All five experts on the Investing in Multifamily: Challenges, Opportunities & Moving Forward panel at 2018’s Connect Apartments hold bullish views on the multifamily market. Yet, the future is not without challenge or uncertainty.
ARA Newmark’s Curtis Palmer, who moderated the discussion, said the Costa Hawkins repeal – which qualified for California’s November ballot – is potentially the “biggest albatross over the investment horizon.” He notes, over the last 3 to 4 weeks, buyers and sellers are starting to express concern that it will tie up properties and they won’t be able to execute deals.
Essex’s John Eudy agreed that the threat of Costa Hawkins is real, even though six to eight months ago most in the industry didn’t know what it was. Now, they understand it, and have gotten educated on what means to production and investment. It is on the radar, and he says the industry must push back and then find ways to produce low-end housing.
He doesn’t see Costa Hawkins as a threat to Essex’s business, and predicts California will adjust to pre-1995, through its repeal will likely cause rampant litigation. Long term, he quietly hopes owners will panic and sell because it will create opportunities for them to buy.
TruAmerica Multifamily’s Noah Hochman notes the company has been an active buyer with 27,000 units and 94 properties totaling $5 billion in acquisitions under their belts in the last five years. He equated the market in a golf analogy: “We’re on the back nine at this point.”
The company’s focus is on the Class B workforce housing space. They focus on the middle market, which rents by necessity, not the luxury or new product type of renters. He says, the “demographics and fundamentals support our view,” of being right in the middle because those renters want safe, clean places to live close to work.
Waterton’s Peter Kuzma points out they’ve been “creative in our approach to classic value-add” via a variety of investment vehicles. They’ve diversified and been “forced to be aggressive” because of the acquisition environment and competitive landscape. Waterton looks to help developers that need to get out of a mezzanine piece of financing as it comes due.
Passco Companies’ Gary Goodman says, “We are cash-flow oriented, and focus on secondary and tertiary markets because cap rates were much better there.” He points to Passco’s investment approach in the Southeast where they “like the story in Florida,” based on immigration policies, jobs, lack of income tax, and the “demographics are solid.”
Goodman says it has steered towards suburban markets because they think the trend of following Millennials into inner cores is too oversaturated. They look for suburban multifamily assets surrounded by single family residences, since homeowners typically won’t allow any other new projects to be built, so that limits the competition. If they can find a recently-built asset, “it’s gold.” They may even consider buying a just-completed project that’s 75% leased up, and go for a pre-stabilized execution financing, which is a strategy that’s worked well for them.
In a discussion of buy versus build, Jamison Properties’ Garrett Lee says its strategy is to tap into the private investor and family office capital. The company actually likes urbanization and density plays. They do investments where “people want to live, work and play.” They look for projects where people can walk to where they want to go, which has involved properties in core areas such as Hollywood, DTLA or Koreatown. They’ve seen a resurgence in dense markets, where jobs and public transportation are, he says. But, Jamison will also look at other areas, like East Hollywood, since land prices have increased in Koreatown.
Since the recession, Essex has built 8,000 units from 2007 to 2017. Eudy says, they’d rather develop than buy, since they can do a 5 or even 4.75 cap. He indicates, development is tough right now because costs are up 10% year over year for the third straight year. But, he points out, “we’re way undersupplied and we need to find ways to bridge the gap.” Yet, since the cost is the same for a luxury and affordable product, developers must find a way to bridge that difference in order to build affordable housing.
ARA Newmark’s Palmer says population growth in California is up and projected to hit 50 million, but warned legislation can kill development and will create the exact opposite effect, by causing less housing to be built.
Eudy pointed out that it will be difficult to make up for 40 years of nimbyism. Though legislators are trying to solve the housing emergency in California by getting more extractions out of developers.
Waterton’s Kuzma predicts markets like Phoenix, Denver, Reno or Las Vegas will benefit from the regulations being forced on other states. He pointed out that “Section 8 doesn’t address the supply issue. Three million units are not going to magically appear overnight. [You] can’t legislate supply into markets,” he says.
He suggests developers and housing agencies will need to do some “big bargaining” to create supply. He noted that housing authorities are bidding on projects now because there’s such a dire housing shortage.
Lee says they are looking to solve housing issues by adding more density on site via density bonuses. Developers, for example, are allowed to build 35% more if they provide 11% affordable in a project in L.A. There’s also the transit-oriented construction incentive based program option as part of the JJJ measure in L.A., where developers receive an 80% bonus by providing 11-18% affordable. They can also explore strategies using in-lieu fees options.
When queried about rate dislocation, Passco’s Goodman says he isn’t seeing it. But, he finds it interesting that they expected cap rates and pricing to go up after interest rates went up, but they are not seeing that occur. He says that’s mainly because there’s so much capital out there. The competition is up, so they’re having to reduce leverage to 55% to get the cash flow the company likes. He noted, “year one cash flow is key for us,” as a property needs to produce yield for investment to be safe.
Kuzma pointed out that following its $1 billion allocation, the company envisioned a “kissing the ring” situation, but that turned out not to be the case due to so much capital in the market. Though he says, lately the “herd is thinning.” There used to be be 5 to 7 competitors in the best and final round, now it is just 1 or 2, he notes.
TruAmerica’s Hochman says because of the “low cost capital we have behind us,” they JV with institutional capital and global capital now. Since there’s plenty of capital available, “investing in U.S. is still attractive for global investors compared to other options. They are in search of yield and stability.”
He also notes, “multifamily is embraced now as an institutional quality asset class that’s more liquid and accepted institutionally and globally.” Coupled with the fact that investors have come to grips with lower returns “12% is better than zero,” he doesn’t see the investment-side demand “abating anytime soon.” He says, multifamily offers an attractive yield and is a safe investment, albeit with lower returns now.
Passco’s Goodman questions the value-add strategy, especially if investors are worried about a recession, they may get stuck with an asset where they run out of capital to complete improvements. He says the returns investors get on value- add plays doesn’t seem worth the risk, especially since rents are lower than class A product, making it a “very risky” strategy in this environment.
ARA Newmark’s Palmer suggested looking for value-add plays in properties built between 2003-2010, since those properties aren’t functionally obsolete, though may not have the new quality of what will be found in post-recession properties, such as amenities, finishes, etc. The value-add play is to add those to bring it up to level of post-recession assets.
Essex’s Eudy noted a strategy they are deploying now is preferred equity deals, as a way to partner with developers and grow Essex’s portfolio. That allows them to get in on development opportunities, “a seat at the table to hopefully be in a position to buy and make 10-11% on the investment.”
In a word of caution, Goodman says all the talk of recession is likely to create a drag on confidence. He points out it takes an event to create a recession, like the tech bubble or the capital markets crash in 2007, but he doesn’t “see anything on the horizon to suggest a problem” is imminent, because tenant demand and financing are on a really solid growth pattern right now.
This article was originally published on Connect Media.