The State of Opportunity for Multifamily Investors amid Macro Headwinds

It goes without saying that 2023 has been a challenging environment for commercial real estate, including the ever-stable asset class of multifamily property. This asset class depends on leverage of varying degrees, and the interest rates for acquiring that leverage has just seen the fastest and largest increase in recent memory. While that has presented challenges, there still exist considerable opportunities.

Those opportunities, like any investments, will carry different risk-reward profiles. Different approaches are more risk adjusted with moderated potential returns. Other approaches may yield better returns but carry higher risk qualities. Either way, gone are the days of high liquidity driving value growth. These are the days where micro-strategies within the asset class will give investors better outcomes.

What are the current opportunities within this asset class as we approach 2024?

Class A and B Properties in Submarkets with Low Projected New Unit Supply

It would be inadvisable to say that all high quality Class A and B properties have uniformly low risk. While most of these properties photograph and tour well, it’s the uncurrent of supply within an asset’s submarket that is even more important. Yes, the tenant base in Class A/B are more responsible and less likely to pay late or need to be evicted. They tend to be more loyal and likely to renew even in the face of rent increases. Class A/B tenants tend to absorb more added service fees like trash concierge, Amazon storage lockers, preferred parking, etc.. But, what can stunt revenue growth with any class of property is incoming supply.

One of the better opportunities for multifamily investors currently is Class A or B properties in submarkets with a low projection of new units coming online. Strategic operators and investors will take a very micro approach to identifying those submarkets that are not going to be overrun with new units in the coming 3 to 5 years. While many submarkets will have some amount of supply almost always coming online, it’s those with large inbound supply that can cause troubles–even for Class A properties.

High Occupancy Assets in High Occupancy Submarkets

Having partnered in heavy value-add syndications where acquisition occupancy was lower than stabilized occupancy, we can tell you growing the occupancy of any asset a large amount is very challenging work. Stabilizing occupancy can be done. It’s done quite often. But the risks are higher with assets in which historically occupancy is not above 90%+. If historical occupancy is low, the local market is telling the investors something is fundamentally wrong with how the property aligns with local renters.

We don’t think investors should stop at the asset’s occupancy, however, when identifying quality opportunities. Operators and investors will be rewarded by finding high-occupancy assets in submarkets that also have high occupancy rates. When a submarket has 92% or more occupancy, it’s risk adjustment because the supply-demand scales are heavily favoring property owners.

Deals with Fixed-Rate New Debt or Assumed Fixed-Rate Debt

There are still deals in multifamily that are being executed with variable rate debt. And, just as before, these loans are being supported by operators buying interest rate cap policies. If we are at peak interest rates, these operators will perhaps someday be proven correct as interest rates drop over the lifecycle of the acquisition. Yet, given the Feds position, the persistence of inflation, and overall unpredictability of midterm interest rate behavior, we think it’s more prudent for investors to partner in acquisitions with fixed-rate debt that still allows for adequate investor return projections.

The exact interest rate of loans from Freddie and Fannie depends on a number of factors, However, new loans are not the only way for multifamily operators to acquire leverage for buying new properties. Loan assumptions are another great way for operators to get fixed-rate access in property acquisitions. For those sellers who originally obtained fixed rate debt prior to the 2020-2021 liquidity bubble (or those operators who rarely used fixed rate during that bubble), their loan terms are extremely attractive. In fact, the terms on those loans are far superior to anything that can be secured currently. Many of these loans allow the buyer to assume the seller’s position on that loan during the property ownership transfer. In these loan assumptions, the buyer gets to carry on with the seller’s favorable loan parameters.

Opportunistic Debt or Recap Funds

With so much variable rate bridge debt expiring in 2023 and 2024, there will be well performing properties put into financially vulnerable positions. With valuations and leverage lower and interest rates elevated, some well performing asset managers are in a pinch. They face cash-in refinances. Or they may be forced to buy new interest rate cap policies at very high prices. Almost none of these deals will have $1-2m in reserves that can be used for these purposes.

This is where opportunistic debt or recap funds are starting to move in. Sitting on the sidelines of the multifamily asset class is a large amount of “rescue” capital ready to be deployed. Fund managers are looking for high performing assets in need of capital due to either expiring terms or interest rate cap policies. These funds look to deploy their capital in varying ways. Some may find opportunities to inject the assets with liquidity in exchange for preferential positioning within the waterfall structure. This positioning ensures their return of initial investment plus very healthy returns—oftentimes at the expense of the original investors in the deal. Other recap groups may look to leverage their rescue capital to completely take over the asset from the current operator and investors. This allows them to utilize their capital to “buy” an asset for 50 cents on the dollar—-or even less in some situations.

If the underlying asset has healthy occupancy and NOI, these opportunities can yield very favorable outcomes for investors as valuations start to stabilize over the next few years.

In conclusion, there are ample opportunities for investors in the multifamily asset class. It has everything to do with looking for high quality assets in high quality markets. There are opportunities with more risk and less risk. The key for every investor is to understand both the asset in which they are investing as well as their own risk tolerances and return expectations.