The COVID-19 pandemic has had a profound impact on the real estate market, with demand decreasing in the hospitality industry and among many others. However, in the luxury apartments sector, many tenants elected to hop on the trend of paying more for less and valuing quality over quantity; as a result, the demand for luxury apartments has increased significantly. According to JLL, overall leasing volume in luxury property types has increased 24% over 2021 activity and a record number of leases have been signed (1). This activity illustrates the resiliency and relevancy of luxury properties within the real estate market which proves to be valuable information for investors and developers who would like to capitalize on this market.
One of the major driving factors for the increase in demand for the luxury apartment sector is the increased growth of the U.S. population. In 2022, the U.S. Census data revealed that there was a 0.4% increase, or 1,256,003, to 333,287,557 in the U.S. resident population as well as an influx of 1,010,923 immigrating to the U.S. (2). With the continued population growth, the demand for housing will continue to increase and that proves to be true, especially in the luxury apartments sector. Furthermore, Mike Cobb Jr, director of analytics at the CoStar Group states that the increasing costs of construction and materials make it challenging to construct profitable multifamily properties of lower quality rather than higher quality (3). Not only are developers and investors flocking towards the high-end and profitable luxury apartment market, but consumers are also gravitating towards these properties that boast premium features and access to luxury amenities. This flight-to-quality trend is especially prevalent among young affluent professionals who are looking for places to live that provide access to a variety of high-end amenities within a short walking distance.
With the current economic conditions it is essential to take into account the impact of the Federal Reserve’s interest rate increases and how this can influence the luxury apartments market. At first glance, rising interest rates can pose a potential threat to investors of luxury apartments as they need to pull out money from their portfolios to purchase these types of real estate (4); however, higher interest rates can deter buyers from taking out mortgages to purchase homes which can drive up rental prices and potentially lead to higher profits for luxury apartment owners and investors. For example, JLL reveals in their 2022 end-of-year recap that tenants have signed a historic number of leases for premium rental spaces in Manhattan, with 190 leases starting at $100 or more per square foot and covering a total of 6.1 million square feet. This leasing volume is twice as much as the previous record set in 2021, which was three million square feet for premium rentals.
The flight-to-quality in the multifamily apartment sector is a trend that is continuing to grow in the post-COVID world. Here at Lever Capital Partners, we pride ourselves on our ability to finance all types of multifamily deals including your next luxury apartment project. Our expertise in financing luxury apartment projects in various stages is diverse and extensive and we are able to get you the most accretive financing options catered specifically to your strategy and business plan. We believe that understanding the availability of different capital structures is the foundation for curating the most efficient capital stack for our client’s projects. Our ability to promptly evaluate creative alternatives allows us to direct any project towards the most optimal capitalization structure given the current market conditions and our client’s strategy and goals.
Are you aware medical office buildings (MOBs) are arguably the safest asset to invest in? Since the pandemic, vacancy rates skyrocketed for traditional offices. The Sage Group reported office space vacancy rates in 2022 in downtown Los Angeles and Long Beach, California were 18% and 26% respectively (1). Despite MOBs being a subset of traditional offices, the demand for medical office space stayed resilient throughout the pandemic even with the rise of telemedicine (2). The Connected Real Estate Magazine shared how 2022 vacancy rates for MOBs nationally were only 8% (3). With MOBs outperforming traditional offices, what has contributed to MOBs becoming a reliable investment?
Because of the rise of the aging United States population, the demand for medical office space is increasing. Although there is strong demand, supply is relatively low for MOBs mainly due to construction obstacles that have in turn made existing healthcare properties more valuable.
One of the reasons for this noticeable demand for medical office space has to do with the aging population in the United States. U.S. data census estimates one in five Americans will be 65 and older by 2030 and one in four Americans will be 65 and up by 2060. Because of the aging population, medical-related office visits are becoming more frequent which leads to practices demanding more space. For example, RPC reported that the average amount of current office space per person is around 5.3 square feet, but this number is estimated to increase to 11.2 square feet per person in order to accommodate the higher aging population (4).
Although there is an increased demand for MOBs, new supply is lagging. The San Diego Business Journal claimed supply of MOBs in 2022 does not meet demand (5). Alliance reported that the average price per square foot for MOBs is $498 where retail is $245/per square foot and normal offices are $315/per square foot. Because MOBs are costly and require complex construction standards compared to other assets, there is less activity in the construction pipeline which results in a lower supply. To put this in perspective, there is only 1% of the amount of space under construction for MOBs compared to the existing stock available (6).
