Overeating has many side effects; without discipline, you will eventually need a new pair of jeans. We tend to bloat our stomachs until we have no choice but to go on a diet but is the lap-band procedure the best first step? The Fed has been pumping money into the economy to the tune of trillions of dollars with COVID relief, additional infrastructure projects, etc. And within one year, the Federal Funds Rate was increased on six occasions, putting the capital-intensive economy into quick ketosis. Federal Reserve Chairman Jerome Powell's "late-night tv diet" quantitative tightening strategy, which aims to get immediate results, is sure to backfire. World leaders are bracing for an economic recession, and many paint a gloomy picture of the road ahead.
At the beginning of 2022, the Federal Funds Rate was a trivial .09% due to previous periods of quantitative easing, causing the upside of a red-hot economy but the downside of rampant inflation. Facing double-digit inflation, the Federal Reserve began to offload the balance sheet and induce a series of rate hikes. Even with five rate hikes this year, Powell plans to keep his foot on the pedal through Q4. The current federal funds rate as of December 2, 2022, is 3.83%. Such an aggressive change in rates has caused a sharp slowdown in transaction volume as interest rates, and asset prices have adjusted accordingly (as interest rates increase, asset prices decrease).
In 2008, new regulatory requirements made it increasingly difficult for banks and traditional lenders to participate in commercial and construction lending. This sparked a significant increase in boutique debt funds that are nimble and operate with different leverage criteria.
Matthew McManus of M2 Equity discusses the current debt market and the impact of rising rates. With over 28 years of experience in capital raising and structured finance, McManus has seen the booms and busts of real estate lending. His firm originates structured financing products in ground-up development and value-add Multifamily acquisitions. Additionally, the firm participates as an operator of boutique multifamily assets, giving them a competitive advantage in the industry.
We asked McManus, "how his firm has positioned itself in the rising rate environment?". He explains how full leverage rate pricing, 75 - 80% Loan to Cost (LTC), for ground-up, adaptive re-use, or transitional multifamily assets today (Interview in Oct 2022) is hovering around 9%. A 125 - 150 basis point hike compared to six months ago.
To help sponsors facilitate healthy operating ratios, the rate is structured as pay and accrue - 6.5 - 7% paid current from NOI or reserves with the balance paid at disposition. As for their underwriting criteria, while they do not have any debt yield constraints going in, they require a minimum debt yield today on projected stabilized NOI of 7.5%; however, they generally prefer yields approaching 8% to factor in future risk. This is compared to a 6.25% yield in March/April of 2022.
Even in this shifting environment, M2's agility as a firm continues to win them new business. McManus details how two-thirds of his most recent business stems from last-minute changes from other lenders re-trading deals. In addition to their execution capacities, M2 can provide their clients with more leverage than traditional structured capital markets. Today they can push 75%-80% loan to cost on a single loan product.
Higher lending rates pose a risk to assets that previously traded at an extremely low cap rate. We asked McManus his thoughts on the risk of future balloon payments and although he doesn't see the significant risk of an equity wipeout, he explains, "I don't see loan maturity risk automatically attacking the capital accounts of equity investors. I think it's just going to defer and reduce returns" and "If a cash-in refinance is something sponsors decide against, a sale should yield sufficient proceeds to make most investors whole."
M2 is still willing to place some high-leverage bets. They are bullish on growing markets such as Florida, Texas, and the Carolinas. Not surprisingly, many of their investors have requested the firm to invest exclusively in business-friendly states with great employment opportunities. Thus avoiding the risks of some states' policies towards rent control and tenant eviction laws.
Turn on the news, and you will see the most prominent CEOs of finance and banking forecasting a great recession. So, where does an investor place cash they need to deploy? Along the lines of previous articles in this series, "Times of great doubt often present great opportunities". Invest responsibly and do your research. CMBS and structured debt data feeds such as Trepp can be an excellent resource for gauging the operating health of individual assets and markets. You might want to consider additional consumer sentiment indicators: Amazon Sales, FedEx Parcel Volume, and Credit Card Balances.
McManus says the financial stress is not there yet. He commented on the availability of debt now compared to previous downturns. "We lived through 2008. Debt essentially went from being as prolific as it was in the early 2000s to almost zero in 2008. Today debt is still actively flowing. There might be fewer providers, particularly on the structured finance side, but agencies are active."
May 10, 2023
Omaha is most notably known for hosting Berkshire Hathaway's headquarters, but to one's surprise, in CNBC's Top Business States Ranking, Nebraska was #7. The low cost of business and centralized location in the midwest has attracted many new companies and commercial development. As a result, the metro continues to see job growth, with unemployment down 2.7% year over year.
May 10, 2023
Greater Boston is home to over 118 colleges and 346,000 students, making it the city with the fourth-highest concentration of colleges in the United States. Universities, healthcare, and finance drive the metro's economy, but additional housing is desperately needed. The metro is undersupplied by 77,000 units, leading investors to redevelop office space, factory buildings, and more into residential space.
May 10, 2023
The multifamily market's current rhetoric is a swirling cycle of good, bad, and ugly. There still is a housing shortage, rents are declining, capital has dried up, and the Federal Reserve is still raising rates. As an investor, how do you navigate these circumstances? The team at Rockval spoke with Bobby Larsen, Principal of Vanamor Investments, to get his insight on the current market conditions. Larsen has over 16 years of multifamily experience, initially starting his career at PIMCO and eventually moving to MG Properties Group. As the Director of Acquisitions at MG Properties, Larsen helped grow their portfolio from $500 to $4.5 billion AUM during his seven-year tenure.