Multifamily - how tf are you guys getting deals to pencil?

Institutional growth markets are dipping into the 3.75-4.00% going-in cap rate range when adjusted for a tax reassessment. Given sizing parameters for most lenders, I can't get a deal to underwrite above a 10% IRR unless I underwrite unrealistic rent growth/increases, or bring my exit cap rate to an uncomfortable level.

Do I just need to say YOLO and be more aggressive on my assumptions, or are you guys actually doing deals at 10-11% IRRs?

Comments (80)

 
Feb 1, 2021 - 4:33pm

Cap rates in the SE are all sub-4 on institutional product, just a fact of life right now.  Shit, every deal in Austin is a 3.5% cap rate.

 

We're doing all the things you said, assuming the deal stays banged up in Year 1 with the slack coming out pretty quick in Year 2+ (outsized rent growth/pent up demand).  Exit caps, we have a minimum cap rate threshold for all of our markets that we won't go past, and we're having to floor it to the minimum on every deal.  The reality is the groups that are getting deals done are pushing their exit caps down into the low 4s to make the deal (not a bad bet if you see interest rates staying low).  The leverage is becoming much harder to get as it is hard to get a 3.5% cap rate to a 1.25x DSCR.  Note that all of that stuff is for low-density suburban deals, the urban stuff still isn't really transacting as developers and other owners are still well-capitalized. 

 

Odd that you can find higher cap rates in gateway markets right now (still low 4s though, maybe a little lower in quality burbs).  Public REITs are still the best play in multifamily right now (personal opinion).  Also, I'd point out that there still aren't a ton of deals on the market today so things are frothy, all of the brokerage houses expect to launch a lot of product in the next 60 days so things could cool a bit. 

 
Feb 2, 2021 - 10:42am

The multifamily REITs are trading today at an implied cap rate in the mid to high 4s today vs the private market where they're trading 100bps lower.  I'd rather invest capital with MAA, EQR, and AVB over the long-term than buy 3.5% cap rates in the Sunbelt in the private markets (note that I am actively doing the latter and still think it is a good relative bet to other investments in the market and our assets have more appreciation upside, I hope, than a lot of the REIT portfolios).  I think there is a lot of upside in those REITs.  AVB traded a suburban value-add deal in Boston a few weeks back at a 3.8% in-place cap rate, and yet their stock trades in the mid-4's.  I'm a buyer of that opportunity (have been throughout the pandemic).  Toss in the fact that stock prices are still ~20% off their pre-COVID levels, and I feel ok about buying that opportunity today.  My two cents

 
Feb 1, 2021 - 5:22pm

it's interesting to me that names associated with 'smart money' (Starwood, BX, KKR) are doing this.  maybe there's a nontraded REIT platform or DST platform managed by each of those guys (e.g. BREIT) but i don't know.  can someone set me straight on this?

 
Feb 1, 2021 - 9:35pm

They see the current environment as one with low interest rates for a prolonged time, and they see multifamily and industrial as having secular tailwinds (not the same for other asset classes obviously).  Also, more importantly, you nailed that they're being most active out of the non-traded REIT vehicles which are fee machines/permanent capital, and they are really just capital allocators for those vehicles (very savvy ones obviously). They aren't buying mid to high 3-caps for their opp funds.

 
Feb 2, 2021 - 9:54am

Count_Chocula

They see the current environment as one with low interest rates for a prolonged time, and they see multifamily and industrial as having secular tailwinds (not the same for other asset classes obviously).  Also, more importantly, you nailed that they're being most active out of the non-traded REIT vehicles which are fee machines/permanent capital, and they are really just capital allocators for those vehicles (very savvy ones obviously). They aren't buying mid to high 3-caps for their opp funds.

Got it, thank you!

 
Feb 3, 2021 - 12:02pm

 

Only see KKR doing this in multi, and they're by far the newest to RE of the three although i'm sure they spent well to bring in a talented team. Examples of BX/SW?

you got me, i'm literally just parrotting a quote from Jonathan Litt.  so, BX i can't say (but again, like another poster above said, probably would be under BREIT ... looking at BREIT's website i see them paying seemingly good prices for stabilized core multifamily product in recent history)... and then starwood i feel like has paid big dollars for multifamily though perhaps it was via Starwood Income Trust or whatever https://www.starwoodnav.reit/investments/ 

 
Feb 1, 2021 - 6:04pm

Balance sheet lender for institutional deals here. We no longer automatically assume 3% rent growth, we do 1-2% rent growth and it is always a battle with originators and the risk/structuring team when it comes to rent growth, taxes, vacancy, concessions, etc. . Our deals are tight and it only getting tighter. Light value add (going in ~7.25% DY and exit in year 3 at ~8-8.25% DY with us sometimes funding 100% of future capex) is our bread and butter but off late we are looking and even signing up deals at a 6.50% going in and 7.50% exit. And we still lose out on deals all the time to the agencies lol. 