Due to the recent pandemic and the realization that there is a significant shortage, MOBs have become a very desirable investment. From the second quarter of 2021 to the second quarter of 2022, the average price per square foot of MOBs increased by 20%. As a result, the limited supply makes existing properties more and more valuable (7). With property values increasing, the average cap rate for MOBs dropped to an all-time low of 5.5% in 2022. Aside from rapidly increasing values, investing in MOBs allows capital providers to diversify their overall portfolios by tailoring their tenant mix in each MOB that they own. This can be done because of the variety of medical tenants in need of the same type of space.
The escalating demand for MOBs presents a momentous prospect for investors seeking steady cash flow and low-risk investment opportunities. As medical practices continue to expand and require more space, the construction of new buildings is anticipated to persist. Capital providers nationwide have expressed keen interest in financing the development and acquisition of such assets, and Lever Capital Partners collaborates closely with these entities, which actively disburse senior and mezzanine debt, preferred equity, and joint venture equity for the acquisition, development, and recapitalization of medical office assets across the country. By optimizing our clients’ capital structures, we enable them to concentrate on operations, construction, and asset management, while ensuring that the capital we procure establishes each project for success, regardless of the prevailing market conditions.
The rise of the Millennial generation has had a significant impact on the real estate market, particularly in the area of short-term rentals. Reaching “peak Millennial” in 2015, USC Professor Dowell Myers states that the majority of this cohort has surpassed the age of 25, which has historically been the threshold for generations entering the first stage of the housing life cycle – homeownership.(1) For millennials, however, they arrived at an inopportune time. From 2014 to 2022, US multifamily rents have increased by a staggering 49%, while wages and salaries at private companies rose only 29.1%. High living costs, coupled with elevated student debt balances, have made it difficult for many Millennials to afford to buy a home.On top of this, Millennial values also gravitate toward short-term living solutions since they offer a more flexible lifestyle than traditional year-long lease terms, granting them very sought-after lifestyles to travel and “live in the moment.” As a result, the vast Millennial cohort has turned to short-term rentals.(2)
Accompanied by the rise in demand, data from AirDNA, a vacation rental analysis company, illustrates that the supply for US short-term rentals has increased by nearly 20% since 2019. Companies like Sonder, a boutique apartment-hotel hospitality company, have expanded their short-term rental offerings by operating traditional condo units like hotel rooms. Marriott has also capitalized on this opportunity by introducing its sub-brand Homes & Villas, a vacation rental platform. For many investors, this short-term rental model can typically yield higher income due to higher daily rates and the ability to adjust prices in high versus low seasons. The distinctive implication for the housing market here is that this approach significantly impacts housing affordability and the availability of long-term rentals.
As investors realize they can generate higher incomes via a short-term rental model through platforms like Airbnb, they are more willing to pay a premium for properties that otherwise wouldn’t be profitable if leased out traditionally. In other words, if a homebuyer can rent out their unit on occasion at the additional monthly mortgage amount from the premium, the decision to pay more can be justified. For example, a homebuyer may consider paying $100,000 over the listing price if they can rent out their unit for a weekend per month at a rate of $600-$665 since this would be the monthly mortgage payments assuming 6-7% interest rates. While this method can make homeownership “more affordable,” the increased willingness to pay at a premium further drives up prices.
On the other hand, long-term rents will rise due to limited supply and increased competition when more traditional units get converted to short-term units. The implication of this offers an opportunity for investors looking to acquire or develop multifamily properties. From core to opportunistic multifamily investors, there is an opportunity to capitalize on the tight rental markets by attracting tenants who were forced out of long-term lease apartments that have since been converted to a short-term model.
In the current economic environment, it’s critical to consider how the Fed’s interest rate hikes control rent price inflation and how that affects the housing landscape. Though the belief is that lowered consumer and business spending leads to lower home and rent prices, that might not be the case. Instead, rising rates can force frustrated buyers into the rental market, increasing competition. Also, rate hikes can limit new construction lending, reducing future housing supply. Either way, there is no clear correlation between rates and rents, but what’s clear is that such raises can create market instability and potentially force the economy into a recession. For short-term rental giant Airbnb, CFO Dave Stephenson says the possible economic downturn hasn’t been enough to cause concern as he believes the increasing number of tourists eager to get back to traveling can preserve demand even in tough economic times.(3)
The decline in homeownership among Millennials and their changing lifestyle preferences, combined with favorable industry trends and financial data, suggests that this short-term operating model is here to stay. Here at Lever Capital Partners, we pride ourselves on our ability to finance your next short-term rental project. Through our significant experience in the space, we are able to get you the most attractive financing the market has to offer. We look forward to discussing your next project and putting together a capital structure that best suits your needs.
