SECTOR NEWS: What Really Worries Multifamily Investors

Berkadia surveys its mortgage banking and investment sales experts every year to see what issues are at the top of their minds. It also does an internal survey of prospective clients, which it doesn't publish. This year's results for the latter were surprising as the twain definitely did not meet.

"We asked them the same question as we did our brokers—what major trends impacting multifamily financing are on your radar for this year—and access to debt, which was among the top concerns for brokers, was the last thing clients were concerned about," says Ernie Katai, executive vice president and head of Production at Berkadia.

Instead, their number one concern was property-level cash flow, he says. "It makes sense of course. When properties are trading at such low cap rates owners need to be right about their assumptions."

As it happens, Berkadia's 2020 Outlook Powerhouse Poll, which will be released this week, identifies several trends that can move the needle on borrowers' assumptions.

Concerns about rent control are one example. That can make it very hard to value a property, Katai says. So far such problems have remained at bay. "What has happened with the legislation is that it has allowed for rather large increases, such as around 7%. The fear in the industry is that at some point it could be ratcheted down to 1-2%."

From the perspective of investment sales brokers and mortgage bankers, interest rates and the upcoming presidential election are expected to have the greatest effect on multifamily investing and financing in 2020, with interest rates (86%), the 2020 presidential election (44%) and GSE reform (41%) as the top three. For trends impacting multifamily investing, investment sales brokers ranked interest rates (77%), the 2020 presidential election (63%) and debt underwriting (40%) as the top three factors.

GSE reform, to state the obvious, has the potential to lead to significant changes for multifamily finance. For this year, the agencies have a scorecard to follow, Katai says, but as they get better clarity about the path ahead their lending strategies could change. "There is a certain cautiousness that comes with that."

It's not all bad news. Katai also says that the continued uncertainty around GSE reform has "paved a wide, prosperous road for institutional investors and other nontraditional lenders to enter the industry."

Debt funds, for example, are becoming more creative. "Also I think we will see more out of life companies, such as more diversity with product offerings like bridge transactions. Everyone is coming to the table in agreement that they have to be smart and creative."

The poll was conducted in December 2019 of over 150 Berkadia investment sales brokers and mortgage bankers across 60 offices.—Erika Morphy

GSE WATCH: What the Market Should Know as the GSEs Prep for Privatization

As Fannie Mae and Freddie Mac move toward privatization, Jeff Lee, president of Capital One Multifamily Finance, believes they will have to make some important decisions.

Specifically, they will need to balance pure economic returns versus mission-driven business. "There could be more of a focus on return metrics to ensure they could provide an adequate return on capital in the event of privatization," Lee says.

Both Fannie and Freddie are taking steps to fortify their balance sheets at the direction of their regulator, the Federal Housing Finance Agency, according to Brian Stoffers, global president of debt structured finance for capital markets at CBRE.

"The GSEs have credit risk transfer protocols in place now for multifamily lending [Delegated Underwriting and Servicing loss sharing for FNMA and K series risk transfers for Freddie]," Stoffers says. "I think those models are being very well received by the FHFA. In fact, there's some talk of creating more credit risk transfer on the single-family side of the business."

If those models work, it could speed the path to privatization. "Mark Calabria [director of the FHFA] has said that he would like to see this [privatization] largely implemented by 2024 and we have every hope that it could happen if they continue to recapitalize with retained earnings," Stoffers says.

If privatization does occur and there are no government guarantees backing Fannie and Freddie, Ryan M. Haase, director of Capital Markets for Franklin Street, says bonds should trade wider. That, in turn would make the GSE's cost of capital higher, which would result in higher rates to the borrower and consumer and effectively level the multifamily lending playing field.

"With less governmental oversight, the GSEs will have more flexibility to go into alternative and adjacent lending spaces where they might create more production and efficiencies, thus resembling a more typical CRE lending institution," Haase says. "Their mandate is to improve housing affordability, but it will be interesting to see how privatization affects the importance of the bottom line."

Others have concerns about Fannie and Freddie leaving the market. Because of the need for Fannie and Freddie to buffer the market in turbulent times, Gerard Sansosti, executive managing director and debt and loan sales platform leader for JLL, thinks questions still needed to be settled about if the GSEs become completely private or if there is some kind of backstop for situations where credit dries up, such as The Great Recession.

"Unfortunately, the private market has shown that we can screw it up and we cannot create [in downturns] liquidity if Freddie and Fannie aren't around," Sansosti says.

For the time being though, the GSE's should continue to be the backbone of the residential lending market. Citing the Mortgage Bankers Associations forecast, Stoffers says the agencies' percentage of the market should range from the low 40 percent to the high 30's. "They have more money than any lender that I know of with $100 billion over five quarters," Sansosti says.

