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No and by and large they haven't since Q4 2021 if you had even the slightest amount of discipline in underwriting
Affordable housing, baby! We may not hit huge home runs if we anticipate a hot market, but we certainly keep churning out singles and doubles in all markets.
Easy to say that since you guys put no equity in the deals. LIHTC dev is subsidized so it doesn’t really abide by conventional market fundamentals. It’s all driven by fees. Therefore, a developer could build a project in a shitty area with bad fundamentals but that doesn’t matter to them because the 10%-15% LIHTC dev fee is guaranteed.
Should have said there are exceptions. Was just talking about conventional market rate new construction.
I’m sorry I have to call b.s. on affordable. I live in a state where 27 deals needed additional funding. Which mean they maxed out their deferred development fee. On top of that you know LITHC deals can a year or two longer to get done when compared with market rate. Affordable is barely humming along as well. Closing are still happening but severely delayed where I’m at.
Garden and 4-5 story walkup deals in the southeast still underwrite to a 6.5-7 yield and did all of last year as well. I'm not going to pretend that they're getting financed in August of 2023, but they certainly were all of 2022 and earlier this year.
I know more than a few people trying to get new surface parked deals started right now. We'll see if they get any money at all, but saying that every deal that has launched over the past 16 or so months is undisciplined is unfounded, IMO.
The bigger problem we're seeing isn't on the onset, it's at the exit. Sale prices are atrocious right now and 50% of deals that are on the market don't trade because the buyer decides they'd rather hold on to the deal than sell for a garbage exit.
What you referenced above is my bread and butter (fellow SE developer). I really think that you have to have unrealistic assumptions to get to a 6.5-7 yield. Asssuming $300K/unit basis for a 4-story surface parked w/ elevators + conditioned corridors, that means you need roughly $2,200 chunk rents or $2.31 PSF today to make your pro-forma work. I don't see anything close to that in any of my markets (Charlotte, Triangle NC, Charleston, Greenville, Nashville, Tampa, Orlando, Jax).
It's not just me and my shop. I've seen internal memos from the likes of Wood, TCR, Mill Creek etc stating that they were doing 2021-22 deals at 5.25% untrended FWIW.
You're missing the biggest market there.
We closed on one in December that was $285.70/unit all in, and $1,836 chunk rents ($2.13/sf), and had a 6.73 underwritten yield.
Trying to finance another now at $259.26/unit all in, $1,794 chunk rents ($2.05/sf), with a 6.82 underwritten yield. (Lord knows this isn't going to be easy right now.)
$300k/door for a garden deal would make me shit a brick, personally, and I would never put an elevator in every building or do conditioned corridors in garden stuff, but yeah if you need $2.30 rents to make a project work I can definitely understand your hesitation.
How did you arrive at the 2200/mo rent and psf math?
300 unit deal w/ 950 avg sf. Assuming 4-story Class A HDS (elevators, conditioned corridors, standalone club/fitness, surface parking) = $25K/unit land + $220K/unit HC + $55K/unit soft costs (18%) = $300K/unit all-in or $90.00M
$2,200 / unit rent ($2.32 PSF) + $150 / unit other income - 5% vacancy factor = $8.04M EGR
2.75% mgmt fee + $2,000 / unit RETAX + $450 / unit Insurance + $4,000 / unit controllables = $2.16M OpEx
$5.88M NOI / $90.00M = 6.53% Untrended RoC.
To be clear, in my markets, the above doesn't exist. Good suburban sites where we build this sort of stuff has market rents today of $2.00-$2.10 PSF which means that my underwritten RoC is more like 5.45% - 5.75%.
To play devils advocate here for discussion purposes: Are you carrying capitalized interest in soft costs? If not, don’t you need to add this to costs as an additional line item? Also, you’re getting $150 a door extra income in $2,200 rents per unit per month? Holy moley. Parking $50 (who pays for surface parking???), dog $50 (this ratio is what 33-50% of renters total?), and rubs $50? May be right, just seems a tiny bit rich. That 6.8% uROC is probably closer to a 5.75-6.25% at best I’m sure, in all reality. Tertiary or prime secondary market? Cap rates have to be closer to 5-5-6% today, so this proves why the math doesn’t truly work today…
Also just adding for discussion - is 5% vacancy assumption still standard practice despite headwinds? In secondary markets especially I'm seeing more like 6-8% among Class A product with incoming supply outstripping demand through 2025/2026.