When depicting Austrian architect Victor Gruen’s notable rise to fame, Malcolm Gladwell commented, “Gruen didn’t design a building; he designed an archetype.” Gruen’s work, the first introverted indoor mall, became an international icon. The success of the indoor mall remained relatively unchallenged until the notorious retail apocalypse began and was followed by the thunderstorm of COVID-19. Department stores filing bankruptcy have further accelerated the classic indoor mall’s decline and led many to close as they lose traditional anchor tenants. Investors are showing increased sensitivity to the future of the retail asset class with more than $40 billion in CMBS loans for shopping malls coming due from 2022-2024 (1) Despite many fears over the death of the indoor mall, lifestyle centers serving their community as a place to gather regularly (for reasons beyond shopping) still show signs of hope. Connectivity between consumers remains essential as recovery from the pandemic revealed that there is no substitute for human connection. While customers and investors shift away from the traditional indoor mall, people are still gravitating toward the “togetherness” provided by open-air malls classified as lifestyle centers. By offering neighborhood connectivity, these lifestyle centers still serve as both profitable investments and anchors in their community.
Green Street’s November Commercial Property Price Index reports that malls have lost more value in the past seven years than any of the nine other asset classes used in comparison: a staggering 48% decline in property value (2). In Q2 2022 alone, super-regional malls lost 1.3 million SF in net absorption, while in contrast, lifestyle centers saw absorption rise to more than 1 million SF. Demand for lifestyle centers continues to increase as consumer preference shifts towards seeking a recreational experience in retail. From Q2 2021 to Q2 2022, foot traffic for experiential tenants increased by 39.4%, while soft goods, electronics/office, home, and hobby tenants lost traffic with declines ranging from -3% to -12.9%(3). This data suggests that as consumers seek entertainment from their in-person retail experiences, lifestyle centers will become increasingly more attractive assets compared to empty-ing traditional malls. Even in the face of rising gas prices and inflation, open-air lifestyle centers showed visits increased 6.3% nationally from September to October of this year (4). Lifestyle centers inviting people to gather for reasons beyond retail—such as farmer’s markets, small concerts, and holiday gatherings—show promise and longevity. It is their ability to provide neighborhood connectivity that still brings in a year-round regional draw.
Repurposing retail spaces within indoor malls to bring in more of the community has recently gained traction in an attempt to revive the popularity of the traditional mall. With many Gruen-esque indoor malls now lacking the ability to keep retailers alive on their own, owners have begun adding mixed-use operations such as apartments and entertainment, with 32 indoor malls across the country even including health care services (5). A shift away from the retail-only mall allows owners to bring in non-traditional tenants that keep the building financially viable and offer a unique sense of place. However, this rise in popularity of alternative uses in malls further indicates that the traditional indoor mall is not financially viable on its own. Without a vision to promote neighborhood gatherings and bring people together, many indoor malls have lost ground and likely will continue to decline. In the wake of the pandemic, families, and customers continue to gravitate towards togetherness and activity in public. A partnership with the community is thus vital for the success of malls today, which is why lifestyle centers will continue to attract the institutional investment that is leaving traditional shopping malls. Sturdy underlying market fundamentals indicate that developers and investors will continue to see favorable returns on these assets. Lifestyle centers stand at the forefront of the opportunity to provide connectivity to their communities and, because of this, will likely continue to attract investment.
We pride ourselves on our ability to finance many different types of retail projects. Our experience ranges from the recapitalization of existing malls to the financing of inline power centers, neighborhood retail centers, and the repurposing of struggling retail assets. Knowing what capital is available for your strategy is key to getting the right project off the ground and we can quickly assess the financing options to determine which direction to go.
In the past few years, the number of residents opting to live in secondary and tertiary markets has increased significantly. This migration to once less attractive markets has been driven by affordability, the opportunity for growth, and increased residential mobility. So, it’s not surprising to see that these smaller markets are on track to outgrow many major US cities. The increased level of competition and the exorbitantly high cost of entry in primary markets, along with the declining demand for CBD office space due to the Work From Home phenomenon, has driven investors to seek opportunities for profit elsewhere. In this article, we’ll discuss some of the up-and-coming secondary and tertiary markets to look out for in 2023 and the availability of capital for different property types in those markets.
Secondary markets, like Denver, Austin, and Portland, have seen significant population growth and job market expansion creating a need for more housing and amenities. Because these markets have less economic activity and exposure as primary markets, they aren’t nearly as saturated providing ample opportunity for investors. Tertiary markets, such as Charleston, Richmond, and Colorado Springs are not drastically different from secondary markets although they are usually more spread out and have smaller populations.(1)
There is huge investment potential in these growing markets for reasons such as less competition, lower barriers to entry, stronger growth potential, and a potential for higher returns. Over the next decade, members of the workforce and large companies will continue to move into these markets, creating an opportunity for investors to capitalize on more attractive acquisition economics. By entering these markets in the early growth stages, sponsors will be able to take advantage and in turn, see outsized returns on their investments.
