS 2.0: no “B” piece buyers have emerged yet for regular CMBS pools.
While multifamily financing appears to be “efficient”, this efficiency is fragile. Everyone on both sides of the aisle in Washington admits that US housing policy must be radically restructured and this puts Fannie and Freddie in the spotlight. The industry has a huge amount riding on the November midterm elections. Elements that led to the GSE crisis (housing bubble, etc) point to multifamily as the solution. Multifamily accounts for a tiny amount of loss for the GSEs. Shifting policy back to supporting a supply of affordable rental housing is politically expedient. The question is how much of a hand should the GSEs have in the market. Under the current GSE structure, we have privatized the gains and socialized the losses. Some of the ideas floating around Washington involve Covered Bonds (the European model) and incentivizing banks to privatize the risk by carrying MF loans they originate on their balance sheet.
Bottom Line on Multifamily Lending:
I: Loans are being funded because of the wide credit spreads and not because the system has been fixed. Historically low treasuries make the loan coupons low enough to create good levered returns. The GSEs are “broken” but lending. The structure has to become clear before we can return to a more normal state of lending.
II: Two-Tier market. There is a big disconnect between the top tier (A and B quality, institutional product, core markets) and “all the rest”. Cap rates are compressing on Tier I in core plus markets (Recent low 5 caps in California and high 5s, low 6s in Texas for core plus). This is rational because institutional buyers are (a) Buying scarcity; (b) Getting a reasonable spread over fixed income alternatives; (c) See little threat to oversupply and some upside in potential supply imbalance as construction has been moribund for 3 years now. One market vet said that for each core plus deal that comes to market there are 40 offers and the top 15 are all-cash(!) There is GSE debt and some equity for Tier 1. Tier 2 is everything else. The cap rates on low B and C apartments are 8.5% to 10.5%.
The opportunity in Tier 2 is the risk premium that can be achieved, especially in the low B and C properties. Buy at a 10% cap with a 3.5% Treasury, the premium is 6.5% and 4% of positive leverage. This will not last for too long but is achievable now for selective buyers. Pimco’s Bill Gross may have done us all a favor by stating last week that “we are in a low yield world for a longtime to come”. Equity funds are listening and retooling their expectations. This will be necessary to make deals pencil in the low yield world aka “the new normal” (If Gross is right).
On the Bright Side: It was pointed out that there were 99,000 new multifamily starts in 2009 with a trend down in 2010. This is 90% below normal. The good news is that multifamily was not overbuilt in the cycle. This was less due to industry self discipline and more due to the product mix swinging big time to Condos mid-cycle. The supply/demand balance is moving rapidly toward under supply in many markets and this will bode well for rents in the near future. This is why we saw several 5% cap trades in core plus markets in California in the past 90 days.
Student Housing: Has held up well. Is a “green” light for campuses of at least 25,000 undergraduates . “Yellow” light for smaller student populations. Enrollments are up during the recession but the ability to pay is down. This is magnified in smaller markets. Demand will remain high in the primary markets. Example: project under construction at USC as a shining example of what can be done in the present environment.
Senior Housing: Also holding out well. National occupancy is at 88% and moving higher. Demographic trends are exactly where they should be to support further growth in rents and occupancies. Little new supply in past 3 years and very little projected in near future. Foresee a big supply/demand imbalance beginning in 2011 and lasting for some time. Good fundamentals getting better. Market specific but good properties with good operators (key element as this is a business) are a strong proposition at this point.
