CREJ - page 10

Page 10
— Multifamily Properties Quarterly — August 2016
I
f you are anywhere
near the real estate
industry, you probably
hear your colleagues
talking baseball with
increasing frequency – every-
one now seems to have an
opinion about what inning
of the cycle we are in. What
the national-pastime-loving
prognosticators are implic-
itly suggesting is that we
are watching a ballgame we
have seen before. Whatever
your view on the timing of
the end of the cycle, one has
to acknowledge that some-
thing is very different this
time around.
It is becoming signifi-
cantly harder to get projects
financed despite the signs
one might typically observe
in the late innings. And the
current state of the lending
market has
significant
potential
implica-
tions for
new supply
fundamen-
tals. The
silver lining
may be that
fewer deliv-
eries have
a positive,
corrective
impact on
the market
and reduce the severity of
the next downturn, if and
when one does occur.
The recent deterioration
of the construction financing
market is profound, espe-
cially given the context of
the continued resiliency in
fundamentals. Loans to cost
have declined, covenants are
more restrictive, guarantee
requirements are more oner-
ous, and some lenders are
even reluctant to lend on
any project located in a sub-
market with a large volume
of planned supply deliver-
ies. This current tightening
in standards is occurring
despite low and declining
commercial delinquency
rates. For a historical comp,
in the last cycle the growth
in nationwide commercial
mortgage-backed securi-
ties issuance did not reverse
until late 2007, well after the
first increase in delinquency
rates in mid-2006.
Explanations persist for
the current state of lending
markets. Maybe the market
is more prescient than past
cycles. Maybe the pain of the
Great Recession was signifi-
cant enough to temper the
hubris that typically increas-
es right until the bitter end
and bring out the bears. And
maybe memories of lenders’
efforts to clear real estate-
owned off their books are so
fresh that they are less bold
than a market showing the
kind of strength that Denver
truly warrants.
In the Denver apartment
market, Class A rents have
increased 10 percent year-
over-year and vacancy con-
tinues its downward trend.
Absorption has been increas-
ing and now is around 8,000
units annually. Expected
future supply is significant
with approximately 23,000
units under construction,
which will take 18 to 24
months to deliver.
Granted, it is not ideal to
have deliveries of several
thousand units in excess of
a very robust current rate
of absorption. However,
with approximately 187,000
apartment units in Den-
ver as a whole, it is hardly
insurmountable. While the
pipeline in planning stages is
similarly robust, these proj-
ects are or will be seeking
financing in a significantly
tighter lending market.
To be clear, certain areas
like downtown will see
significant new supply,
especially relative to exist-
ing stock. Some softening
is inevitable and its vital-
ity will rely on continued
strong absorption. However,
with its 24/7 live-work-play
attributes and trends favor-
ing city living, downtown
should continue to emerge
as a highly desirable sub-
market. In the meantime, we
believe projects in locations
and submarkets that benefit
from supply constraints and
irreplaceable qualities are
the best places to focus our
efforts.
One would also hope
some of this sobering up
causes the dramatic rise in
construction costs to pla-
teau or reverse. Maybe this
is wishful thinking, but what
looks inevitable is a new
equilibrium between con-
Brian Cason
Chief investment
officer, BMC
Investments,
Denver
Lending
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