Lenders used to be weary of these markets because of the inherent risk of investing in a smaller market with less demand and therefore reduced opportunity to push rents. Debt was more expensive for investors, and they also faced lower available leverage because banks needed to hedge for the riskier investment. Lenders are now keying in on these markets because of the larger demographic trends at play. People are choosing to live and work in less expensive cities as larger companies such as Microsoft, Google, and Coca-Cola move in.(2)
The lower level of competition is based on the fact that real estate private equity firms and big REITs generally focus on primary markets and sometimes secondary, creating fierce competition among themselves. This is driving up pricing and reducing cap rates. On the flip side, secondary and tertiary markets tend to be less popular among big investors and more accessible to all investors, lowering the level of competition and barrier to entry.
We’re seeing a greater focus on specific markets from both the debt and equity providers and therefore make sure we capture as much data as possible as these parameters change. Because of our hyper attention to detail, we’ll only approach the capital providers we know are interested in your target markets.
Implementation of Environmental, Social, and Governance (ESG) criteria within Real Estate investment plans is on the rise. According to CBRE’s 2021 Global Investor Intentions Survey, 60% of the survey respondents have implemented ESG metrics within their investment criteria, a significant increase compared to previous years(1). With the amplified focus on social responsibility, how can you be the next to implement ESG criteria within your investment platform and take advantage of this important trend in Real Estate investing? Socially conscious investors continue to adopt these standards, implementing them in their companies and overall investment philosophies allowing them to achieve attractive returns for investors while creating a positive impact on the environment and community.
Climate Change and its associated impact on our planet are one of the most pressing issues our society faces today. As we move towards a more sustainable future, real estate professionals can take the next step to reduce the negative environmental impacts of their properties. Some of these negative environmental impacts reveal themselves within the construction process and the yearly carbon footprint buildings produce with ongoing operations. To mitigate these negative environmental impacts, developers can incorporate water conservation methods, safe disposal of waste, and the use of renewable energy. One way this is measured in new builds is through the Leed Certification. Getting a property Leed Certified allows a landlord to implement a Green premium on rent while also reaping the benefits of numerous financing incentives. For example, HUD loans have a reduced mortgage insurance premium for green properties. Implementing these features would allow real estate operators to both increase profit and help reduce their burden on the environment.
As a society, recently we have been making major strides in equality, diversity, and other social measures to move towards a more just society. The “S” portion of ESG encourages business owners, managers, and real estate operators to consider the social impacts of their projects. Some examples are the impacts a business or investment has on the local community, a company’s employees, and the suppliers they partner with. Essentially, the goal of this metric is to ensure all of the stakeholders related to a business or project are treated ethically and fairly. To incorporate the social aspect of ESG into one’s investment strategy, investors should take into consideration the impact of a real estate project on the local community. Considering the local community, the lack of affordable housing is a major issue throughout our country. Local tenants are being priced out, and this is being exacerbated by the increase in new development projects and premium rents. Operators can also improve their social impact by focusing on the treatment of their employees by paying reasonable wages, offering various benefits, and encouraging the personal development of employees. One of the most important ways a real estate owner/developer can improve their social impact is by ensuring that the raw materials used in the construction or rehab process are being ethically sourced.
The final aspect of ESG is governance which focuses on how a company or real estate project is governed. Within a business, governance can be in the form of transparency, allowing shareholders voting rights on important issues, or ensuring board members do not have conflicts of interest. Particularly in real estate, firms have been working on improving the diversity of their board of directors and implementing corporate socially responsible policies. Real estate firms have also been adopting new technologies such as benchmarking and reporting platforms to ensure they are meeting their goals in terms of ESG metrics.
In recent years, firms have been working towards aligning their projects in accordance with ESG criteria. Operators have been focusing on incorporating environmentally friendly materials into real estate projects and improving social and governance aspects within their firms. Our society continues to further increase its focus on the implementation of ESG as sustainability and equality for all have become more important for employees and investors of companies. One reason why investors have been hesitant to invest in environmentally friendly building elements is due to the misconception that investing in ESG will reduce profits. As firms focus on environmental sustainability, this thesis is changing as they are finding that implementation of ESG criteria can help increase profitability.
As the industry continues to align itself with the ESG metrics, real estate firms will focus on implementing ESG criteria within their firm and investments. Investment teams are focusing on improving their green metrics within projects by working towards achieving certain certifications such as the Leed certification. The U.S Green Building council is responsible for reviewing projects and then certifying them with the Leadership in Energy and Environmental Design (Leed) Certification. Leed Certification is an internationally recognized green building rating system (2). There are different levels of LEED certification, depending on what sustainability and environmental aspects are implemented in a project will determine the level of LEED certification a project receives. As buildings achieve LEED certification, operators can both improve the lives of the people using the buildings and also charge a green rental premium to their tenants(3). As different elements are implemented to achieve the certification, projects will help reduce carbon emissions, improve environmental quality inside projects, create healthier spaces, and bring in happier tenants. Once owners implement ESG improvements to their projects, owners will be able to charge a green rental premium to their tenants. Green leases will incentivize owners and lessees to maintain certain usage metrics such as electricity per occupant (kilowatt hours per employee), water used by area, and the volume of waste disposed of in landfills as a percentage of total waste produced. With lease structures promoting change, we will start to see an increasing difference in prices between green rental premiums and brown rental discounts for projects.
