SAN DIEGO — While agency volume may decrease slightly in 2019 due to tougher energy conservation standards in green lending programs offered by Fannie Mae and Freddie Mac, the multifamily debt market overall is expected to grow this year, according to a veteran mortgage banker.
Jeff Burns, managing director at Walker & Dunlop’s Walnut Creek, Calif., office, spoke to REBusinessOnline at the MBA 2019 Commercial Real Estate Finance/Multifamily Housing Convention & Expo. The event, held at the Manchester Grand Hyatt San Diego, took place Feb. 10-13.
Although the 10-year Treasury yield is down about 50 basis points since reaching 3.2 percent in early November, most economists expect long-term rates to rise in 2019. (Investor worries over trade conflicts, a volatile equities market and falling oil prices led to a precipitous drop in the yield on the benchmark Treasury note.)
Burns, who is responsible for new loan origination in California and the western United States, discussed trends in agency lending as well as the state of the multifamily market. What follows are his edited responses:
Rebusinessonline.com: What trends are you seeing in agency financing for the multifamily sector in the western region?
Jeff Burns: Fannie Mae and Freddie Mac continue to play a very significant role in the multifamily finance market. In 2018, agencies represented about 46 to 47 percent of the total multifamily debt origination market, which was just over $300 billion nationally. We see them play major roles in both the acquisition and refinancing of multifamily properties. They’re especially big players in the middle-market space — meaning deals for mid-2000s vintage product to 1970s vintage and everything in between. We’ve also seen explosive growth in Fannie and Freddie’s green programs over the last few years, which have allowed them to lend significantly above their lending caps established by FHFA (Federal Housing Finance Agency). That’s been an important driver in terms of providing consistent liquidity to owners.
Out west, the trends have been fiercely competitive. There’s a lot of capital in the multifamily space on both the debt and equity sides. We’ve seen steady low, long-term fixed rates, and that should continue in the near future. Our multifamily finance market should grow again in 2019.
REBO: There’s always some hot money flooding into real estate, and it frequently shifts direction. Where exactly is the hot money that is flowing into the multifamily sector today coming from?
JB: That’s a great question, but one that has different answers from different lending sources. There’s a lot of private equity money that has come into real estate looking for yield. That’s the bottom line no matter where that equity money is coming from. It’s all searching for the same thing — yield — which is hard to find this late in the cycle. That money comes from everywhere. We’ve seen everything from pension fund and endowment money to foreign money to private equity.
The returns and pricing that these capital sources want can range from 250 basis points over LIBOR to 700 basis points over the 30-day LIBOR (which currently sits just below 2.5 percent), depending on the risk parameters of the deal. It’s hard to peg one number, but all of this money is chasing some level of yield contingent on its risk appetite.
REBO: The 10-year Treasury yield closed at 2.63 percent on Friday, Feb. 8, down from 3.23 percent in November. Many borrowers were encouraged to lock in rates in November, only to see them fall now. Is this precipitous drop in rates sustainable, and what advice to you have for borrowers with regard to this volatility?
JB: It’s been challenging to ride that roller coaster with our clients. When it comes to locking in a rate, we advise our clients to remember that we are real estate lenders and investors, not bond traders. If a deal worked at a 3.2 percent Treasury yield, and you felt good about it, try not to look backwards too much because often it happens the other way around.
Today, we’re working with our clients to identify loans that are coming out of yield maintenance a year or two years from now. These are loans for properties that have seen significant rent growth and which are oftentimes out of the interest-only period or have already had a supplemental loan done. These are loans that have incurred prepayment penalties and have trapped equity, so it makes sense to undertake some prepayment penalties and reset with the Treasury yield where it is now. We’ve also seen spreads tighten since the beginning of the year, which we see most years when new capital gets allocated to agency markets.
So, it’s a good time to be a borrower. Treasuries feel artificially low to me when you consider GDP growth and job growth. But as everybody knows, we’re living in a more volatile political age, which is driving movement in Treasury markets to a greater degree. So, all bets are off. With another government shutdown, we could see 10-year rates as low as 2.25 percent.
REBO: With 10-year rates this low, do clients feel like they could or should do more floating-rate deals?
JB: We definitely have those conversations with clients. But right now, we’re only recommending floating-rate loans if clients have short-term game plans to increase a property’s net operating income (NOI) and don’t want to trap themselves in long-term, fixed-rate loans, or if there’s some other piece of the business plan that has them exiting in two to four years. Beyond those scenarios, everybody is doing fixed-rate financing. If you’re doing a floating-rate deal at 200 basis points over LIBOR, you’re basically at the same price point as doing a 10-year fixed-rate deal, and you can lock in and sleep better at night. So, we’re seeing our mix of fixed-rate deals outpace that of floating-rate deals in early 2019.
REBO: According to Reis, the national apartment vacancy rate closed 2018 at 4.8 percent, up from 4.6 percent in 2017, but still historically low. Demand has grown, but supply has kept up for the most part. How bullish are you on the apartment market in terms of macro-level supply and demand?
JB: From a macro level, we’re still very undersupplied. However, the macro data doesn’t capture the misalignment between the type of supply that’s being delivered and what’s actually needed. There are huge supply crunches in many areas of the middle-market workforce housing space. In the western U.S., this is particularly evident in gateway markets like Denver, Portland, Seattle, the Bay Area and parts of Southern California. The new supply is concentrated in those areas, and in order for these developments to make sense financially, rent levels have to be higher.
The challenge is that all that new supply is chasing the top of the market. The real supply needed in those markets is for the middle market — properties that can house teachers, firefighters, policemen, etc. This is the housing stock that’s needed the most, but it’s very hard for developers to build at those rent levels. There’s a real disconnect between the broad need for more supply andwhere the supply is coming out — and the price point at which it’s coming out. There’s too much high-end product chasing too few high-end renters. When it comes to deals that are in lease-up in some of these gateway markets, we’re seeing concessions being offered that never quite burn off, as well as softening rents in Class A product. That’s something to keep an eye on in 2019, which is a peak year for new supply deliveries.
Between land prices, construction materials cost — steel, lumber, labor — as well as increasing regulatory costs to develop in certain markets, you have to have rents at $3.50 to $4 per square foot. There’s only so many renters that can afford that.
REBO: We know there’s tremendous need for workforce housing. Is that product type less attractive to developers because it’s harder to make the numbers pencil out?
JB: The challenge lies in finding markets where you can build at price points that allow you to command rents that cover. But in places where you can do that, workforce housing product isn’t needed, and that’s the great challenge. We need those projects in the East Bay, in San Jose, near downtown Los Angeles, and unfortunately those are the areas where it takes rents of $4 per square foot or more to make the project work.How do you bring cost structures to the markets that need it the most? That’s the great challenge that market participants and policymakers need to address.
— Matt Valley, Taylor Williams