Obviously this was expected. 10 yr jus thit 2.7%. Likely going to see 3% soon. How are you smaller MF acquisition shops handling deal flow? Is it still growth mode? Or wait and see?Are deals on hold since sellers still think they can get 3.5 caps. Probably won't impact the pension funds or large investment houses but wondering how the smaller acquisition and development shops are managing?
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I mean, residential real estate existed before the advent of super low interest rates.
Yeah, but also consider the spread between interest rates and cap rates. 2018 had a brief moment where the spread was 200 bps, 2006 it was as low as 100 bps, and the 1980s-1990s had some crazy points where it was negative, but I think OP's point is that with the spread so low it's a harder buy, that's why he's curious what the outlook is.
Enlighten me. I'm seeing interest rates for 5-10 year product in the 300-350 over SOFR range for multifamily product. So... 3.50-4.00% all in. Cap rates in NYC, depending on product, seem to be anywhere from 4-5%. Obviously higher for crappy rent stab, whatever. I don't have any first hand knowledge of other markets, so I won't speak to those, but that means we're looking at maybe 50-100 bps of spread. Which is probably temporary, since interest rates are inherently more dynamic than cap rates, which usually take a while to adjust to a differing interest rate environment.
So... what is the problem? As rates go up, money will flow into other asset classes, and cap rates will rise. If the complaint is "how is anyone supposed to make money for the next 3-6 months" I guess that's valid, if you believe that it should be easy to make money in this industry. Because the obvious answer is "manage your buildings better than your competitors." And if the market slows for a few months and then snaps to a new normal, that's barely a blip.
I just don't understand why this is a question that needs to be asked - it seems like it's coming from someone whose been in the industry for less than 24 months. And even the most cursory reflection would indicate what the answer is.
Bro did someone sleep with your mom and kick your dog today? Why are you always shitting on people? I suggest you get some help from a professional and I can recommend some books as well.
OP is asking a legitimate question. Our recent deals in Tampa and ATL had cap rates in low to mid 3s. This is a real concern for us but also for smaller shops. Sellers are going to be holding longer and LPs involved with smaller shops are going to being asking more questions now. Smaller shops will have a harder time staying solvent if transaction volume doesn't pick up. A buddy of mine is at a small Acq shop and they're essentially praying that rent increases are significant enough to even exit with a reasonable IRR as cap rates will move up.
1) Is your 5 -10 year product some kind of swap- based fixed rate execution or floating rate? SOFR should move in lockstep with the FFR, so, on a floating execution, your 3.50% - 4.00% rate is likely widening out 100 - 150 bps this year alone. Also - I'm seeing stabilized fixed-rate quotes in the 160 - 210 over UST range from the likes of the GSEs and Life Co's - please let me know where you're finding a consistent 3.50% fixed-rate coupon on full leverage in today's market conditions that isn't a relationship driven bank essentially buying the business at a loss.
2) Are you seeing 4-5% going-in caps in NYC, or is that on a stabilized basis? I'm on the West Coast, but every acquisition I worked on in 2021 was a sub 4 cap going in and whisper prices on deals on the market today are closer to a high 2 cap going in. Per RCA, NYC Metro ranked #4 in 2021 for total deal volume @ ~$18b .Dallas & Atlanta were 1 & 2 at $25.6b & $20.9b - ask people active in those markets how many 4-5% cap deals they're seeing. Most of these hot markets (a) have pricing expectations that result in substantially negative leverage today (b) were inundated with debt fund 3+1+1 buyers that, to a degree, rely on similar cap rates & interest rates to exit & are not are not prepared to see their rate rise a full 200 bps in Y1.
3) - Title of Analyst 2 is outdated, but I'm still only ~ 5-yrs in the industry and still relatively green. I understand the sentiment of your last comment, but, as a counter point, I can't help but feel like the dismissive attitude towards the idea that there is a systematic problem w/ rising rates is coming from people who seem to have entered the industry right around 2008 & have become complacent to the magnitude of the fed's accommodative policy.
This doesn’t really account for rising SOFR which will be 2% in no time and then you have negative leverage
You sound like a dum*** and bad investor. Higher interest rates decreases yields which eventually has inverse impact on prices.
As it relates to Multifamily:
I don’t think we’ll see a pull back from investors looking to hold long-term. Floating debt will be the route as it has been more cost effective historically over fixed debt. Granted, GSE’s have also pulled back a bit and bridge lenders have took much control over the steering wheel…so optionality will be limited buying today if you’re looking to lock in 75% LTV. I do believe more investors will focus there strategies on taking a bigger piece of the LP equity capital stack on ground up development to get in at cost to bypass increased pricing due to compressed cap rates.