 
Feb 2, 2021 - 10:21am

CAGRator

Institutional growth markets are dipping into the 3.75-4.00% going-in cap rate range when adjusted for tax reassessment. Given sizing parameters for most lenders, I can't get a deal to underwrite above a 10% IRR unless I underwrite unrealistic rent growth/increases, or bring my exit cap rate to an uncomfortable level.

 

Do I just need to say YOLO and be more aggressive on my assumptions, or are you guys actually doing deals at 10-11% IRRs?

We're finding a fair numbers of deals that work out to a 12-15% IRR, maybe a touch more with some luck.  

Just have to look at deals in slightly non-traditional ways.  Put an affordable component in, in return for a tax abatement or a PILOT, and gain some certainty on tax growth (by far the biggest uncertainty in our underwriting).  Ask for Section 8 credits.  Those aren't even super creative!  

 
Feb 2, 2021 - 10:45am

That is interesting.  Are you worried about impairing the exit value by adding in the affordable units?  Assuming the PILOT expires at some point, won't the new buyer be stuck with higher taxes?  Just curious how you're working that.  We have a buyer on a deal who is doing something similar in order to clear a regulatory hurdle with the local municipality.

 
Feb 2, 2021 - 11:29am

Count_Chocula

That is interesting.  Are you worried about impairing the exit value by adding in the affordable units?  Assuming the PILOT expires at some point, won't the new buyer be stuck with higher taxes?  Just curious how you're working that.  We have a buyer on a deal who is doing something similar in order to clear a regulatory hurdle with the local municipality.

Depends when you want to exit.  We're anticipating 10+ year holds.  So yes, you remove some upside, definitely.  And of course the PILOT will eventually expire - generally speaking, when your benefit runs out, so does the obligation to keep units affordable (not always, I understand).   So you give a new owner the option to opt out and raise rents, or try and renew the abatement and keep some portion of rents low.  As always, it's a question of a higher floor in exchange for a lower ceiling.  Less risk equals less potential reward.  Additionally, you can put extremely attractive long term fixed rate debt into place.  I don't want to buy assets on the back of cheap debt (as opposed to underlying value), nor do I usually prognosticate about where rates are going... but if we have lower rates than today in ten years, the economy in general is in a lot of trouble and I'll have bigger problems.  So in this interest rate environment I'm almost forced to pay in part for the cheap debt I can put on (because someone else certainly will, so I'll lose the deal if I don't), but I tend to cancel it out by assuming the remaining 15-20 years of life on my cheap debt will look relatively attractive when the discount rate is 1.25% and not 25 bps.

But on a more general note, look at where the rest of the capital markets are, today.  You can't buy yield (in a metaphorical way, obviously you very much can literally buy yield). So go out, buy the asset at a 4 cap, put some certainty on the taxes, and then go to an investor and tell them you have a deal that's throwing off a solid 5 cap.  Once you remove uncertainty surrounding taxes, there is an argument to be made that you're buying the cash flow at a several hundred bps delta to whatever else is in the market.  Especially when you look at programs with federal subsidy behind them, like Section 8.  If I tell you that we can buy what amounts to a US Gov't bond at a 5 cap (after putting an abatement in place), lever it up to an 8 or a 9.... well, again, that's an attractive look for most people.  If treasuries were priced at even a third of that, you'd see everyone liquidate out of whatever they're holding and pour on in.

Which isn't to say there's no risk.  But at some point our investors trust us to manage the property well, keep opex down, and minimize vacancy and bad debt.  If they didn't, they shouldn't be coming to us no matter how amazing our investment thesis is.  Yes, costs could skyrocket; the housing market could go back on a tear, too.  

 
Most Helpful
Feb 2, 2021 - 11:15am

We're getting 6.5%-6.75% yields with roughly 18% IRRs on a 36 month exit, but sometimes getting the the IRR that high (which is funny, because we used to get 22%-25%) is a struggle. I'd argue we're way too conservative on underwritten cap rate, but I understand why we're being that way. Still underwriting 3% rent growth. 