On the traditional affordable housing funding, Lee says that Fannie and Freddie also both recently re-entered the LIHTC space as equity investors.

"There has been increasing competition for LIHTC in recent years, but this isn't a new trend for 2019 and 2020," he says.—Les Shaver

MARKET VIEW: New York Gets Sense of Pricing Following Rent Control Law

New York's multifamily market has seen an overall lag in investment sales since the passage of the Housing Stability and Tenant Protection Act of 2019. However, a recent uptick in activity in the Northern Manhattan area suggests that investors are becoming active again, according to Ariel Property Advisors.

"The Housing Stability and Tenant Protection Act of 2019 eliminated or altered many different legal mechanisms to increase rents. We're still seeing how the market will adjust, but it is clear that investors are basing values much more off of in-place cash-flow versus future upside," says Victor Sozio, executive vice president and founding member of Ariel Property Advisors. "While this new legislation has presented its challenges, investors have begun to reassess pricing and strategies. We anticipate higher transaction volume in the upcoming months to end the year."

Northern Manhattan has been a particularly bright spot lately with two large transactions skewing the overall dollar volume figure. In East Harlem, for example, L + M Development Partners purchased a portfolio of buildings from Brookfield Properties for $1.16 billion. The six properties consist of 2,654 residential units and 40 non-residential units. Two-thirds of the units will be converted into affordable apartments, with L+M purchasing the properties through its Workforce Housing Fund.

Another example is in Central Harlem where Fairstead Capital bought two properties from Harlen Housing for $75.5 million. The two affordable buildings, located at 50 West 139th Street and 560 Lenox Avenue, contain 214 residential units.

"Activity in 2020 Q1 this year is trending to be more active than the same time last year," Sozio says. "The market has had time to adjust to legislation and so we're seeing larger amounts of valuations and listings. While the market is still hungry for post-legislation multifamily data points, we're starting to see a clearer picture of the new normal."

For instance, he continues, in December 2019, the company led the sale of a 31-building affordable portfolio for $120.6 million.

"The market is getting active again."

In 2019, multifamily transaction volume was down in New York City approximately 36%, from 450 multifamily transactions in 2018 to 290 in 2019, with the dollar value of multifamily transactions down 40% from $11.5 billion to $6.9 billion. —Tanya Sterling

BEHIND THE DEAL: Where You'll Find Distressed Opportunities in 2020

Late in 2018, Daniel Lebensohn, co-founder at BH3, started a debt opportunity fund to purchase non-performing loans. "We are specifically targeting non-performing loans from banks and what we call tourist lenders or folks that have come into the space that are bridge lenders," Lebensohn says. "They took over a huge chunk of the business that conventional lenders shied away from due to the new regulations that emerged after the recession."

These capital providers are handling more sensitize, higher-risk transactions. That makes it more likely that their loans will run into problems, according to Lebensohn. "That's not to say some banks heavily into construction lending won't have their share of distress," he says. "But a lot of these tourist lenders pivoted from equity to debt. Everyone and their grandmother is in the lending space today."

BH3, which bought non-performing loans from banks and recaptured assets in the last recession, is not seeing much distress yet.

"If it was a faucet, it's not quite a drip or a trickle yet, but some of them are chunkier loans," Lebensohn says. "We recently purchased a loan on a Manhattan high rise in July."

That condominium deal, 125 Greenwich Street, consisted of 273 condominium units and 320,000 square feet. "Not all of them [those loans] are that chunky, but there is more coming," Lebensohn says.

While Lebensohn doesn't think there will be the same distressed buying opportunities as there were during the recession, he thinks the cycle is over. "Money is still very cheap, so it's still very compelling to invest in hard assets," he says. "If someone needs to get money out, there will be a lot of appetite to buy. But it's not the same market that it was a couple of years ago."

Lebensohn sees problems in condos, particularly projects developed later in the cycle. "In the higher end, where units are selling for $4 million and up, you will see distress," he says. "Then you'll see it in multifamily where people projected much richer rents than they're getting."

Multifamily could get hit especially hard in areas with rent control laws, which could lead to more problem loans. "One area where you will see it [distress] is in New York City rent-stabilized housing," Lebensohn says. "You have a million units across New York City that have virtually been shut down. There is little to no room for rental increases through the new legislation."

There will also be a limited opportunity for capital improvements.

"Anyone who over-levered those product types, which are predominantly pre-war, walk up over the five boroughs of New York City, will be in some pain," Lebensohn says. "Taxes are going up and utilities are going up, but rents are not going up. I think the legislature got it completely wrong, and the housing will suffer as a result. A lot of capital won't be going into those buildings."—Les Shaver

Exec WATCH

Cushman & Wakefield has hired Michael Movshovich as an executive managing director to lead its new Alternative Investment Advisory Group in New York, a division managing leasing and operations for clients that include hedge funds and private equity firms.