For the social aspect of ESG, investors seek to implement socially beneficial measures. In the market, we are seeing an increase in affordable housing projects as we see sky-high rent prices. Building owners will also implement health and wellness amenities for their tenants to use. Especially with the recent coronavirus, we are seeing an increased emphasis on improved hygiene measures in buildings. In office space, owners are starting to redesign each of the spaces to promote the health of their tenants with improved air circulation systems and social distancing measures. Mixed-Use, multifamily, and retail owners are working to improve the tenant mix by including more healthy food options as part of their restaurant options. Governing bodies also will work to improve the diversity of their board of directors or executives and improve the tracking of their benchmarks with the increasing use of technology.
Previously the industry did not focus on ESG investing metrics. Lenders and investors did not place an immense emphasis on sustainability, social, or governance factors while looking at projects(4). As of late, investors and lenders have been working on implementing ESG criteria within their own companies, and have been placing more of an emphasis on this space within their investments. As capital continues the implementation of ESG metrics within their work, we will see capital providers creating invectives for ESG-friendly projects. For example, lenders will provide lower interest rates for projects that fulfill certain ESG criteria, leading to the incentivization of investment into a more socially responsible future.
Here at Lever, we have extensive knowledge and experience with a wide variety of lenders. Understanding how Debt and Equity partners are adjusting their criteria to incorporate ESG into their investing strategies, we see where the future is going with the incorporation of ESG into real estate. We can help advise you on the needs and wants of capital partners to help you strategically position your investment to achieve the most favorable capital terms to help support your project. As we see the prevalence of ESG investing in the Real Estate space, many capital providers are adjusting their parameters to incorporate ESG within their companies. Increasing the focus of a project to fit ESG goals, can not only help the investors but improve and grow the local community of investment projects.
There’s a newfound need for office buildings, just not for office space. Work From Home has reduced the need for office space thereby creating large vacancies and in some cases, completely empty buildings. So what does the future hold for such assets?
As you might have heard, the United States faces a serious housing shortage. This has resulted in increased rental rates as demand far outpaces supply. Repurposing vacant office buildings that once were extremely sought-after into apartment buildings has become a highly desired adaptive reuse project for many owners. Due to the dire need for housing, local, state, and federal subsidies for repurposing such buildings have been made available and many jurisdictions have lifted zoning restraints on such projects.
The future suggests that this adaptive reuse will likely be here for many years to come. However, despite the promising profitability of such projects, obtaining affordable financing for it in the current economic and global state is a challenge.
In 2021, the country as a whole had its lowest vacancy rates in office buildings since the 1990s. In California there’s been a four basis point increase in vacancy rates in office buildings from the end of 2021 to the end of Q1 in 2022. As of late April, New York City, which is one of the largest in-person working epicenters in the world, only saw a 37.1% office building occupancy rate. Data from Commercial Edge, a real estate data firm, reveals that Office Buildings’ price per sq. foot has dropped in Central Business Districts to $284 when it was once at $400 in 2019 and $370 in 2020.
While office assets continue to struggle, multifamily apartment buildings are holding their value, as many markets continue to see significant rent growth. Due to the housing shortage, there is strong demand, alongside limited supply, significantly increasing rent. Additionally, consumers are willing to pay months of rent in advance and are paying well beyond the original asking price to ensure they have a place to live. On top of all of that, as interest rates rise the cost of living follows. As a result of this shortage combined with rising interest rates, 1-bedroom (1).
These two trends working together have made repurposing office buildings into residential apartments a highly attractive project. Also, this type of project is even more attractive and profitable, as certain parts of the United States have subsidized portions of such repurposing and have lifted many zoning restraints on such projects. This is seen and proven by the increasing popularity of repurposing office assets into apartment buildings. In the past two years, around 41% of buildings that were repurposed into apartment buildings, were formerly failing office buildings. On top of that, between 2020 and 2021, there were nearly 32,000 conversions, compared to a mere 5,300 conversions in 2010 (2).
Given the soaring values of existing multifamily apartment buildings and the decreasing value of office assets, repurposing existing office buildings offers substantial opportunity for experienced sponsors. However, to achieve profitability with this strategy, creative yet efficient financing is direly needed, given the current economic state. Lever Capital Partners can help! Through our expert knowledge of current real estate trends, economic states, and the capital market space, alongside our significant real estate financing experience, we can help you optimize your capital stack by bringing the most efficient capital to the table that’s tailored to your adaptive reuse business plan and strategy.
