Multifamily Deals Are Getting Harder to Pencil

“How are you navigating current market conditions,” asked Mark Renard, executive vice chairman of the capital markets group at Cushman & Wakefield, at the opening of the Transaction Talks: The Art of Multifamily Dealmaking panel at RealShare Apartments this week. For some of the panelists, the response was that the market is challenging today—and it is getting more challenging—but there are still reasons to be excited about the multifamily market, including growing demand and class-B and secondary market rent growth. Renard moderated the panel, which included Tim Hennessey, managing director at PGIM Real Estate; David Schwartz, CEO and chairman at Waterton Associates; Gary Goodman, SVP of acquisitions at Passco Companies; and Mark Deason, managing director and head of US asset management at Starwood Capital Group.

Schwartz said that looking at higher borrowing rates and higher exit cap rates based on interest rates, it is becoming more difficult to get a deal done in today’s market. While there are also a lot of positives, including rising rents in the class-B apartment space, improving rents and fundamentals in secondary markets, Schwartz said that capital is flooding into these markets, creating substantial competition. “It is challenging to put money out, and groups like us are going to do fewer deals,” he said on the panel.

Goodman and Deason agreed that there are increasing challenges in the market, but had a more positive outlook, especially on the long-term prospects for multifamily. Goodman said that downsizing baby boomers and millennials preference for rental product is converging to create unprecedented demand for multifamily product. “We are late in the cycle, but the demand is going to be huge in the next 10 years,” he said about the impact of the two demographic groups. Deason added that while there has been a shift in capital focus. Today, capital is looking for core and core-plus opportunities and moving out of the value-add space. Deason said that typically, Starwood would typically leave a little meat on the bone for the next buyer to find upside in a value play. Today, the firm is taking meat off the bone for a more stabilized capital pool.

Much of the shift away from value-add is due to the limited opportunities for value-add deals. The same is true for shovel-ready development deals, according to Hennessey. He said that it now takes six to 12 months to get a land site ready for construction. “I think the days of shovel ready deals are over, and they have been for several years,” he said. That is forcing us up the risk curve and commit to six to 12 predevelopment periods.” To fund these longer and more complicated transactions, they are forming joint venture partnerships.

In California, already difficult transactions may get more complicated if Prop 10 passes next week. The panelists predicted it would fail next week, but also agreed that this was the first of another iteration of rent control in California. This is one of the biggest uncertainties for investors in the future, and other markets—including Illinois, Oregon and Massachusetts—are looking into similar rent control measures as a way to combat growing affordability issues. “We are waiting to see, and I think there is a lot of uncertainty,” said Hennessey. “Prop 10 would make things more uncertain, and when you have uncertainty, capital retreats.” In the meantime, his firm is taking a proactive approach. It recently launched a social impact fund to focus on investment in existing affordable housing and to develop new affordable housing projects. “Our firm understands it, and understands the affordable housing problem,” he said. “We are trying to respond to what we see as an opportunity.”

Schwartz agreed that this is the path the industry should take to tackle affordability and prevent similar legislation from coming down the pipeline. “Our industry needs to be proactive,” he said. “We are also trying to figure out ways to address affordable housing.”