Development Equity

Based on the most helpful WSO content, the development equity market is indeed challenging right now. Many contributors have noted that equity for development deals is scarce, and capitalization is tough to achieve. Here are some key insights:

1. Untrended Yield on Cost (UYOC) and Spread:

   • Multifamily (MF) development deals are seeing UYOC in the range of 6.2% to 6.9% (trended), depending on the market. For example:
     • Denver: 5.8% (untrended) to 6.9% (trended).
     • Phoenix: 6.4% (untrended) to 7.1% (trended).
   • Exit cap rates are generally 200bps over market caps, aligning with your observation of needing spreads above 7% for deals to pencil.

2. Market Sentiment:

   • Developers are facing significant hurdles due to rising construction costs, higher interest rates, and conservative lending practices. Many are reporting 60%-65% LTC (Loan-to-Cost) on deals, with equity packages being structured conservatively.
   • Some developers are opting for all-cash deals to bypass financing challenges, though this is not the norm.

3. Sector-Specific Trends:

   • Multifamily (MF) remains a focus, but the spread between yield on cost and exit cap rates has tightened, making it harder to justify new developments.
   • Student housing at 7% UYOC might not be far off, but it depends on the specific market and assumptions.

4. General Observations:

   • The spread between UYOC and exit cap rates is critical. Historically, spreads of 200-300bps were common, but in some markets, this has narrowed significantly.
   • Developers are advised to underwrite conservatively, as assumptions on rents, cap rates, and costs are volatile.

In summary, while some deals are still getting done, they require careful market selection, conservative underwriting, and often lower-than-desired returns. The broker's numbers might not be entirely off, but the feasibility depends heavily on the specific market and deal structure.

Sources: Yield on Development Costs, https://www.wallstreetoasis.com/forum/real-estate/is-development-dead?customgpt=1, Is anyone capitalizing development deals??, Spreads on New Multifamily Development, Calling everyone...Biggest 2018 Takeway