Is anyone else in multifamily space doing a lot of development deals right now (i.e. preparing to close on new sites, rather than stuff that's been in the works for 12 months +)? If so, what tolerance for yield spread does your shop have over prevailing cap rates? In my shop, we are very focused on current (untrended) yield vs. stabilized (trended), and need to be at 125 +/- bps greater than cap rates (untrended) and 150-175 bps +/- trended at stabilization. Core/urban stuff obviously falls in the lower end of this spectrum, whereas suburban product is in the upper range. Is this the norm where you work, or my group extremely conservative?
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hi, I'm a newbie, could you explain this for me please? "In my shop, we are very focused on current (untrended) yield vs. stabilized (trended), and need to be at 125 +/- bps greater than cap rates (untrended) and 150-175 bps +/- trended at stabilization". So, your yield on cost should be 1.25% more or less greater than cap rate untrended? How would it be greater than cap rate if no rental increases are taken into account- this is what you mean by untrended right? I appreciate it!
I'll use small numbers for simplicity. Let's say your stabilized NOI is $5, and cap rates today for similar, stabilized proeprties are 5%. That means your property at stabilization should be worth $100. So if you are thinking of building a new building that will have a $5 NOI, would you want to build it for less or more than$100? You obviously want to build it for less so you can make a profit. Let's say you can build it for $80. That means your $5 NOI would be a 6.25% yield ($5/$80). This would be a 1.25 bps spread that the OP mentioned, and would fit within his spread tolerance. The reason you don't trend rents in this analysis is because you want to compare your yield on costs to cap rates TODAY. The reason you want a spread is to build a buffer for potential losses (mostly selling your building for less than you built it for). There are a ton of other factors but this is the high level.
I think lenders are hyper focused on current yield today as well, given how many of them got destroyed last cycle by signing off on trended rent rolls that evaporated in the downturn.
Prevailing cap rate = what similar assets are trading at. Every development deal that doesn't lose money, must achieve a yield greater than the current market cap rate or you are selling for less than what it cost you to build.
What market are your development deals?
This seems appropriate for what we have spread in the DFW market. I have experience with a wide range assets that are similar to the pre-close/construction you've mentioned that range from 40MM to 100MM+ (urban-core high-rise).
I'm also in DFW. We take closer to 100 bps spread trended on super core high rise, but I'm struggling to find deals in the burbs that meet our threshold for stick frame product (150-200+ bps spread trended) at the price land is going for these days.
Right on, glad to see someone else representing DFW!
The yield really depends on who the developer is and if they can snag an off-market non-arms length site. We've seen a few that resulted in yields closer to 300bps but again this is somewhat unique to the economies of scale (multiple deals in the area) and developer expertise. More commonly we've seen yields around 150bps and extremely slim yields on the urban-core where the yield is less than 100bps (given the un-trended rents are top of the market to begin with).
The spreads OP mentioned are in line with what we looked for at my former job. To avoid any confusion, our spread was applied to an assumed exit cap rate (with built in expansion to account for widening rates... not current cap rates) and our uw yield on cost. While there weren't really MF developments in super core markets coming across my desk, I'd think in 3.75%-4% cap rate markets like SF or NYC you could pull off an economically feasible project with a tighter spread, maybe 100 bps for untrended.
We are seeing a lot of cap rate compression in the marketplace, and very very small spreads. The only people starting new deals are doing so because they have to, so they fudge a proforma until they get the spread their investors want.
The only 'new' deals in my pipeline are things we started working on 2+ years ago, with 2019 starts.
It's smart to be conservative right now, at least in the DC area. Not familiar with your market, except that it's busy!
I think that's really market dependent, to be fair. We're doing new deals because we're seeing 200 bps spreads still in the Southeast. Suburban in particular is taking off.
Interesting! And here I thought my group was conservative at a 100 bp spread for untrended deals. We do super urban/core Class A MF and even at a 100bp spread are having a lot of trouble getting new deals. I think we've had 2 new deals this year, when we normally have 5-6.
I think it's entirely determined by the developer's potential to reduce the cost basis of the project. Most boutique development firms have seen the direct impact of rising land prices due to the scarcity of land for development. The only ones who are really able to move deals to execution have extensive power and relationships to snag an off-market land sites and development contracts with lower hard/soft costs than anyone else in the market.
I'm working with an international development company, 1.5B+ in current global development, that has a yield of 225bps on Class A+ (condo level finish mid-rise) DFW project.
Spreads are everything. Even at a 100 bps I honestly find the returns to be a joke. Developers do all the ground work, they do land acquisition, permitting, architecture and engineering, environmental, construction financing, and the list goes on. On the multiple development deals that we did, only one went smoothly, the others always had an issue from a construction standpoint or entitlement process. Developers have a tough job and I find it ridiculous that some feel a 100 bps is enough. I guess its just the market we are in now.
Couldn’t agree more. Almost commented at the post above regarding relationships, because when valuations are where they are, a landowners best relationship becomes the guy from HFF or CB who will market his site to 20 bidders...even though you’ve known him for years.
almost always need to be at 150-175 +/- bps greater than cap rate as stabilized at purchase; the extremely conservative approach is to always protect us from external market factors. If you want to keep your returns for investors consistently high throughout several economic cycles, that is the way to go.
200 bps or your just another guy collecting fees not creating wealth
i recently read an article that mentioned new development is down 20% since this time last year
Yet if NMHC is any indication, there is just as much capital out there than needs deployment.
should be an interesting year with sales falling double digits q4 of 2017 (greater ny area)
Re-dev is where it's at in '18.
isn't 100 bps at a 4 cap the same as 150 bps at a 6 cap? (20% return)
Yes. It's the same cost-to-exit premium.
In the west coast core markets we are at or below 100 bp on the spread. Recently did a SF dev deal under 90 bp spread.
How about the scenario where cap rates are lower than interest rates? What are owners and leveraged funds going to do when they all of the sudden are levered at rates of 6%+ holding assets that are valued at below that? Beyond loss of NAV on portfolios, how would negative leverage impact these groups?
One of three scenarios:
Scenario 1 - Interest Rate Growth > NOI / Economic Growth = Asset Prices go down
Scenario 2 - Interest Rate Growth = NOI / Economic Growth = Asset Prices remain flat
Scenario 3 - Interest Rate Growth NOI / Economic Growth = Asset Prices go up
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