Mark Thomson, HFF
How long will the scorching hot multifamily market hold up? The transactional markets continue to be bolstered by low interest rates, as well as an insatiable appetite from both private and institutional equity. I don’t believe the multifamily market will cool off in 2015.
Our HFF multifamily team in Philadelphia will soon be shattering price per unit records in both the suburbs and in Center City Philadelphia. Interestingly enough, half of our transactions will be purchased by new buyers, meaning buyers new to our market, new start-up companies, or established funds that are new to the multifamily arena. As is typically the case, attractive debt and abundant equity are fueling the fire.
With respect to multifamily debt, it has been encouraging to see some true competition back in the market. We enter 2015 with an extremely robust debt environment wherein the agencies are being forced to compete with regional banks, life companies and CMBS options.
Back in October, HFF brokered the sale of Yardley Crossing in Bucks County. This 196-unit, Class B asset, built in the early 1970s, was priced slightly below a 6 percent cap rate and roughly $170,000 per unit, but still commanded 25 tours and 15 offers. Why? Because those numbers still yield positive leverage due to the debt markets. Our buyer hired the HFF Philadelphia debt team to hit the market for them and they quickly generated 10 different options within one week. The best quote was from a regional bank, which beat Fannie’s rate by 50 basis points! That being said, banks typically max out at 75 percent leverage, so the buyer opted to go with the agency because they achieved 82 percent leverage as well as a two-year interest-only period. Sure, 50 basis points is a big spread, but for the buyer it was still much cheaper than preferred equity.
At press date, we anticipated closing a similar transaction for a property almost identical in size and asset type, called Halstead Townhomes in West Chester. The buyer does not necessarily need max leverage but opted for an agency loan because their rates have come down. In comparison to our nearly identical loan only a few months ago, this one will have a rate almost 50 basis points lower along with one additional year of interest-only payments. The cap rate is 25 basis points lower than Yardley and price per unit is 10 percent higher.
We are further encouraged about the growing competition in the multifamily debt markets when we observe some of our refinance activity.
Our HFF debt team is refinancing one of the largest assets in Delaware. A high-quality asset, low leverage and strong borrowers created the perfect environment for life insurance lenders to snatch some business from the agencies. Despite the fact that the current loan was with Fannie Mae, the seller opted to go with a 10-year loan from a life insurance lender with a 30-year amortization and interest-only payments for the full 10-year term. Another advantage of doing business with life companies is that they will rate-lock for 90 to 120 days, which will become increasingly valuable when interest rates begin to rise.
While the agencies will continue to be the lender of choice for private buyers and syndicators due to the higher leverage and interest-only periods, it is exciting to see legitimate options back to foster competition.
The amount of equity flooding the market, both private and institutional, continues to grow rapidly. While the high pricing has helped increase transactional velocity, the buying opportunities have not increased quickly enough to satisfy the demand. The result has been that equity is willing to consider new markets. This is great for core deals, meaning that prime assets in Center City are now getting the attention of buyers who typically stay in New York City, D.C., Chicago and San Francisco. It is also great for assets in secondary locations.
We recently closed two transactions in Delaware totaling 300 units called Mill Creek Village and Limestone Terrace. At 7 percent cap rates and pricing approaching $80,000 per unit, many local buyers were hesitant, however we still generated 12 offers in 30 days, many of which were from out of state and had never considered Delaware. Our buyer was a New Yorker, who owned only in North New Jersey and his capital stack was a combination of private investors, a private fund and a crowd-funding shop from San Francisco!
We still see a large percentage of transactions in our market being gobbled up by the large private companies, but even they are buying in new submarkets. We are selling a 1200-unit portfolio in Central Pennsylvania to a company from New York that owns in Delaware and Pittsburgh and thinks it made sense to fill the gap.
I believe the multifamily sales market is capable of withstanding and increasing in rates to the tune of 50 to 75 basis points without missing a beat, perhaps even a bit more. Buying Class B assets at 6 percent cap rates with financing in the mid-3 percent range yields cash-on-cash return of roughly 9 percent. That’s positive leverage! If you layer in a couple of years of interest-only payments, that 9 percent shoots into the teens. With equity getting more competitive, it is not uncommon to see preferred equity stepping down from 8 percent to 7 percent. Depending on the structure, the sponsor can take that extra 3 to 6 percent return and pay down the equity account or take some more profit.
Multifamily investments provide the best risk-adjusted return of any investment vehicle today (while also hedging against inflation). I encourage all investors to capitalize on the opportunity to explore new debt and equity relationships while the options are plentiful.
— By Mark Thomson, Senior Managing Director, HFF. This article originally appeared in the January/February 2015 issue of Northeast Real Estate Business magazine.