More Multifamily Supply Slated for 2016

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LOS ANGELES—More multifamily product is headed for the market in 2016, according to Cory Stehr and Cole Martens, brokers in Lee & Associates LA North/Ventura office. Stehr and Martens have seen a huge increase in valuation requests at the end of the year from multifamily owners looking to sell sometime in 2016. They say that the idea that we are hitting a market peak is encouraging owners to list, but they also note that this could mean a flood of product hitting the market at once. Either way, they expect to see transaction volume increase significantly next year. To find out more about this shift, what is driving property owners and how an increase in product will affect the market, we sat down with Stehr and Martens for an exclusive interview.

GlobeSt.com: Why do you see product increasing in 2016?

Cory Stehr: In 2015, cap rates have really made the move to 4% and upper-to-mid 3% for institutional deals and certain deals that had a value-add component, and I think the consensus in the market was that is about as far as rates could compress given the capital markets and the cheap cost of capital. I think that a lot of people understand that cap rates are really a function of how you finance deals and your cost of capital. Rents have also started to plateau. As a result, we are seeing with the mindset that if there was a time to get out, now would be the time. A lot of people are also selling as part of their business plan. 2005 was a very busy year on the fund side, and most funds have projected 10-year holds, so we are going to see a lot of those deals come out. Some of the people that raised those funds want to be ahead of further rate hikes.

Cole Martens: In the last few years, we have seen a lot of guys sitting on the fence because every year, they see the new highest price per door or the lowest cap rate. Those people have been sitting on the fence, watching the numbers go up and up, and at some point, there is only so far it can go. Cap rates have been compressing right in line with interest rates, especially in the prime markets, and guys are starting to realize that it is time to capitalize on this pricing before we see a turn in the market.

GlobeSt.com: Are you seeing owners move capital out of multifamily and into other asset classes?

Stehr: We are seeing a bit of both. Some of the funds that don't have money to exchange because they have raised the money from endowments and nonprofits are not exchange. A lot of the moms-and-pops are exchanging, but the comfort of knowing that there is inventory in the market is driving a lot of those exchanges. For the first time, we are starting to see a lot more inventory in the market, and that gives sellers a degree of confidence that they will be able to find an upleg.

GlobeSt.com: When you do have sellers exchanging, is there a preferred asset class, or is it pretty diversified?

Stehr: It is pretty diversified. We are seeing a lot of guys going outside of their discipline. If someone is exchanging a core asset, they are also willing to look at a value-add deal, and vise versa. It is really a function of what is going to drive the highest after-tax yield to these investors. A lot of them are feeling very confident.

GlobeSt.com: The limited supply has fueled the compressed cap rates and the rise in pricing. With more supply coming online next year, do you think we will see more of an equilibrium between a buyers and sellers market?

Stehr: I certainly do. We could see a rush of sellers moving to the door at once. A lot of what has driven these prices is, like you said, a lack of supply. For the guys that did step up and execute a disposition, there was limited inventory, so to satisfy their exchange, they really had to pay up for something or entice a seller to take the same risk. With interest rates as well as increasing inventory, we may have a situation where we see sellers all hit the door at once and we may see prices soften.

GlobeSt.com: Do you think the Fed's rate hike last week is helping to encourage owners to sell?

Stehr: I think that overall people in the industry have called the Fed's bluff for quite some time. Most people thought we would have a rate hike in 2013 and 2014. At a certain point in the last four quarters say that they'll never raise rates. Cheap money and this monetary policy is the new norm. Now that we have had our first hike, obviously no one has a crystal ball, but we certainly know that the days are numbered for this low cost of capital environment. So, for people that were holding out to see that, it has been proven. I have two clients who were waiting to see this decision and have now come to us an asked for valuations.

GlobeSt.com: When do you expect we'll see this increase in sales?

Stehr: I think the first quarter is going to be a little lighter, but the second and third quarter will be very active. Now that we have had this rate hike, it will take some time to digest and strategically look at the impact on pricing, and that will move us into the second and third quarters, especially on some of the larger transactions. I think transaction volume in 2016 is certainly going to outpace 2015.

Martens: Absolutely. Cap rates have always been a function of interest rates. If anyone had an inkling to sell their building, they have to realize that as interest rates go up, so will cap rates. If they want to capitalize on today's asset valuations, they have to be considering selling in the next few quarters.

GlobeSt.com: In which markets are the most owners looking to sell?

Martens: I would say owners in more tertiary markets are more motivated to sell because we have seen huge swings in any downturn, and those markets get hit a lot harder than core Los Angeles markets.

Stehr: We are seeing it all over, but definitely the most emphasis in tertiary and secondary markets. But, we are seeing a lot more interest than we normally see in the primary markets. I think a lot of guys were looking at those almost as a bond backed by real estate, so if you could get a particular deal at a 3 cap or a 4 cap unlevered on some of these trophy deals, guys were buying them because it is a spread above the treasury and it is backed by real estate. If that continues to move, obviously the real estate market is going to move with it. There are a lot of sellers that are stepping up there, just not with the same urgency.