CREJ - Multifamily Properties Quarterly - May 2017
Multifamily development continues to surge across the Front Range, with a large amount of it being Class A. This trend stands, despite the sustained – and widening – gap in affordable product available, while the demand for Class B and C housing holds fast. A number of variables within the multifamily market, at the state and national levels, continue to be in flux. To gain some insights into current trends, as well as top opportunities and obstacles in this space, Jerry Green, with NCS Colorado, spoke with Ralph Lowen of Walker & Dunlop. • Green. What do you see as some of the largest overall trends and opportunities within Colorado’s multifamily space? • Lowen. We see investors gravitating toward value-add deals and away from new Class A development. The market sure feels saturated at the top and returns are getting thin. There is opportunity in the affordable and moderately priced part of the market where demand is high and supply is tight. The trouble has been in making the numbers work at today’s construction costs, which have doubled over the last 10 years. Construction costs were a major catalyst for the recent boom in Class A development. Developers couldn’t build at the higher costs without higher rents, so they all built Class A. Investors seem to like value-add deals because they can tap into pent-up renter demand and find attractive yield without biting off too much costly construction. • Green. What impact has the presidential election had on the real estate market? • Lowen. We saw an immediate impact on federal low-income housing tax credits. The new administration has tax reform on the agenda and this turned the tax credit world upside down. If the corporate tax rate goes down, so will investor returns on tax credits. If investors are not willing to pay as much for tax credits, there will be less equity available for new affordable housing projects. We are seeing huge equity gaps in affordable deals that were thin even before the election. Many of these deals are being abandoned. This is a tragic consequence that will slow new affordable development. The most frustrating part is that we don’t even know if tax reform will be successful or where the ultimate tax rate will fall. But the uncertainty is too great and investors are pricing accordingly. The good news, despite these challenges, is that there are still some affordable deals moving forward. They tend to be the stronger deals with various layers of subsidy. This makes the lender’s job more important too as borrowers need debt with higher leverage and flexibility to offset reduced tax credit equity. Freddie Mac, Fannie Mae and the U.S. Department of Housing and Urban Development will play a significant role in the near term for affordable deals. • Green. As the Denver area and Colorado region continues to experience explosive and consistent growth, what specific challenges are you seeing? • Lowen. My clients are having a difficult time finding deals and many are temporarily on the sidelines. They just can’t get a reasonable return at these lofty valuations. In the past, investors came to Denver to find value off the beaten path. Now Denver is very much on the national scene and local investors are going elsewhere because pricing and competition remains elevated. The trouble is that so many multifamily markets around the country are experiencing the same thing, so it is driving investors into even smaller markets to find yield. • Green. At a broad level, what trends in financing are arising in response to these changes across the state? • Lowen. Big picture – it is a great time to borrow from nonbank lenders. With banks still highly regulated and skittish about over building in Class A projects, nonbank lenders are open for business. Truly, it’s never been a better time to borrow Fannie Mae and Freddie Mac debt; they have available capital at aggressive terms. They’ve also rolled out various green programs that are driving much more bang for the buck, helping borrowers make their pricing more aggressive and lowering interest rates. Right now, nearly all of our borrowers are taking advantage of the green programs available through Fannie Mae and Freddie Mac. The HUD business also is strong right now and it is a good time to be a HUD borrower. Although not the best fit for every deal, when the market, deal and borrower all align, HUD financing can bring the most aggressive terms available – 85 percent loan to value, 35- and 40-year amortizations and available construction debt. Here I would definitely say, where the bank door is largely closed in this area, HUD has available construction debt for developers. • Green. That’s interesting about the increased prevalence of green programs by nonbank lenders, what other products are on the rise? • Lowen. Borrowers are looking for loan products that cater to value-add deals and prestabilization financing. There is a ton of new apartment supply and it will all need permanent financing. The prospect for rising rates makes the need even greater to exit variable rate construction debt. Some great options exist right now for newly built projects seeking permanent financing. Whether they are stabilized or prestabilized, we are getting these deals done with amazing terms. Other products, such as moderate rehab programs, have emerged recently in response to this investor shift to value add from Class A. Fannie Mae and Freddie Mac have acquisition/rehab programs that allow for greater flexibility during renovation. • Green. If you had to characterize the themes and trends across the multifamily space in a few sentences, what would you say? • Lowen. We will continue to see the delivery of high-end Class A units through 2018-2019. I do think we’ve hit the inflection point for high end so we will likely start to see this tapering off and lots of projects with construction debt in need of permanent debt. This will provide additional opportunity for nonbank lenders, who are not highly regulated and have greater autonomy, to handle these deals and get the construction debt off the bankbooks and into permanent financing. Lenders with experience in prestabilized and recently stabilized financing will continue to play a large role as this unfolds. In my opinion, more critical and creative thinking, as well as a scrappier attitude, will be the names of the game in the multifamily market here in Colorado and across the country going forward.