2022 will be a transformative era for capital markets in all sectors of the U.S. economy. In order to combat inflation caused by the stimulus measures implemented by the Federal Reserve during the COVID-19 pandemic, the Federal Reserve has recently decided to accelerate plans to increase interest rates. On December 15th, 2021, the Federal Reserve announced that it would end its pandemic-era bond purchases in March of 2022 and plan for three 25 basis point interest rate hikes by the end of 2022.
Due to the leveraged nature of commercial real estate, the rate hike by the Federal Reserve will have significant impacts on both debt and equity markets. As properties are often financed with commercial mortgages, commercial real estate markets are most exposed to interest rate alterations. With the rise in interest rates, we see the cost of debt rising accordingly. There are many debates regarding whether there will be increases or decreases in cap rates as a result of the interest rate increase and current macroeconomic factors.
Fundamentally speaking, increased interest rates lead to more expensive financing. From an equity perspective, acquiring new properties will have narrower margins, and in turn, may create a more conservative market. From a debt perspective, the increased rates may cause a decline in deal flow, however that loss in volume may be balanced by increased margins on invested capital.
The record low federal fund rate at the beginning of the pandemic (0% to 0.25%) reduced the cost of financing, and as a result, instigated a surge in buy-side activity, development, and increased prices. As with any artificial injection of capital to stimulate the economy, there are repercussions; one of which being the rapid increase in inflation. Thus the Federal Reserve’s upcoming move to not only increase interest rates but to raise them ahead of schedule has been a long time coming.
To look at lasting effects on commercial real estate markets, lenders and investors are looking towards two factors regarding interest rates. One, the effect of the interest rate hikes on cap rates, and two, the adaptability of commercial debt markets in regards to a rate hike. Concerning cap rates, there are generally two ways they can move. One, many believe that a rise in interest rates correlates with a rise in cap rates as property values decrease. Two, others believe that with increased interest rates, investors pay more to borrow capital, cutting into profits, and thus decreasing cap rates. However, when considering cap rate movement in relation to interest rates, we must consider a longer timeframe. As a result, it becomes hard to predict changes in cap rates as a result of increased interest rates, as other factors come into play such as capital flows, investor sentiment, and real estate fundamentals. Historically, changes in federal interest rates have not resulted in immediate changes in cap rates. The ultimate question is whether the market is well prepared to adapt to such a change.
Broadly speaking, the effects of rising interest rates are unpredictable. In addition, recent geopolitical developments such as the Russia-Ukraine War make it uncertain where the Fed will go with interest rates. However, we are certain that they will go up, and as such, create an environment for the movement of cap rates and the exacerbation of current squeezes on markets.
Graph 1.1
Graph 1.2
Secondly, we will see some asset classes take the hit worse than others. From the graphs above, we can see how historically speaking, with previous interest rate increases in 2015-2018 and 2004-2005, cap rates have generally compressed. However, stable cash-flowing asset classes with high occupancy rates such as multifamily will fare better than higher risk higher reward asset classes such as industrial, office, and retail. Since the margins on rent from these asset classes become tighter through the increase in interest rates, the risk of industrial, office and retail in regards to defaults will increase. We can see this through Graph 1.2, where apartment cap rates saw less compression than industrial, office, and retail asset classes. While the previous two interest rate hikes have led to cap rate compression, this is not indicative of what will occur in the present day. However, we do see that multifamily generally can withstand these macroeconomic trends better than office, industrial, and retail asset classes.
With the increase in the cost of financing, we will see spreads tighten as value add opportunities diminish. Since the market for many stable cash-flowing asset classes such as multifamily are already facing extreme demand and competition, the increasing cost of debt due to interest rate hikes will continue to chip away at the returns of value-add opportunities. According to Forbes, many investors in 2020 faced a difficult decision of either accepting lower returns with the appropriate amount of risk or finding ways to add more value to hit more opportunistic returns. The interest rate hikes of 2022 will exacerbate this trend as financing becomes more expensive. Ultimately, the interest rate hike will make competitive markets less viable, pushing investors to do two things. One, more conservative strategies such as core and core-plus will be adopted in order to accommodate for the increasing competitiveness of value-add opportunities, and two, we will see expansion towards suburban areas. Regions such as many of the Sun Belt states (i.e. Texas, North and South Carolina, and Florida) have high suburban demand for multifamily. According to Matthews Real Estate Investment Services, the demand in this region is driven by rapid population growth and increasing employment opportunities. With these growth and demand drivers, investors are looking to those areas to find more lucrative value-add opportunities.
