How rising Treasury yields are changing the math for US multifamily

A roughly 30 basis point increase in the yields for 10-year US Treasuries since the start of the 2022 is having an impact on lenders’ ability to have deals pencil out in the multifamily market, according to panelists at New York-based advisory Ariel Property Advisors’ quarter Coffee and Cap Rates webinar.

The 10-year Treasury is now yielding about 1.9 percent, its highest level since 2019, and this is having an impact on borrowers’ ability to get multifamily deals done.

“We’re now seeing sub five percent [going-in] cap rates for acquiring assets,” said Sharif Mitchel, operating principal at Dantes Community Partners, a Washington, DC-based affordable housing specialist. “In the first month [of the year] we’re already seeing [yields] 30 basis points wide on the 10-year Treasury from end of year, [and] we’re already starting to see that impact.”

Cap rates continue to compress, which is making the situation more complicated. “We’re still dealing with these tight macro factors [as well as the] increased cost of renovation work, which is making deals more tough to pencil,” Mitchel said.

The macro issues around the multifamily sector are very important to the broader commercial real estate market due to its performance during the covid-19 pandemic. While this robust asset class is still on the podium for gold or silver – next to its rival, the industrial sector – investors are becoming concerned about the impact of cap rate compression, inflation-adjusted rent increases and interest rate hikes.

New York focus

These factors have helped to lead New York’s multifamily market to become somewhat of an investment destination for institutional capital, said Shimon Shkury, founder and president of Ariel Property Advisors, who moderated the panel.

Investor appetite in New York multifamily was up 60 percent year-on-year to $7.2 billion in 2021, according to data from Ariel. Blackstone set the bar high in 2021 with a series of luxury apartment properties in the city, including a $220 million asset in Brooklyn and two in Manhattan for $850 million and $930 million, respectively.

“Investors, [including] international family offices, are viewing New York multifamily as a safe haven,” Shkury said. “Experts say we are at the tail end of the pandemic, and investors are watching carefully to see how the J-51 [tax abatement program for multifamily housing] will impact landlords and tenants and C-PACE lending.”

There are other issues that continue to affect New York’s multifamily market. Invesco Real Estate, a firm believer in the beds and shed strategy, reckons interest rate hikes and a weakening dollar could present more than a few bumps in the road for New York multifamily.

“New York City performance in multifamily investing in the last 10 years is at the bottom of the chart for the 50 top cities in America,” said Robert Deckey, a managing director at Invesco. “When the larger investors look at their macro models and look at where they want to invest, New York city has earned the spot at the bottom of the list where money goes to die.”

Deckey cited a few factors behind this.

“One of the reasons why New York City has higher cap rates is because we have this rent control stabilization issue, and have done for the last four or five years. We’re going to start seeing energy expenses have rapid inflation, and we’re also all getting hit this year with increased real estate tax,” Deckey said.

Deckey stressed that mayor Eric Adams will need to make a choice that will affect the fortunes of the multifamily market. “Do we want investors running away from New York multifamily, or to come here?” he said.

Flip of the coin

But Dantes’ Mitchel believes now could be the best time to enter the market.

“We’re seeing assets trade at $150,000 per unit, and in a place like New York city, the replacement cost is triple that,” said Mitchel. “Just looking at macroeconomic basics, the supply and demand [situation is strong]. You cannot build it for the same [cost] as you can buy it. The pandemic has proven that there is an increased population of folks falling into these rent-controlled buckets, so the demand is there.”

Dantes, with a portfolio that spans Maryland, Virginia and Washington, DC, has little exposure to New York. “We’ve been seeing cap rates in the impact, workforce and affordable [housing] spaces, really coming down,” Mitchel added.

Despite the discount to replacement costs for New York City apartment properties, competition is driving up pricing. This makes it difficult for firms like Dantes to compete due to its focus on affordable housing preservation. Changes in rent control legislation in New York could also make it easier for investors to get into multifamily properties in the city.

“It might take more time [to structure a deal] and you may have to get comfortable underwriting to a negative NOI for the first however many years, but I think the legislation will chip away a little bit and if you can work with Article XI, figure out how to structure the deal and work with the sellers to get to the finish line, then there is opportunity,” Mitchel added.

The Article XI Tax Incentive is a tax exemption for Housing Development Fund Corporation-owned new construction or renovation of affordable housing.

“It’s going to take partnerships with like-minded sellers which might leave five or six percent on the table to work with a group like us to execute transactions with certainty, a quicker closing time, and deliver that preservation that we say we’re going to do,” Mitchel said.

Bigger picture

Despite drivers such as government intervention, policy and the pandemic making multifamily forecasts difficult, many firms anticipate increased transaction volumes for 2022.

One of those firms is Los Angeles-based commercial real estate debt and equity firm PCCP.

“On the macro forecasting side, we approach that with a great deal of humility,” said Brian Haber, senior vice-president. “[However,] the debt markets are back, the liquidity is there, there’s more competition for banks and [we expect] higher transaction volumes.”

The $15.2 billion firm originates senior and mezzanine loans that fund value-add business plans, including loans to lease-up and stabilize assets, loans on properties that are being repositioned in the market, construction loans, and loans for discounted payoff and discounted note acquisitions.

In June and July of 2020, the firm closed a multifamily deal in the Carolinas for a long-term separate account.

“The view [of the other party involved] was that liquidity had frozen up in the markets and that we were staring down the teeth of an impending recession,” said Haber. “But the reason we were able to convince them to do these deals was [highlighting] saving on costs [since] labor and materials will be cheaper.”

Haber reckons the key to success is having good products in high quality locations as well as not being over levered and securing projects on a longer-term basis.

“Fast forward 24 months and we are so glad we did those deals – but for all the opposite reasons,” said Haber. “Costs have run, the rents never missed a beat, cap rates are down 100 percent in Raleigh and Charlotte. That’s informed our views, and we [continue to] focus on what we can focus on.”