Construction prices are bullshit and we've all but given up on wrap deals at the moment - only looking at high rise or surface parked. 

 

Commercial Real Estate Developer

  • 6
  • 1
 
Feb 2, 2021 - 5:22pm

So you're yield on construction cost is mid 6s. Thats pretty damn good! What type YOCs seeing on garage wrap deals? Also what market is this?

Array

 
Feb 3, 2021 - 9:48am

teddythebear

So you're yield on construction cost is mid 6s. Thats pretty damn good! What type YOCs seeing on garage wrap deals? Also what market is this?

Southeast. 

I couldn't even tell you what yields we're seeing on wrap deals because we all but stopped looking at them. Low 6's to sub 6's. They don't make the 6.5 threshold my company requires. 

Commercial Real Estate Developer

 
Feb 2, 2021 - 12:20pm

Take what you think a reasonable cap rate is, then go a bit lower. Then, if you want to win the deal, just go a bit lower then that. And if its a solid asset, ...just a little bit lower. 

I don't think most CRE folks realize how much cash is sitting on the sidelines right now, looking to be invested. Big PE or REPE groups are jumping the gun on low yields to ensure money gets out the door and their MOIC maintains a level of normality. But the banks are coming right behind them with orders of magnitude more money and more incentive to deploy. 

As to why MF specifically, I think there is a fear that worst comes to worst, can we get cash month-over-month? In strictly commercial spaces such as office/retail/industrial/hotel, its no longer guaranteed. That's also why the SFH market has grown significantly in ownership via institutional capital. Who wouldve thought big players would be buying houses and renting them out to keep the wheels turning?

 
Feb 3, 2021 - 11:30am

There are two pre-requisites for a 2007 like situation to happen again: 1) high leverage and 2) potential for investment capital to flee the space. Right now it doesn't feel like we have either. There is a TON of equity in these deals. Banks are still disciplined albeit less so than 2011-17. Also don't see the potential for investment capital to flee rental housing. If anything, you'll see more investment capital flow in as there is a ton of dry powder and funds shift their allocations out of retail, non-core office, and hospitality into multifamily, core office, industrial, med office, life science etc.

 

Just my $0.02  

 
Feb 3, 2021 - 1:00pm

Agree with this. I think the story of multifamily this cycle is going to be more of a portfolio management story, compared to a demographics one last cycle, with further cap rate compression coming. Been listening to a lot of Bridgewater/Ray Dalio stuff lately and their take is that cash and fixed income are essentially f'd, which was a trend pre-COVID and is now exacerbated with US ZIRP. In my mind this will further accelerate what was already happening with pension fund real estate allocations, with Multifamily being a prime beneficiary as the best inflation-hedged true real estate (non-growth sector) play. Think US Multifamily will essentially be viewed as TIPS with upside potential.

 
Feb 3, 2021 - 1:05pm

an interesting comment made by a developer to me was that a 2007 would typically involve more 'chain of title' debt, even if there are certain players (e.g. perhaps value-add multifamily comes to mind) who are quietly employing extra leverage thanks to the plethora of available preferred equity or mezz.  those investors and lenders can and might lose money but, because it's mostly 'unsecured' capital, it won't be in a way that ties up stuff in court for lengthy periods and get things stuck in gridlock, the way that having a huge high-LTV 2nd mortgage could (?).

the comment came from a developer who spent years at a REIT and eventually developed a (poorly timed) high-rise with multiple layers in the capital stack that got totally wiped out, so i trust he has at least a little experience with those types of hairy situations.

 
Feb 3, 2021 - 12:45pm

I don't see institutional MF in trouble any time soon, maybe some submarkets are getting hammered or individual buildings can't collect rent, but SFH is where the real disaster is going to be. The govt keeps pushing the eviction ban, but it's going to get lifted eventually and there will be a world of pain for homeowners. Institutional buyers are going to scoop them up and rent them out just like last time, but this time they know what they're doing from the get-go. 

 
Feb 3, 2021 - 1:19pm

Yes and no.  In 2008 there were probably excessive building by a few years.  Now we've been building at the same rate as household growth which is far less building than you need since some property is always going out of service from age.  
 

also the rate market is completely different.