According to Cushman and Wakefield, in the long term, this rate increase will benefit the health of property markets. The purpose is ultimately to reduce the potential for inflation to become entrenched, giving way to a more aggressive hike in the future, and potentially causing a recession. In the short term, interest rates are not necessarily a shift away from the current norm, but a force that can exaggerate many of the effects we saw in recent years. Multifamily will continue to offer stable returns, despite its slow yet steady cap rate compression, and investors will become more risk-averse and/or find opportunities in emerging markets.
In a constantly changing market, one slow step could be a missed opportunity. At Lever Capital Partners, our steadfast team of industry experts track the latest trends and understand how to source and utilize the best available capital. Whether you are looking for an equity partner, a lender, or a combination to fund your next project, Lever can advise you on obtaining the most attractive financing the market has to offer. Here at Lever Capital Partners, we pride ourselves on our wide range of experience in refinancing, recapitalizing, converting assets, ground-up construction, acquisitions, and our overall creativity in getting our clients the capital they need for any commercial real estate related transaction. Our industry professionals look forward to speaking with you about your next project.
As we approach the two-year anniversary of the start of the Covid-19 pandemic, it is important to recognize how quickly society has adapted to new work routines and in turn how that has impacted certain areas within the real estate market. With the significant migration from metropolitan to suburban and rural areas, the office and retail markets have struggled, requiring many investors to get creative in how they capitalize on the distressed opportunities. Additionally, working from home has increased the demand for single and multifamily properties. In turn, residential housing prices have skyrocketed, leaving many hopeful homebuyers unable to afford homeownership. As a handful of employers start to welcome their employees back to the office, there is one pandemic trend that is here to stay: the demand for flexible and short-term apartment and single-family home rentals.
Most US workers were not traditionally accustomed to working from the comfort of their own homes. However, due to the stay-at-home restriction during the pandemic, many workers started to utilize short-term rentals in more remote locations. With the uncertainty around when people would be able to return to the office and the risks associated with densely populated metro areas, many employees fled major cities. An astounding number of professionals took the opportunity to experience a nomadic lifestyle, living in a new place every month. While hospitality struggled due to sanitary concerns and regulations, short-term rental demand increased exponentially, leaving Airbnb as the big winner. Because of Airbnb’s business model, they quickly adapted to the changing landscape and were able to offer “covid proof” lodging accommodations that traditional hotels couldn’t compete with. Although many workers are returning to their normal commutes, housing companies are predicting that 20% of workers will continue to work remotely. That 20% represents about 36 million workers, leaving a significant market for short-term rental accommodations. These short-term housing companies are betting that renters will ditch the traditional 12-month lease if a more convenient and flexible alternative is available. That is why companies such as Blueground, June Homes, and Landing are expanding into new cities and adding thousands of units to their platforms. Even JLL and Brookfield want a cut of the pie through strategic partnerships with companies specializing in short-term rentals.
Companies like Blueground, a New York City-based apartment rental company, were able to raise significant capital. Blueground raised $140 million in September 2021. Although Blueground had setbacks due to the pandemic, they are still planning to aggressively expand to 30,000 units by 2025 from the current 5,000 units. The pandemic has accelerated the trend that Blueground relied on: flexibility. The financing that Blueground was able to obtain given the current circumstances was extremely attractive and provides support for the growing market trends in short-term rentals.
Looking at future trends, new demand for short-term rentals will return to the cities according to AirDNA predictions. As vaccines are distributed and attractions reopen, urban travel is expected to begin to recover in early 2022, with urban demand exceeding 2019 levels by 2023. Urban rentals could rebound even quicker than anticipated if business travelers opt for private accommodations, rather than traditional hotels. As the US reopens its borders to international travelers, demand in once highly sought-after urban markets, such as New York, San Francisco, and Miami, will rebound and likely exceed pre-pandemic levels. The increasing demand for short-term rentals will bring in thousands of new hosts, allowing more and more people to stay in short-term rentals instead of traditional hotels. This would create an opportunity for investors to meet the demand by supplying more short-term rentals, whether it is in the suburbs or in mid to large cities.
Unlike hotels, extended trips will become more common than they were pre-pandemic due to flexibility. According to AirDNA, in Q1 2021, the average length of stay was four days, 25% higher than before the pandemic. As leisure and business travel returns to cities that were heavily impacted by the pandemic, the length of stay is expected to shorten, but remain materially higher than 2019 levels. The norm is that more travelers will combine business trips with leisure, which will extend trips, creating a demand for mid-term accommodations.
Multifamily and single-family assets have become very popular because of the current market trends. With limited new supply and strong demand, most short-term rental operators are able to continue gradually raising rates, in turn increasing the revenue earned per unit. Due to the scarcity of housing supply and increasing demand, rates will continue to rise for the foreseeable future, making single and multi-family rentals more and more attractive to investors. The drive to meet the housing supply needs will prompt more real estate development in suburban markets. Meanwhile, banks, insurance companies, pension funds, and mutual funds are aggressively looking to deploy capital in these assets in 2022 as they have significant dry powder ready to be invested.