Hey man I'm a developer - just slap the most aggressive somewhat passable assumption and go with it!
I was including a ballpark interest reserve number in my $55K assumption, but going back and looking through some recent models - you're right. Should probably be more like $60-$65K/unit which means that all-in is probably somewhere around $305-$310K/unit.
$150 other income is not crazy if you include app/admin fee, reserved parking (don't charge for unreserved), storage, standalone garages, cancellations, late fees, NSF fees, pet fees, pet rent, pest control, trash rebill, RUBS, valet trash, and our managed WiFi offer ($60).
Sun belt locations
$450/unit for RE tax is insane coming from a NE Developer.
What's your land basis need to be for a surface parked garden style to be $300K/unit?
Yes, we still have plenty of developments starting as well a few sales this year. Volume has definitely dropped a bunch since last year however
I think with where the treasury is today, cap rates are going to have to expand quite a bit for market-rate to make sense; or some type of harsh macro event will need to pull rates back down. I don’t really see rents rising or costs reducing to make the spread work.
I’d be interested to hear others thoughts on the matter - should we all be long on development even in face of current conditions?
Maybe a dumb question, but how would further cap rate expansion help market-rate development? That would just lower your terminal value, no?
I wasn't very clear here - this doesn't bode well for development in the near term. Cap rate expansion needs to happen though to get people to start transacting again.
Yes. Still seeing 6% YOC on untrended rents which is a go.
Left coast where/what product?
Seriously - I would love to know where on the West Coast you're able to underwrite to a 6% YoC right now.
on what numbers? Broker, sponsor, LP? If it's on LP numbers, that means the sponsor is probably underwriting a 6.5%.
I've been having this conversation weekly with other GPs across the United States since last summer. Really breaks down into two groups,
I tend to land in the first group and think the second group is effectively placing a macro bet through real estate, which seems miss guided, imo. I just can't wrap my head around breaking ground a new deal where your construction loan is going to be 8.25% - 8.75% just to solve to a 5.75% in a market like ATX. Any miss on budget, delay in construction, or US10Y not materially decreasing blows you up.
Separately, but related, part of what I have been considering a lot lately is the institutionalization of real estate and the development of these larger operating companies that represent much more of the deal flow today versus say 10 - 15+ years ago. It seems like you have fewer and fewer truly local developers that self develop maybe one or two projects at a time. Thus, as a result, is some of the market sentiment a result of having to take on additional risks because you're grown this large platform and now need the fees / activity to keep it going? Just thinking out loud.
This is a good assessment of the market.
Regarding your prediction I’d also add that in theory rents can increase during this period or construction costs can decrease (I know this is unlikely but I could happen), not just cap rate compression.
Fundamentally if there is a shortage of housing rents should start to increase again but I’m starting to question if market rate housing actually is apart of this shortage. What are your thoughts here?
A few thoughts on skating to where the puck is going,
As of now my best guess is we take a 12 - 24 month pause on any material NOI growth that would allow you to green light new development taking a fundamental only approach. In the short-term, we'll continue to see 4 - 5% rental rate increases but at the same time see the same, or more, in operating expense increases. But over the same period, I expect households to go back to their employers and ask for raises that exceed CPI to catch-up with the quality of life they've lost in the last few years. This should make housing more affordable and should allow outsized rent growth in 2025 - 2027, right when new deliveries dry up. This is all to say, at this point I think we'll have to grow rents out of this slump. Hopefully we see a stabilization in the US10Y in the 3.50% - 4.00% range over the same time period, which should give the market certainty of where cost of capital is for the next many years.
But once again, this is just me thinking out loud and where I land with all of this today. Reserve the right to change my opinion as the facts change.
Well said
This is a really great thread.
I work in Bay Area, and not a single market rate ground-up deal we have looked at pencils. Rents need to move up & costs need to stay flat / decline quite a bit for anything to make sense, and costs are pretty sticky here given a lot of the markets we work in pretty much require union labor.
We have been looking at buying existing multi deals at below replacement cost - mostly from distressed sellers. Normal sellers are still living under the delusion that they can expect their deals to sell for mid-high 4% caps or low 5% caps which is insane given the risk premium you'd like to get over the treasury as @Esque_ said. We've mostly been looking at distressed sellers, loan sales, or trying to work directly with lenders on deals that are fully underwater. The lenders don't seem to have gotten religion either...
