Thinking outside of the multifamily box

Until now developers have sought to capitalize on the greater returns offered by the residential market, but the landlords’ market is turning as prices and rents level off.

As the residential market overheats across the US, lenders and developers will need to address the lack of supply across other major asset types 

At a four-way intersection down the street from my apartment in a gentrifying Brooklyn neighborhood lies a microcosm of the US multifamily construction pipeline: a recently completed rental building at one corner, and three residential developments in progress on the remaining three.

Until now developers have sought to capitalize on the greater returns offered by the residential market, but the landlords’ market is turning as prices and rents level off.

As CoStar wrote in a report last week, “an unprecedented pipeline of new supply is beginning to exert pressure on multifamily market fundamentals nationally.” 

thinking-outside-the-boxDevelopers could do existing residents a greater service by turning to the other major asset types instead of piling new apartments and condos into an already saturated market. Ultimately, they will have to. 

At my Brooklyn intersection, one of the residential buildings was completed about a year ago with a banner advertising rents that were frankly exorbitant, and the avenue-facing retail remains vacant.

Otherwise the picture looks bleak: two of the developments have seen little to no vertical progress since they were purchased by their respective developers in August 2014, and the final project has stalled mid-way through construction due to an alleged design flaw.

Meanwhile, much of the retail moving up and down the intersecting avenue remains unchanged and unexciting, if not impractical — not unlike the situation in neighborhoods across the country.

“Just about every major urban area in the country is under-supplied in retail,” Spencer Levy, Americas head of research at CBRE, tells me, adding that “we have not built anywhere near” the level of office or industrial that was built during the last cycle either.

“This is also true in many older/more established middle income areas of major cities, [where it’s] still very hard to find a traditional grocery store and other ‘necessity’ retail,” he says.

But regulations and other burdensome market conditions are making it difficult for both lenders and borrowers to address the lack of supply that still exists, Levy says. That includes volatility in CMBS, pending Dodd-Frank risk retention rules, regulations on the banks, and a more conservative underwriting approach from lenders.

“It’s clear that debt providers are underwriting more conservatively… and availability for borrowers has gotten more challenging,” Levy says.

Though spreads have tightened significantly after volatility earlier this year, they never compressed back to levels seen during the prior cycle. For banks, regulations have caused a pullback out of riskier parts of the market, particularly when it comes to construction lending. And conduit pricing has served as a “proxy for increased pricing” across lending groups (think non-banks and insurance companies), especially on construction loans.

“We have more room to run here because new supply levels are not where they were previously,” Levy says.

But for developers looking to borrow and build, paying more for loans is obviously discouraging. And if one thing is certain, regulations and volatility aren’t going away anytime soon.

As the end of the real estate cycle looms, lenders may need to relent on pricing, providing incentives — along with government agencies — for developers to focus their attention on under-served asset classes instead of the overheating residential market. In a perfect world, addressing this imbalance could benefit all, including lenders, borrowers and neighborhood residents. 

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