 

im long the home builders.  We have a lot of building to do.  

 
Feb 3, 2021 - 1:29pm

traderlife

Now we've been building at the same rate as household growth 

Actually, we've been building LESS than the rate of new household formation. According to research from Freddie Mac, we are short about 2 million houses. 
 

Remember going into the grocery store and trying to buy toilet paper and not finding any suitable options? That's the housing market today. 

 
Feb 3, 2021 - 12:52pm

Definitely getting hard to pencil some projects, a few shovel-ready projects that we had ready to go pre-covid are basically shuttered and we're trying to find a way to claw our way out of it. Otherwise, we're doing and looking at more affordable development for the fee revenue. Getting yield on cost to 6% has been a struggle, but kind of necessary to get a decent spread since cap rates are already rock bottom. 

 
Feb 3, 2021 - 1:47pm

You don't get to a 10% IRR by just buying and holding, nor has there ever been a market where that was the cases. Cap rates moved down because interest rates moved down - the two largely neutralize each other. If you want to get a 10%+ IRR you don't just buy and pray for 5% rent growth. You have to reno units, add amenities and get more aggressive on the management side to force rent premiums.

 
Feb 3, 2021 - 8:29pm

Because most of the guys who are buying $100mm deals give 0 fucks what real estate used to trade at years ago. Institutional investors need to deploy dollars (literally) and need something to counter-balance a portfolio that more likely than not is mostly equities. So your traditional options are either in fixed income where even junk bonds are going at 2 handles, or in real estate where something with credit-worthiness (in the tenant base) is going to yield you....3 or 4 times that after leverage. The continued flow of dollars in will continue to dampen yields because relative to the next best things, the risk adjusted return is like 10x (maybe a slight exaggeration...) of what public debt is going at. Even private credit, while yielding higher, has nowhere near the downside protection of a hard asset-backed investment. 

 

 
Feb 11, 2021 - 1:02pm

I work at an investment sales brokerage in NYC, have worked on institutial product before, and I'm seeing high-rise multifamily 50-150 units in the 5 cap range (this is off net rents with at least 2 months free)

Is it actually true that garden style, suburban multifamily is going for sub 4 caps in the Sun Belt? I have no experience in this market but I can't imagine the real estate in those suburban areas is worth more than NYC right now. I understand COVID hit the city hard but...

 
Feb 12, 2021 - 1:44pm

Wow a 5 cap. Thats a lot higher than I thought. I know secondary cities in the SE are in the mid 4s on T12 numbers. This is like 80-90s vintage stuff too.

Array

 
Feb 18, 2021 - 2:59pm

PropShark

Is it actually true that garden style, suburban multifamily is going for sub 4 caps in the Sun Belt? I have no experience in this market but I can't imagine the real estate in those suburban areas is worth more than NYC right now. I understand COVID hit the city hard but...

Most of what I'm seeing is mid 4's, but a sub 4 cap suburban deal in the southeast is far from unheard of. 

Commercial Real Estate Developer

 
Feb 17, 2021 - 9:35pm

It's almost impossible with skyrocketing construction costs over the last year and even the last 3 months alone. But, a few things work in developers' favor.

  1. There's so much financing available that you can pretty much finance any reasonably decent development. Someone's going to give you money. So, lever up to 85% and don't use much of your own money.
  2. Add to that a 3% development fee and a 1.5% CM fee, and you can make back more than your entire equity investment on the fees alone.
  3. With a favorable waterfall, a sponsor can still get the deal to work for them, even though it might fall short of the LP's target for a development.

No question that deals right now are going to be hard to hit a home run on. I expect that the projects my firm will break ground on this year will probably get 15% deal level IRR's given the current environment. Maybe not even that, considering the volatile economic conditions.

 
Feb 22, 2021 - 9:59am

Also, just a PSA from a developer to all the LPs out there, your realistic return profile on wood-frame development in the SE today is a 5.75-6.00 YoC, 15%-17% / 1.5x-1.6x LP IRR / Multiple. A lot of the LPs I've talked to are way behind the times given how much construction pricing has gone up. This is on realistic assumptions not developer bullshit.

 

Also, lenders need to get it out of their heads that a 10 debt yield still exists. Pretty much everything is a high 8 to low 9. Always super frustrating with the debt folks because they rarely reduce their DY requirements even when the cost of perm financing is maybe 1/2 to 2/3 of what it was 2-3 years ago.   

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