I wanted to get a good discussion going about cap rate expansion, returns on cost, and interest rates given the talk (and action) of further interest rate increases. I've had two banks tell me this month that they are pausing all multifamily construction lending given the uncertainty and talk of interest rate increases coming forward.
Me and my partners build entry level housing (no class A stuff) and the two questions I ask myself is:
Do I think affordable housing will be more of a crisis in the future than it is today? (Yes)
And do I think rents will increase or decrease from today in the next few years? (Increase)
We are building at 8+% returns on costs. The last firm I was at, I rarely came across anything in the 6's. I would like to my partners and I are better positioned than a lot of firms assuming some sort of down turn, but hearing from banks that they are halting lending is a bit ominous. Curious to hear everyone's thoughts.
Building to similar yields and would be curious on everyones take of the same.
So you’re ignoring the fact that the debt you’ll rely on to take out your construction financing will now be materially more expensive and the exit caps which you hoped would provide your salvation will widen as a result?
So umm.. are you able to share what size banks you’re talking about here? Definitely an interesting anecdote and something to monitor.
I’d imagine more pricing power on rents, if new supply drops off a cliff because rate hikes and YOC not penciling out to make it worthwhile
Good question. Both are small to mid size banks. We are talking 1-2 billion in assets, so yes extremely anecdotal.
Agree on pricing power for the rents. I think this wealth gap is going to get much worse.
Oh and on a side note, I just got back from a trip in Belize and met a few Canadians there. As crazy as real estate has appreciated here in the U.S., it doesn't hold a candle to what people in Canada have experienced (specifically Vancouver). A lady told me her home appreciated by 3x in 4 years. She bought if for $400k and sold it for $1.2M. I think it was a 4/2 or 4/3, nothing absolutely crazy. Then I ran into a 19 year old from the U.K. who told me he would be renting for the rest of his life unless his parents somehow bought him a place.
We still have pretty affordable real estate here in the U.S. all things considered.
Can confirm that story is one of many
Is this all Chinese money? Where is this money coming from?
Well if you bring nationality/ethnicity/race into it, you get called a racist, which makes finding a solution challenging in todays political climate.
Some are investors who have refinanced their 5-unit apartment portfolios at 2% on 5-year fixed mortgages now need a place to put their newfound money. Some are families "syndicating" money to invest in groups. Some are boomers giving gifts to their kids to help them get on the real estate ladder. Is it all foreign money? No. Is there a lot? Yes. For example, there is a well-publicized story of shady characters (ie. known to police) bringing hockey bags full of cash to casinos, exchanging for chips, playing for 1-2 hours, then converting back to cash (we are talking hundreds of thousands of dollars each time, weekly, for months on end). This was all caught on camera.
A desirable SFH (call it 2200 to 2600 sf in a decent neighbourhood) will have 15-30 offers, no subjects, no inspection, and financing already completed. It well sell easily over $1.5M, likely over $2M, and often into the mid/high $2M range.
Canada just reported 400,000 immigrants in 2021. In a city that would receive ~50,000 immigrants, the annual increase in housing stock is definitely less than 10,000 units (SFH, townhome, condo, etc.), and more likely less than 5,000 units. This pattern has been in effect since at least 2008.
Your yield on cost is 8%? How is that possible? Especially on affordable where the rents are regulated and low af. My company’s deals are probably around 5.5% on a good one, realistically.
They are not actually "affordable" by any legal definition. They are affordable as in they are priced similarly to 1980s and 1990s apartments. We do everything we can to build them cheap - smaller sized units (400-450 sq ft one bedrooms, 715 square foot twos), vinyl siding, no washer dryer hook ups, zero amenities, etc.
Interesting. Not to hijack the thread with questions but what size of communities? Are you running full payroll or is it pretty light?
those do not sound like desirable apartments to live in by any means. that requires total desperation because you can't afford anything else. it's like paying to live in a jail cell!
Multifamily rents will need to increase if land cost, cost of entitlements, and construction costs keep going up. I think there's just so much capital chasing deals right now that cap rates will continue to compress. As real estate gets more institutionalized, yields are coming down. We used to do deals that were 10-12% ROC, those days are long gone for us...
10-12%?! Holy f*** that’s be incredible. How would any deal like that not pencil?
What yoc have you been getting to over the last couple years?
