Finance & Economy

Real Estate

State of CRE 2023: 4 big takeaways

January 13, 2023

State of CRE 2023: 4 big takeaways

The Walker Webcast recently released its State of CRE 2023 discussion with top experts in the CRE space.

As 2023 gets underway, there are clearly some troubling signs for investors in the multifamily market space. In addition to an unexpected drop in demand for apartments in the third quarter of 2022, multifamily lenders are tightening lending criteria and the cost of capital has skyrocketed since the first quarter of 2022.

However, there are still positive signs emerging in some corners of the multifamily market, as Walker & Dunlop in-house experts – executive VP of research and securities Ivy Zelman, executive VP of investment sales Kris Mikkelsen, and senior managing director of capital markets Aaron Appel – shared during the firm’s “State of CRE” Walker Webcast.

Despite clouds, some potential bright spots emerge

“The overall underwriting has definitely significantly changed; it’s more stringent and uses much more conservative rent assumptions,” said Zelman. “And obviously the demand side is being hurt by the elevated cost of capital, (to the point where it) feels like the transaction market has come to a bit of a halt. But the good news is that with the ten-year treasury rallying (from a high of 4.25% in late October to hovering around 3.5% in December 2022) and the cost of debt coming down, I think that there might be some signs of price discovery and maybe some indication there's a slight increase in interest.”

Price discovery finding floor

On the transaction front, Mikkelsen stated that there are encouraging signs as the year begins. Multifamily sales were somewhat modest during October and November 2022, with Walker & Dunlop awarding approximately 40 transactions at an average price of $55 million. But following a low point in mid-October when the ten-year treasury spiked to 4.25, there have been encouraging signs, particularly in terms of price discovery. Mikkelsen’s team recently priced about a dozen assets and it appears a floor is beginning to form on pricing. Buyer interest is gaining momentum, he said, evidenced by the growing numbers on bid sheets. “We've been successful at really making markets and getting some price discovery within the last two to three weeks (late November, early December) that we frankly weren't able to find 45 days ago.”

Financing still available for quality assets

GSEs like Freddie Mac and Fannie Mae are still lending, but the aforementioned conservative underwriting and cost of capital are causing a drag on acquisitions in the multifamily market. Lending for apartments decreased by 16% year-over-year in the third quarter of 2022, according to the Mortgage Bankers Association’s Quarterly Index of Commercial/Multifamily Mortgage Bankers Originations. But Appel said that there is financing available for well-located quality assets.

“For core plus value-add multifamily assets, there's plenty of liquidity; it just costs more,” said Appel. “So, I think it's a cost funds issue relative to what the value is or what people are willing to pay.” Appel and his team recently secured $204 million in loan proceeds from MF1 Capital to refinance The Axel, a 29-story mixed-use multifamily and commercial asset with 284 multifamily units located in Brooklyn for sponsor Hope Street Capital.

Large multifamily building
(Image available to public via press release)

“It's a property that's (currently) 50% leased, and there's a small commercial component to it. When it stabilizes, it (should have) a $13.5 million-dollar net operating income on a $200 million loan. So, it's about a 7-ish-% debt yield. That asset today is probably worth about a five and a quarter cap, so there's a good spread for the lender in terms of value versus their loan amount.”

He added that there was significant interest in financing the asset, with approximately 10 groups interested in the deal. That number was eventually whittled down to three that were willing to meet the market in terms of the amount of leverage they were willing to provide, before the deal was awarded to MF1 Capital.

Rent growth will remain strong for the near term

Following a torrid period of sustained rent growth of 22 percent between January 2021 and October 2022 (according to Yardi Matrix), rent growth has been slowly decelerating, and the national average asking rent fell $9 to $1,719 as of November 2022. However, the current 7% rent growth is still a strong number from a historical perspective.

Multifamily units

“Overall rent growth is actually (doing well) on the renewal basis,” said Zelman, who is also CEO of the housing industry research and advisory firm Zelman & Associates, a Walker & Dunlop company. “I think that the new move-ins are definitely moderating at a faster rate, but they're capturing loss to lease today, and there's no question renewals are stickier. In our forecast right now, we see a moderation in blended rent growth (moving) more into the historic range – a little bit above four and a half percent and then continued moderation in ‘24 to more like a 2% growth rate. But I think that overall, the renewals are stickier and holding up better than new move-in rates.”

It should also be noted that rent growth may vary by region, with Freddie Mac expecting the best performing markets to be predominately smaller southwestern and Florida markets. A recent Walker & Dunlop Insight also speculated that there may be room for growth in some markets based on rent-to-median-family-income ratios. While nationally that ratio is 26%, the Great Lakes region – which encompasses major markets like Chicago, Columbus, Detroit, Grand Rapids, Indianapolis, Milwaukee, and Minneapolis – averages 19%, potentially leaving room for rents to run.

The SFR market remains strong

Despite some slight hiccups that the SFR/BFR market is experiencing, scarce home inventory, high interest rates, and record-high home prices are keeping the market strong.

“There's a lot of people within a class A multifamily asset that might not be interested in living out in the (suburbs) and looking at a single-family rental for a three-bedroom home,” said Zelman. “But I also think it's also clear that affordability is stretched in the for-sale market and that builders are actually turning to the rental market….They're continuing to move forward on their overall plans and strategies to develop more lots for the rental market. So our expectations will continue to rise in 2023.”

Although there are some troubling headwinds in the multifamily market, it remains real estate’s most sought-after asset class, due to its relative stability and predictability for investors.

Read Transcript

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