I can only opine on luxury/high rise as we don't do garden or stick, but I haven't seen anything that makes sense in at least a year at this point.
To be fair, we haven't spent much time on ground up high-rise because a quick BOE usually tells us the land is usually worth nothing or so far below ask so we don't spin our wheels.
We're busy with conversions which we've been able to pencil and move forward on a few, but even those are tight without enough incentives.
Would love to hear what you're seeing on PSF conversion costs
hard cost floor is at least $250/gsf for a gut job
Im in SoCal and the only thing thats been close to a 6% ROC is a project utilizing state density bonus laws
Every single project in CA will use some sort of density bonus, and if you’re SoCal which you’re clearly not in city of LA, who uses TOC or 35% city bonus, and even tier 3 & 4 TOC aren’t penciling today (bid/ask spread has been far apart for 2+ years so far). You can remove almost all parking from site planning and would still be at or below a 6% (u)roc.
the true issue becomes: how do you accurately calculate (u)roc today? Is it todays rents with todays construction costs? Is it todays rents with construction pricing grown to vertical start? Or do you have a case to say that you have just as much (lack there of honestly) of where costs and rents are, so you grow both to construction start and say that’s your (u)roc? People may try and beat this one up, but if you think through how hard it is to predict costs and rents, you have to legit ask LPs/investors to look at it from a specific lense today. Otherwise, broad brush todays rents over todays con costs (grow rents and costs to con start and show as a secondary variable every time) will not pencil at the state density bonus level (50%density/20% affordable requirement)
ramble over\
Is trending construction costs typical in SoCal underwriting? I've never done it, but different market and all that.
I see lots of land deals hit the market for potential developments. They all look terrible. Doing development right now is more about developer fees than investor returns.
Just posted this in another thread but probs more relevant here:
A deal in a non prime location in westla, with 30 units (1,150 average unit size) and 10k of whatever retail, just traded for a 4.01% cap / $29.5m (or $999k a door with retail). It assumed a $15.1m loan at 3.69% I/o for 7 more years. Not a trophy asset but 2016 built with minor street appeal (2 floors Resy / 1 floor retail across from 6 story new build).
If we continue to hit 4% caps in SoCal, we’ll continue to build (like crazy hopefully $$)
Question though - what would the cap rate have been if the assumable debt wasn't there?
cap rate is still the same regardless = 4%…
cash on cash for this sale is what though, 4.8%ish?
so let’s say $29,250,000 is the sale price, what would the cash on cash be with current debt capital markets?
Let’s say 55% LTV at 6.5% I/o…
proceeds: $16.1M x 6.5% = $1.05M
$29,250,000 x 4% going in cap rate = $1.17M
Cash on cash = 0.9% return ($120k / $13.15M), down from 4% all cash.
Now let that ride out for 7 years and let’s just say that 4% cap rate / NOI grows by a percent each year (3% rent growth / 2% expense growth, even tho not 100% accurate, close enough) = $1.26M NOI = 4.3% cap rate on initial sale IN year 7. Anyone have a crystal ball clearer than treasury bills today that thinks this asset will out perform T Bills over the next 7 years? 4.8% cash on cash today growing very incrementally, vs a 4.27% (hmmmmmm ironically nearly exactly the same as the cap rate in 7 years as the 7 T Bill today…… ) How do you sell or refinance this property in 7 years? Hope and pray cap rates come back down…?
I must be missing something to understand this play……..
.
Curious your opinion - what do you think the nicest condo project you can conceive right in downtown bozeman could fetch per foot
I think you are probably pushing it at $900/SF but there are a few out there closer to $1000/SF.
Curious how you are projecting rent growth with 20% of Bozeman existing stock already under development, plus your 500 units to such a small market …. I’ll hang up and listen
PS: forgot to include how Boise is the single leading market national for rental contraction -7% yoy as of a week ago…
I keep hearing that word Bozeman. Probably worth looking into at this point.
One of my favorite places in the US, although I think I would shy away from building there personally.
Amazing fly fishing nearby, I've heard
What’s everyone up to?
New year same problems?
Nah, going to close on 3 ground up multi deals in Q1. Things have gotten much better on the development side.
When did you guys source equity?
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