INVESTMENT TRENDS: Top 10 CRE Investment Predictions

At this moment, 2020 looks well positioned for further growth for commercial real estate, albeit perhaps not as much as the pace seen in the last few years. Following are 10 investment predictions for the year that will help shape this year's growth.

1. Rent Control Will Spread in the US New rent control laws were enacted in Oregon, California and New York in 2019 and will spread to other states in 2020 and beyond. Look for IL, NJ, MD, VA, MA, MN and other states to adopt new and disastrous rent control laws in the next few years with the US apartment market eventually evolving into two tiers. The A tier will be states without rent control and pro-real estate policies and the B tier will be the states with rent control and anti-real estate policies. Cap rates will rise 1.0%-1.5% in the tier B states due to the negative effects of rent control.

2. Interest Rates Will Increase Due to the booming economy, low unemployment and higher inflation expectations, long term interest rates will rise. The 10-Year T-Note which is currently 1.84% will increase to 2.75%-3.0% in 2020.

3. REIT Returns Will Soften REIT returns for 2019 as measured by the FTSE-NAREIT All Equity Index will be up over 26% and one of the highest returns since 2014. This is up from annual returns of -4.04% and 8.67% in 2018 and 2017, respectively. We expect 2020 returns to moderate with a total return of 10% consisting of a 3.5% dividend and 6.5% price appreciation. Although returns will decline, all individual investors should allocate 10%-20% of their 401K or total portfolio in a diversified equity REIT fund.

4. CRE Investment Returns Will Decelerate The high and robust returns in CRE the last several years will begin to decline as many properties are overpriced, especially core assets, which are trading at sub 4.0% cap rates. Many properties have seen rents double or triple since the Great Recession and some of these high rents are not sustainable. The retail sector in Manhattan is one example of ultra-high rents that are coming back to reality, with rents on the storied Fifth Ave. and Park Ave. sections, down by over 20% during the past year.

5. Consolidation Among Data Analytic/Software Firms Will Accelerate The CRE data analytics and software sectors will see more consolidation as the larger and well-capitalized firms gobble up their smaller and weaker competitors. The larger firms see acquisitions as a quicker way to scale their business and cross-sell their suite of products. In the data analytics space, look for two public firms to be the industry leaders and acquirers, CoStar Group and Real Page. In the property management software space, look for Yardi, MRI, Skyline and Real Page to be the key players. So far this year, over $1 billion in deals have been completed with CoStar's acquisition of Smith Travel Research, the largest hotel data/consulting firm, for $450 million and Real Page's acquisition of Buildium, a property management software firm, for $580 million.

6. Cap Rates for Apartments in CA Will Increase Cap rates for apartments in CA will increase .5% to 1.0% due to the new rent control laws and higher interest rates. Many long-term apartment owners in the state will be net sellers in 2020 and the ensuing years to realize profits before cap rates begin to rise.

7. The Shadow Lending Market Will Take More Market Share from Regulated Lenders The shadow lending market in the US is comprised of CRE lenders that are unregulated and include; REITs, private loan funds, hard money lenders, mortgage bankers and CMBS originators. The shadow lending market which typically provides short term, bridge, permanent, mezzanine and high yield construction loans will increase its market share from approximately 15% of total loans to 20% of total CRE loans. The total volume of new loans originated in 2018 was a record $574 billion with the shadow lending market accounting for approximately $75 of the total. See also, the section below on the collateralized loan obligation market.

8. 2020 Will be Another Record Year for New CRE Transaction and Loan Activity In 2018, $574 billion in new loans were originated and overall transaction volume was $811 billion, both records. We predict that the 2020 amounts for both loans and transactions will rise by about 5% to new records. This is very good for the real estate brokerage industry as exemplified by the stock prices of the two largest brokers, CBRE and Jones Lang LaSalle, which are at or near record highs.

9. National Cap Rates Will Rise Due to the booming economy and higher inflation and interest rates, average cap rates will rise across the U.S. We expect the increase in cap rates to be 1.0%-1.5% depending on the property type and location. This will be good news for buyers and the $200+ billion is capital that is sitting in private equity funds looking for new deals.

10. The Retail Apocalypse Will Begin to Subside The retail apocalypse of store closures and bankruptcies will begin to moderate. There were major retail bankruptcies in 2019 including; Sears, Payless Shoes, Barneys, Forever 21, Shopko, Gymboree and many more. According to Coresight Research, store closings in 2019 will hit approximately 10,000, while store openings will be about 4,000. Most analysts and research firms expect 2020 store closures to dip to around 5,000 and store openings to be about 4,500.

Joseph J. Ori is executive managing director of Paramount Capital Corp.

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Up Front: What's trending in the world of commercial real estate?

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