CREJ - Multifamily Properties Quarterly - August 2017
Halfway through 2017 and it is business as usual in Denver’s multifamily market. On the heels of a record 2016 with sales volume eclipsing $6.6 billion, the multifamily investment sales market is chugging along at a steady pace. Since the beginning of 2015, quarterly multifamily sales volume in the metro Denver region averaged approximately $1.15 billion, while the first two quarters of 2017 averaged $935 million (50 units and greater). The slow start to the year was not limited to multifamily, as the capital markets slowly settled into a new normal after the presidential election in late 2016. The spike in treasuries sent quoted interest rates on long-term debt skyrocketing as lenders held spreads, uncertain how the dust would settle in the new year. By mid-February, at the annual Mortgage Bankers Association conference, the dust had settled as buyers and lenders alike accepted the new environment and got back to business. Spreads adjusted downward as the treasuries stabilized, and the market geared up for another year of healthy activity. For perspective, the post-election 10-year Treasury has fluctuated between 2.14 to 2.62 percent compared to 2016 (pre-election) when the index bounced between 1.4 and 2.25 percent. Fast forward to August and although the Denver market is on a slower (but probably more realistic) pace than 2016, there is still plenty of liquidity in the market for multifamily debt. Freddie Mac’s new business volume trend showed that, despite the slow start to the year, loan origination was only off 1 percent through the second quarter when compared to the same period in 2016. Denver metro multifamily remains a preferred asset class for lenders and investors as the economy booms and people continue to move here in search of opportunities in employment and in lifestyle. Though the state legislature has taken steps toward reforming construction defect laws, new condominium activity has been almost nonexistent. The single-family home sector is increasingly competitive and a scarcity of new product has benefitted the apartment market. Lenders from all food groups have deployed billions of dollars for new construction, rehabilitation projects and long-term, fixed-rate debt for stabilized properties over the last few years. Construction financing faces the strongest headwind at this point in the cycle, primarily due to tightening regulations in the banking space coupled with lender exposure limits tied to the dramatic amount of new supply. The seven-county metro area has welcomed over 31,000 units since the beginning of 2014 with an additional 21,700 units under construction and an additional 18,700 units on the drawing board. While the increased supply seems to be absorbing steadily, lenders have expressed concerns about increasing concessions and flattening rent growth, particularly in the urban core. Obtaining construction financing is as challenging as developers have experienced during this cycle with lenders ratcheting down on leverage, introducing higher levels of recourse beyond traditional completion guarantees, and some pulling out of new construction altogether. Those developers successfully obtaining construction financing have experienced higher costs of capital with Libor, the universal index for floating-rate debt, creeping higher and higher each time the Federal Reserve has raised interest rates. At the time this article was written, the UK Financial Conduct Authority announced that Libor will be eliminated by the end of 2021. That, however, is a topic deserving of its own article. The government-sponsored entities, Freddie Mac and Fannie Mae, remain bullish on the Denver multifamily market and continue to remain the most popular options for multifamily debt. In 2016, Freddie Mac, with $56.8 billion in loan originations, narrowly outpaced Fannie Mae at $55.3 billion, both of which were new records for each entity. The GSEs or “agencies” are attractive for borrowers, offering high-leverage, fixed- and floating-rate options, typically with an interest-only component. Although prepayment penalties typically include yield maintenance or defeasance, the ability to add supplemental loans enhances the assumption process by giving buyers the ability to push leverage. Life insurance companies have adjusted spreads to solve to preelection interest rates with 10-year money as low as 3.5 percent for low-leverage multifamily. The ability of life companies to provide long-term money, up to 40 years in some cases, makes them an attractive option for long-term legacy assets. The commercial mortgage-backed securities space has seen demand come and go for multifamily. These lenders capitalized in 2015 when the agencies hit the brakes around second quarter after outpacing their allocation targets early in the year. Multifamily loans now are few and far between in the CMBS space with the agencies competing fiercely for new business. The number of bridge lenders has exploded over the last few years with several equity funds shifting their focus to providing senior debt to satisfy investor return requirements. Short-term bridge capital provides a compelling option for value-add investors with flexible terms, high leverage and generous interest-only periods. There is reason for optimism in the Denver multifamily market. Despite the continued noise around overbuilding, slow absorption and flattening rent growth, the market fundamentals relative to population growth and the local economy are as strong as ever. Denver is a top performer in wage growth (3 percent per year since 2010), educational attainment rate (top 10 in the country) and statewide unemployment (2.3 percent, tied for the lowest in the nation). A recent CBRE white paper on the topic of multifamily affordability showed that Denver is still relatively affordable compared to coastal markets. The average rent-to-income ratio in Denver is approximately 23.2 percent, compared to markets like New York at 56.2 percent and the San Francisco at 40.9 percent. Even without wild rent growth projections, investors in Denver’s multifamily market will enjoy a long runway thanks to abundant debt capital available with interest rates still at an attractive spread to cap rates.