Multifamily Development is as hot as it has ever been. Occupancies are up, rents are on the rise, and cap rates are close to the bottom. Even though unemployment is at 8.2% and many other economic indicators are well below average, the nationwide multifamily market has less than a 4.7% vacancy, which is about as good as it gets. Here in Texas occupancies are hovering around 94% to 95% with rental rates increasing on average of 5.7%.
DFW has averaged 13,000 new units per year since 2000, and yet there are currently only 5,500 units in the pipeline for new development. Dallas absorbed over 9,000 units in the first half of 2012, of which 2/3 of those units were absorbed in the 2nd quarter! Higher occupancy and increasing rental rates signal that it is time to once again start building apartment properties. So why are we not seeing an explosion in multifamily development deals? Several extenuating factors are affecting the latest development cycle.
Debt – The biggest reason is the banks. It is not that banks are not lending for multifamily units; indeed, banks are all actively looking for properly underwritten construction loans. In fact, under the right circumstances, higher leverage is available. MCA recently closed on a construction loan placement in Oklahoma City that exceeded 85% of project cost.
In the case of new construction, what it really comes down to is to whom the banks will lend. Our firm is actually seeing banks compete by driving down fees and pricing to get a piece of the most coveted development projects. However, you better be a coveted borrower. While liquidity is still king, your resume needs to be deep with experience. The ability to show the lender that you have “been there and done that” speaks volumes to the bank since they want borrowers with proven track records.
In the case of our recently placed $20mm+ construction loan for a 300 unit project in Oklahoma City, the developer had just completed, leased up, and sold another 300+ unit project in the same market. This sale validated the exit value of his proposed project. The developer knew his building costs inside and out, and he had newfound liquidity on his balance sheet.
Equity – A large swath of equity providers have not yet woken up from their five-year hiatus, or they are still looking for existing product with a “D” in front of it…Distressed, Depressed, or Discounted Payoff. Although the distressed acquisitions market has never really materialized as projected, there still exists a huge inventory of over-leveraged properties with maturing loans that opportunistic investors are waiting on the sidelines to devour as these properties transition to a potential distressed situation.
Simply stated, the number of equity providers that will consider a to-be-built Class A multifamily project is completely overshadowed by the available capital seeking opportunistic existing property acquisitions. The stable of equity providers who will consider a new development transaction are seeing EVERY deal and are acutely aware that their type of capital is scarce. As a result, equity capital providers are being selective with respect to sponsor quality/track record and are only pursuing projects with much better-than-average risk adjusted returns.
Product Type – The type of proposed multifamily project is also playing a huge factor in capping available supply. At MCA, we’ve seen a number of proposed new Class A “Garden Style” projects with costs ranging from $90,000 to $110,000 per unit. But, the vast majority of equity providers don’t want to invest in suburban apartments. Rather, they prefer to ride the wave of new urbanism “close in live/work/play” environments where land costs, construction costs, and overall project costs alone dictate that not all the “Regular Joe” developers will be able to get on the playing field. Most of the projects are either mid-size, high rise, or podium type projects with structured parking. In any event, unit costs are considerably higher than the garden style costs of $90k to $110k per unit.
All of the dynamics seem to be playing right into the hand of the equity capital (and construction lenders) that are enlightened enough to make the jump from existing opportunistic deals to new ground up development projects. These capital providers are trickling into the marketplace, albeit at a snail’s pace. The first wave of completed and leased properties are just now entering the sales market where product-starved, cash flow-oriented institutional investors are gobbling up these assets at record low Cap Rates. As more projects are completed, sold, and the exit strategy validated, undoubtedly more equity providers seeking higher returns will begin to evolve and enter the capital provider marketplace. For the time being, however, capital will be focused on best-in-class developers.
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