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Page 10 — Multifamily Properties Quarterly — February 2017
CONTACT US Michael Thomas
303.810.5170
Scott Graber
303.647.4262
Recently Completed:
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St. Louis, MO
$5,508,900 FHA 221(d)(4) New Construction 1st Mortgage
Affordable Elderly 62+ Residences
Market Rate and Affordable Elderly Age-Restricted 62+ as well as
Multifamily and Healthcare Requests are Welcomed Nationwide!
COVENANTPLACE
The 10-year Treasury rate
ascended more than 70 basis
points in the two months fol-
lowing this year’s presidential
election. The Federal Reserve
stated its intent to increase interest
rates throughout 2017.
Freddie Mac and Fannie Mae loan
programs were created by Congress
to perform an important role in the
nation’s housing finance system – to
provide liquidity, stability and afford-
ability to the mortgage market. They
provide liquidity (ready access to
funds on reasonable terms) to the
thousands of banks, savings and
loans, and mortgage companies that
make loans to finance housing. These
two loan programs have had the big-
gest jump in their interest rates, as
these two loan programs are directly
connected to these long-term met-
rics. Many multifamily investors were
once enamored by new low interest
rates. Now, many multifamily inves-
tors have become desensitized and
spoiled by interest rates under 4 per-
cent.
The days of interest rates in the
low to high teens do not seem to be
impending, by any means. However,
the chances of interest rates being
higher five years from now seems
much more feasible, given the his-
torical trends of interest rates. In the
mid-2000s, we were in an interest-
rate environment that typically cost
the investor in the mid-5 to low-6
percent range. These rates, although
historically low for the time, seem to
be the direction that the Feds want to
incrementally achieve again.
Multifamily assets have started to
and will continue to be affected by
rising interest rates. The question
that remains in
the minds of many
multifamily inves-
tors is: When and
by how much? We
have seen, espe-
cially in the newer
multifamily prod-
uct, values drop-
ping to as low as 8
to 12 percent just
in the last 90 days
alone. Investors are
considering buying
a 4.25 to 4.75 per-
cent cap rate with
debt levels above 4 percent. With the
threat of increasing interest rates,
the effect is to either retract their
plans to purchase or, at the very
least, rethink their investment strat-
egy.
Larger, more institutional capital
with “patient money” could afford
to chase smaller margin deals that
only yielded 3 percent returns. Those
returns continue to shrink and sev-
eral institutional capital firms now
are contemplating a holding pattern.
Even if the holding period becomes a
wait-and-see attitude to keep capital
on the sidelines until there is more
certainty, clarity or direction with
the new administration to achieve
some degree of positive leverage,
cap rates must, at some point, fun-
damentally retreat backward. This
could equate closer to a 5 percent
cap rate, depending on the product
and proximity to the core and trans-
portation-oriented development
areas for newer built product. To put
that into perspective, this equates to
about a 10 to 12 percent decrease in
multifamily asset value!
Recently built
apartment build-
ings are realizing
less and less rent
growth as more
competition comes
to the market.
Although demand
seems to be steady,
concessions are
occurring in many
new projects and a
month (or two) may
be the new norm.
In the future, this
translates to inves-
tors drawing back on what they were
once willing to pay for an apartment
investment property.
The different apartment building
classes will not experience these
changes in the same way. When it
comes to Class B and Class C apart-
ment buildings, the effect may not be
seen as immediately or dramatically
as the Class A apartment buildings.
One could make this conclusion
because Class B and C apartment
assets trade with higher cap rates
due.
In the current Denver multifamily
climate, older multifamily product
is trading in the low 5 percent cap
rate up to the high 7 percent range,
depending on the property’s location
and condition. For example, a B prod-
uct in the core could trade at a 5 per-
cent cap rate or even lower in some
cases. The strategy in this example is
to buy, renovate and achieve not only
rents that are more competitive than
the A product but also a higher end
yield than the A product purchases.
In terms of B and C properties, the
delta in interest rate to the cap rate
ratio allows for the increase in inter-
est rates to be absorbed without the
dramatic increase to cap rates.
Value-add types of multifam-
ily product also feel pressure. Pro-
forma rents are becoming more of
an unsure measuring tool for stress
testing the sufficient future returns
on an older renovated property. At
some point, the concessions for the
A product trickle down to the B and
C product to compete with the highly
amenitized newer construction prod-
uct.
For example, if the rent for a one-
bed, one-bath in central Denver that
was built in 1970 pushes to $1,200
and has very little amenities, such as
no parking and only a laundry room
for a perk, that property could be
competing against a one-bed, one-
bath new construction that has park-
ing, a dog wash, a lazy river and a
balcony for $1,700 with two months’
free rent, yielding the tenant a net
savings. That scenario transpires into
the Class B building lowering rent,
etc. This has happened before in our
market, and we know history repeats
itself.
To conclude, Class B and C multi-
family asset types will have a stron-
ger outlook moving forward than
the Class A product in terms of rent
growth. Developers are simply unable
to build what would rival Class B
and C product due to available and
affordable land, not to mention the
development’s hard and soft costs.
In the past, interest rates have
allowed values to continue to climb
upward at a staggering rate. This will
continue to be a main point of dis-
cussion along with how values can
be softened. s
Jason Koch
Managing director,
Greystone Unique
Apartment Group,
Denver
Ryan Floyd
Managing director,
Greystone Unique
Apartment Group,
Denver
Financial Market