In a constantly changing market, one slow step could be a missed opportunity. At Lever Capital Partners, our steadfast team of industry experts track the latest trends and understand how to source and utilize the best available capital. Whether you are looking for an equity partner, a lender, or a combination to fund your next project, Lever can advise you on obtaining the most attractive financing the market has to offer. Here at Lever Capital Partners, we pride ourselves on our wide range of experience in refinancing, recapitalizing, converting assets, ground-up construction, acquisitions, and our overall creativity in getting our clients the capital they need for any commercial real estate related transaction. Our industry professionals look forward to speaking with you about your next project.
The effects of COVID-19 have been felt throughout the entire commercial real estate sphere and continue to impact investment decisions across all property types. The pandemic has revealed a plethora of new opportunities in the marketplace, creating trends that are expected to continue into the foreseeable future. One of the most notable trends we are seeing is an uptick in multifamily investment and financing. The combination of record-high rental rates, surging demand, and skyrocketing market values is creating financing and capital event opportunities for property owners while forcing developers and investors to get creative.
Demand for multifamily housing has spiked dramatically in the first three quarters of the year and according to data from property management and analytics platform RealPage, “absorption of multifamily units jumped by more than 255,000 in the third quarter.” This extreme increase in demand can partially be attributed to the post-pandemic job market recovery we’ve been seeing, specifically regarding middle and higher-income jobs. Peter Linneman, of Linneman Associates, “believes that 3.5 million people will return to the workforce in the next six to nine months, and there will be an additional 2 million or more jobs added as the economy continues to grow” (Linneman, BisNow). Subsequently, more people than ever before can afford apartments due to stabilizing incomes related to job market recovery. This can be attributed to “the most recent ADP data from September [2021], indicating a [growth in] jobs [from] the previous two months”, due to the “elimination of the additional unemployment benefits issued in response to the pandemic” (Linneman, BisNow). Significantly more people are seeking employment as covid subsides and there is no shortage of available jobs, from the restaurant business to middle-income level jobs.
Additionally, the average price for multifamily assets has increased over the last 2 years, along with demand. Pricing and demand are projected to continue this upward trend in both the short and long term. In August of last year alone, there were “new construction permits totaling over 57,000 units issued across the U.S.” for multifamily development. This is the highest demand for permits in a single month since June of 2015. The trend is not expected to slow anytime soon, as 450,000 multifamily units are projected to be developed in 2023-2024.
While the demand for multifamily continues to surge as the market recovers from the pandemic, increasing uncertainty around office and retail assets has prompted many to convert those existing buildings. Both office and retail assets have seen record low occupancy rates during the pandemic. As a result, we are seeing many of the distressed properties getting converted to multifamily. This conversion strategy allows investors to capitalize on rising rents and demand in the multifamily sector, without having to buy in at the price levels we are seeing in the residential market. This trend has created a significant opportunity for developers and investors, as “renovations could cost about 30% to 40% less than new construction for the same number of units.” Not only are investors saving on construction costs, but they are also able to buy these distressed buildings at significantly lower prices than comparable existing multifamily properties in the same markets. Multifamily developers have experienced many challenges throughout the pandemic, especially regarding construction costs. These challenges and specifically the increased costs have made it difficult for individuals to start investing in the multifamily space, making the conversion strategy that much more attractive.
While multifamily investors key in on the conversion of commercial assets to multifamily given current market conditions and compressing cap rates, current property owners are able to take advantage by capitalizing on the current borrower/sponsor-friendly state of the capital markets. As cap rates compress, property owners/sponsors can get significantly more attractive debt, whether it be construction, bridge, Mezz, or permanent financing. “Multifamily cap-rate compression averaged 31 basis points in infill markets and 41 basis points in suburban markets” (ADG Multifamily). With market prices at all-time highs and the gradual increase we’ve seen in rental revenue due to record demand, it is the optimal time to get financing for a new project, refinance your existing debt, or recapitalize your equity. Investors have significant dry powder ready to be deployed in the multifamily space, whether it be a conversion or ground-up development. Meanwhile, banks, debt funds, and insurance companies aggressively look to deploy capital in both areas at rates lower than any other asset class.
Lever Capital Partners has significant experience in the multifamily space and can assist you in securing any financing needs for your next project. Whether you own an existing multifamily property and are looking to refinance or recapitalize, or you are a developer looking for construction financing for asset conversion or ground-up development, we have the resources and experience to get you what you need. We pride ourselves in our ability to bring clients a range of financing options that reflect only the best that the market has to offer.