We would get in a deal at an attractive land basis located in or nearby a growing neighborhood. Maybe even hold the land for a few years. Up-zone to achieve a higher density (map amendment no PUD process). Build stick over podium. By the time complete, rents have gone up 10-15% in the neighborhood from the time we started construction.
Lumber and concrete have gone up astronomically over the past few years. Actually everything has. Construction labor shortage adds to the fire and extends construction period. Subs are overworked but making a killing. Rents have eclipsed pre pandemic levels for us recently but construction cost increase will more than offset this. Now our home run deals are penciling at 6.5%-7%.
"multi-family rents needs to increase" would be appropriate from a supply/demand perspective.
however, you also have to factor in true affordability at this time. wages are not keeping up with housing costs. apartments are getting smaller and people need to effectively squeeze more people into tinier spaces to afford rent because median income is less able to support the increases in rent.
Curious if you could share what type of housing you’re building to an 8% ROC? And in what type of cities? Is this small apartment buildings? Duplexes? Large buildings? What cap rate will it sell for?
Two-story garden style apartments with interior corridors. 16 unit buildings.
They are in the types of "cities" that you have to find via Google Maps lol. Think 15-30,000 population. We actually are about to be in two that are about 75,000 population. Those should be really good deals.
We expect to hold them, but refinance at a 6% cap rate. If it's more, then that is just icing on the cake. I have a couple new areas I'm looking at that might go for a 5%-5.5% cap rate if we build and take it to market.
I have seen 0 evidence of this at my top 10 balance sheet bank. People love financing real estate right now.
Maybe it’s your weird communities that sound cut rate, cheap and speculative based on your replies to other comments.
delete
Trying to achieve 5.25%+ stabilized yields for urban development with spot caps today in the 3-3.25% range. Rates are challenging, but we don’t trend our rents significantly.
I would be interested to hear what folks are trending rents at right now and what the proxy you utilize for said assumptions? Forecasted CPI? CoStar projections? REIS projections?
Genuinely curious, looking backwards I totally think building to a low five is rational. But seeing where perm rates are today, or where the 10yr is at, how do you guys feel about either a refi or sale in a few years?
“Spot” is 3 bc of implied rent growth getting you to same YoC that you were getting to previously buying at 4s with less rent growth. Meaning, the targeted YoC hadn’t changed. If you thought you could sell stabilized without material MTM for those “spot” cap rates, you deluded yourself.
delete
My company is owned by a large PE fund and they have told us we should be underwriting our deals at +100bps cap rate... Seems a bit excessive to me!
Heard the same, maybe know where you work if this came out in the last week lol
Plus 100 bps on the exit ?
Quisquam quisquam qui ipsum et repellat et rem repellat. Veritatis aut recusandae architecto cupiditate ut architecto. Et aut dolores voluptas vel velit recusandae. Maiores quisquam quis voluptatem placeat non. Illum dolores consequatur ducimus laboriosam natus.
Quisquam suscipit eaque animi magnam molestiae. Ipsa repudiandae sit qui minus. In enim at et maxime officia. Voluptatem consequatur qui est in velit est officia.
Magni ullam sapiente non eum ut asperiores veritatis. Asperiores asperiores qui est qui ratione alias repellat. Suscipit vel hic voluptatem molestiae natus sit. Non assumenda at veritatis.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...
Ut animi veniam dolor facilis ut maxime labore. Fugit nihil qui rerum facilis earum deserunt. Quae nihil iste nihil aut. Quisquam ipsa dolores temporibus est.
Iusto aut occaecati architecto non animi at distinctio. Et voluptatibus quam et voluptatem recusandae optio sed. Officiis perferendis voluptatem et corporis ut minima voluptatibus cum. Tenetur quis molestiae voluptatibus nulla tenetur eum aut. Aperiam magni eius minus quos.
Quam exercitationem doloremque distinctio quo quae consequatur. Reprehenderit voluptas molestias rerum sapiente et corrupti. Excepturi earum consequatur quam quasi velit nisi. Sed aut officiis pariatur molestiae optio assumenda. Eos dolor minima aut rerum doloribus optio tempore vitae. Sint sunt quia saepe omnis et fuga earum qui.
Qui velit quis est non nobis minima. Sint quia alias iure beatae eum nobis. Vero ut ex aut enim provident quas hic culpa.