Can you explain why a floating rate would be the route to take moving forward in a rising interest rate climate?
Historically I agree, it has been the better option since interest rates have been dropping for a long period of time but with rates likely rising wouldn’t you want to lock in a low rate while you still can? And if you want to sell you can either have someone assume your low rate or you can pay off the loan via YM (which would decrease as rates climb)?
This is a genuine question, I’m just trying to see where my logic is off. Thanks
Floating is generally a bridge loan which gives you higher leverage. With floating debt, you usually have to buy at least a 2 year rate cap so you can limit the risk of rising interest rates by hedging with a 1% cap for example if you are truly concerned. Fixed debt whether from a lifeco or agency is going to be lower leverage IE require more equity to close. Freddie debt is already north of 4% and with DSCR constraints you could be getting quotes in the high 50% leverage range depending on in-place economics of the deal.
where did you read about floating debt outperforming fixed? In a rising environment,who is comfortable to borrow w/ floaters?
Lol that floating rate comment didn’t age well did it….
we are in an everything bubble. Cap rates will go to the 7s. Rents will go down. It will be a bloodbath. Real estate blows up at same time as equities and private equity so lp’a will be yanking funds across the board and many shops will collapse. Even capital call lines of credit will see defaults and losses as LPs renege on their commitments.
Everyone assumes they're the first person to go through a transitional economic cycle, and cries wolf.
It's happened before, it'll happen again. Good operators who have sufficient reserves and didn't take too much leverage and who operate well will survive, and have an opportunity when others go bust.
People who thought, "low interest rates and cheap equity means I can be as aggressive as I want!" will get fucked. Which is an inherent good. Bad operators should be punished. You think it's the responsible, well-capitalized firms that have pushed prices up? No, it's newcomers and shady groups who don't care about their investors or their tenants who have decided to put all their money on black and double down, assuming a continually rising market will bail them out.
I generally agree with the macro, but your micro point about rents going down, at least materially - i dont see how that can happen given the amount of equity and debt in the system, along with other inflationary pressures and a housing supply/demand imbalance in the background.
Does anyone really see a 30% drop in rents?
Not anywhere with in-migration (so the entire southwest and southeast)
College student here. Would someone mind explaining in simple terms how rising rates are problematic from a mathematical standpoint? My understanding is that if you purchased the asset at a 3% cap (essentially your unlevered yield) and rates move to 4%, then it does not even make sense to use leverage. I don’t think I’m thinking about this correctly.
You more or less answered your own question. There are other issues, but generally if you can't get good leverage to improve equity returns, you're just not going to do the deal. No deal = no money = no business.
Yes, but many many value-add investors are buying 3-cap deals with the expectation of achieving a 5-cap within a couple years through outsized rent growth and value-add renovations/process improvements.
Further, you can manufacture yield through multiple years of interest-only on your financing while you're implementing your business plan.
How big of a factor has floating rate debt been lately? Been out of this game for a few years, but I know that the 10-year, fixed-rate, I/O debt was plentiful and priced favorably for the past 5+ years. Rents are going to continue to grow in most markets, so if you have 10 years for your yield to calibrate to a potential increase in cap rates, you're going to be fine. But if you have floating rate debt, and suddenly have negative leverage on the deal you bought last year... there could be some opportunity for distress?
floating rate deals (with cap/swap) are pretty common for value add business plans. 3-1-1 type deals. The 10 year fixed rate program you mention is for stabilized deals that will provide the takeout once the value add plan is executed.
Can you please throw some light on 3-1-1 type deals? Not sure how those deals work. I am a 1st year analyst who works mostly on the equity side.
Some of the commenters who talk about underwriting conservatively by exiting at a higher cap rate than at purchase (and other methods - no rent growth, no cutting expenses, etc) I do not understand how you’re doing deals. Maybe you make a ton of offers or maybe you’re bidding on properties nobody wants. I worked in acquisitions and development. We didn’t make an acquisition for 5 years because we underwrote like a normal person - sorry, this doesn’t get deals done. Hate to say it. We were bidding against 20+ other companies who had to place money. I assume they were extremely optimistic or downright naive going into the deal, but to their luck they were bailed out by decreasing cap rates.
But oh buddy were we wrong on predicting our exit cap rates in development. We’d get historically high offers, then another company would come in and offer 20% above that. We loved that.
