Tag Archives: RealEstateInvestment

How Will Multifamily Operating Expenses Affect NOI in 2025?

by: Dalton Morgan

Multifamily properties have long been considered one of the more resilient real estate asset classes. However, rising operating expenses are posing challenges to profitability. Factors such as high inflation, wage growth, and increased material costs due to supply chain disruptions are driving up these expenses. As operating costs rise, net operating income (NOI) is directly impacted, diminishing investment returns. Read on to see what we think the impact will be next year.

Rising Operating Costs

Operating costs have historically risen over time, but since 2021, the growth has accelerated. According to Moody (2024), expenses like payroll, utilities, repairs, and insurance are increasing at two to three times the rate of the preceding decade. For example, payroll and benefits have risen by $75 to $120 per unit annually, utilities by $55 to $95, and repairs and maintenance by $35 to $95 per unit depending on the market quartile (Globe St., 2024). 

Key Drivers of Cost Increases

Inflation: Rising prices for goods and services are significantly impacting multifamily properties. Utilities, which account for 15%-20% of overall operating expenses, have risen by an average of 10.7% across the top 50 U.S. markets, increasing total operating costs by up to 2% (Matthews).

Construction Materials and Labor: Prices for materials like timber, steel, concrete, and copper have surged due to high demand, supply chain issues, and inflation. Labor shortages are exacerbating the issue. As of May 2023, there were 396,000 job openings in construction (NAIOP). To attract skilled workers, companies are raising wages, which in turn increases development costs, further impacting NOI.

Insurance Costs: Insurance premiums for multifamily properties have risen 33% year-over-year, amounting to an additional $180 per unit (Matthews). This increase is driven by the heightened risk of natural disasters such as hurricanes, floods, droughts, and wildfires, which collectively cost the U.S. between $179.8 billion and $496 billion annually (Center for Disaster Philanthropy).

Impact on NOI and Rental Market Dynamics

Net operating income growth has slowed significantly, achieving only 2.8% in Q1 2024 compared to 24.8% in late 2021 (Globe St.). Owners may attempt to offset rising expenses by increasing rental rates, but market competition and tenant affordability concerns limit rent growth. The oversupply of multifamily housing is another factor. In June 2024, private-owned housing completions rose by 10.4% to a seasonally adjusted annual rate of 1.71 million units, with 656,000 being multifamily units (Globe St.).

With supply outpacing demand and mortgage rates keeping homeownership costly, property owners face limited room to raise rents. Moody’s forecasts asking rent growth in the low- to mid-1% range for 2024, while the gap between asking and effective rents exceeds $90 per unit. For a 100-unit property, this translates to $9,000 in unrealized rental income, while expenses remain elevated.

These factors also put pressure on debt service coverage ratios (DSCR), which generally need to be in the range of 1.20x to 1.25x. Rising expenses reduce the cash flow available for debt payments, heightening the challenges of refinancing and the risk of default, particularly in an unpredictable economic environment. At Lever Capital Partners, we understand the obstacles many investors encounter when acquiring or refinancing multifamily properties. Contact us today for a prompt analysis of your unique situation, so we can provide a customized solution that aligns with your investment strategy.

Future Outlook

Some factors may provide relief for multifamily property owners in 2025:

  • Onshoring and Supply Chain Adjustments: The push for onshoring could stabilize material costs over time. Infrastructure enhancements may balance supply and demand, potentially reducing construction expenses.
  • Interest Rates: Mortgage rates are expected to remain in the low 6% to high 5% range throughout 2025, a notable improvement from the 7% national average in 2023 (US News). Additionally, loan rates from Fannie Mae, Freddie Mac, CMBS, and other sources could drop by 1%-2% due to Federal Reserve rate cuts, easing borrowing costs.
  • Inflation Trends: Inflation is projected to slow to 2.4% by late 2025 (Goldman Sachs). However, potential tariff policies could push inflation closer to 3%.

While the outlook suggests possible improvements, the timeline and effectiveness of these changes remain uncertain. Multifamily investors must navigate ongoing challenges and adapt strategies to preserve NOI amid fluctuating operating costs and market conditions.

The Millennial Influence: What the Rise of Short-Term Rentals means for the Housing Landscape

by: Ao Ma

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.

References:

https://www.nytimes.com/2017/01/23/upshot/peak-millennial-cities-cant-assume-a-continued-boost-from-the-young.html

https://educationdata.org/student-loan-debt-by-generation

https://www.costar.com/article/1874040746/us-short-term-rental-market-poised-for-further-growth

Lifestyle Centers As The Future of The Mall

by: Kennedi Templeton

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.

References:

https://www.bnnbloomberg.ca/cmbs-market-faces-crunch-as-40-billion-of-mall-debt-comes-due-1.1663360

https://www.greenstreet.com/insights/CPPI

https://www.us.jll.com/en/trends-and-insights/research/retail-market-outlook

https://www.placer.ai/blog/placer-ai-mall-indexes-october-2022-update/

https://fortune.com/2022/04/25/shopping-malls-health-clinics-medical-care-conversion-covid-19/

The Growing Popularity of Secondary and Tertiary Markets

by: Michael Wyant

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.

References:

https://www.pioneerrealtycapital.com/compelling-reasons-to-focus-on-investment-in-the-secondary-and-tertiary-markets/

https://www.bisnow.com/atlanta/news/capital-markets/atlanta-tops-global-cre-investor-demand-other-secondary-cities-rising-in-prominence-112755

Investing in CRE: The ESG Framework

by: Brandon Fikhman

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.

References:

https://www.cbre.com/insights/reports/esg-and-real-estate-the-top-10-things-investors-need-to-know#introduction

https://www.tylercauble.com/blog/what-is-esg-investing-and-why-it-matters

https://www.usgbc.org/

https://www.investopedia.com/terms/e/environmental-social-and-governance-esg-criteria.asp