Depends on the deal, we grew like crazy last year, but have only done 2 deals in the last 5 months. One of those deals we did a lease up on a multifamily in Texas. New construction with 20% leased out at ~3.5% cap and while under contract leased up to 99% and the cap at close was near 5%. We could've sold the next day and made good money. You can still get lucky in deals, it's more so going for these 2.8% cap new constructions that are already 99% leased with above market rents that I don't understand how investors are getting on board with.
So y'all bought the property when it was 20% occupied at I guess a proforma stabilized assumption, and then by close it was a 5% cap rate essentially (maybe because of rent growth or either expenses were lower than projected? I could see that. I guess it's risky, but it's better than "winning" a deal simply because you outbid everyone else. Good on y'all.
Think? I guarantee they still will - possibly before stabilization/at CO too.
Beyond that, I'm selling deals built at 2020 and early 2021 prices. Good luck building anything next to me for less than a 30% hard cost increase.
Just because those deals are trading at those prices today doesn't mean they will in the future if interest rates continue to rise. I ran a few sensitives and here are my takeaways:
1) Assuming you're buying at a 4.8% cap rate / 65% leverage at 150 bps spread - the breakeven 10-Yr. T to achieve the same 10 year rate as cash-on-cash % is only 3.90%.
2) At a 10-year treasury rate of 3.90% you start failing the agencies max DSCR threshold of 1.15x (assuming 1.50% spread). You start failing the 1.25x test at 3.20%.
3) To maintain the same cash-on-cash % as buying at a 4.8% cap rate (6.70%) at 65% LTV when the 10-year is at 4.0%, the value has to drop 20% (most of the equity that goes into a deal).
4) A 150 bps increase in the 10 year (from 2.50% to 4.0%) is equivalent to a 47.9% increase in the debt service payment. In other words to maintain the same DSCR you have to grow NOI by 10.0% annually for 5 years (which translates into an even higher rent growth rate). That's a perfectly executed value-add play with no upside for the equity.
If you look historically at the 10-year it has been above 4.0% for five out of six decades. Multi-family is a commoditized product that is priced based on the spread between cash-on-cash and and an interest rate. This is the first time in a decades we're facing dual winds of massive inflation and pull-back from the fed. I have no idea how you can justify investing equity (especially at sub-4.0% cap rates) in multi-family right now. There's literally no upside if rates increase just 150 bps.
PM if you want to see the math in Excel.
To clarify, I'm not saying it is a mathematical slam dunk. I'm saying that it'll happen regardless.
Of course just because deals are trading at those prices today doesn't mean they will in the future if rates go up 150-200 bps, but that's a lot of theoreticals in one sentence and none of them impact the deals I have on the market right now which I talked about above or the OP's question of "are deals on hold." They aren't. Maybe they will be someday, but today there is plenty of hungry money out there and it is only getting hungrier, not more skeptical.
You should post a google sheet with the math.
Nothing pencils, we're likely pencils down for ~6 months. My Acq guys are pissed.
We're chugging along still at the moment across LA/SD/Denver/Dallas/SoFlo/NE/LV/PHX. The hope is these SoCal infill markets (my specific market to cover) will have owners of commercial assets with valuable land that can't afford to have no tenants or low occupancy, and get cold feet and want to sell. Hopefully there's also a slow down in development which lessens demand for materials and we can stabilize HCs a bunch. That's more of a hope of mine but I think we'll definitely see a slow down from the smaller and less vertically integrated, or less efficient, dev shops and there will be a "flight to quality" in the teams capital chooses to work with moving forward. My firm has so fricken much dry powder at both the LP/GP and Debt levels to deploy and simply not enough deals. Owners are way up in the clouds thinking their trash credit / tenant retail strip center is worth $250-300k per door in LA.. if those owners lay down the crack pipe and come back to reality, then more deals will open up for us. Only place that's penciling for podium product in LA is in SM and we are delivering 1,500 units over the next 3-5 years there. Tough to make a deal right now but we're finding a few pockets that are yielding us large projects..
Good insight. Is your insight mainly involving retail centers or other asset classes as well?
All sorts, but primarily retail with lots of unbuilt land. Offices as well but they usually utilize more FAR so existing asset value and land value are more out of wack compared to a low FAR retail play..
Seems like development is still relatively attractive compared to value add (assume this is because returns are slightly less dependent on leverage?)...
Do you look at high-rise? Or just podium and garden? I know podium costs have gotten a bit out of hand (costs look similar to type 1 in some recent deals I've seen) - pure wood frame remaining a little more affordable?
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