Filed under: Apartment Building Investment Cycle, Multifamily Investments
The Strange Tale of the Seattle Apartment Building Investment Cycle
Back in 2012 it appeared that Seattle’s movement through the real estate cycle was stalling out. Not the actual market by any stretch of the imagination but instead where it was placed on the apartment market cycle charts in the Cycle Monitor report from Dividend Capital Research. These quarterly reports on the real estate market cycles for the five main Commercial Real Estate (CRE) sectors in more than fifty markets around the US were widely followed but something was wrong.
The reports are written by Dr. Glenn Mueller, one of the leading experts on real estate market cycles who published his first paper on them back in 1995 when he was National Director of Real Estate Research at Price Waterhouse (now PWC): Mueller, G. R. (1995). Understanding real estate’s physical & financial market cycles. Real Estate Finance, 12(3), 51-64. I can’t find a source online for that paper but here is a link to his 1999 paper: Real Estate Rental Growth Rates at Different Points in the Physical Market Cycle.
Professor Mueller has presented his work in testimony to Congress as well. His presentation has expanded over the years but the core understanding of CRE market cycles remains. Here are slides from a presentation last year: Commercial Real Estate and Market Cycles March 2014.
So he knows what he’s doing and has been doing it a long time, you could say he wrote the book on CRE market cycles. But still as I’ll show something definitely went awry with Seattle’s trip through the apartment real estate cycle. In doing so I’ll cover a number of issues that investors and advisors should be aware of when using research provided by sources that do not have a strong local presence in your target market.
The problem was that while the Cycle Monitor had Read more
Filed under: Apartment Building Investment Cycle, Multifamily Investments
…In its apartment building investment cycle?
Well Integra Realty Resources (IRR) is just out with their 2015 Viewpoint Report covering where they think things are and where they might be headed in the five major sectors of Commercial Real Estate (CRE); office, industrial, retail, multifamily and hospitality… as well as a bonus piece on self-storage. IRR is one of the largest independent commercial real estate appraisal firms in the U.S and this is their 25th annual IRR Viewpoint in the fifteen year history of the company according to their chairman in his introduction. Not sure on the math there but I do have their reports going back to 2002.
In the report they cover cap rates, going-in cap rates, discount rates, yields, reversion rates and much more but the first thing I look at is their market cycle chart for the multifamily sector:
So IRR has an idea of where your apartment market is, provided your market is in one of the sixty plus places where they have an office. The big question is do you agree with their placement? It is very important to review the data and form your own idea on this because there are good reasons to doubt Read more
Once again apartment building investment loan rates have hit the hard boundary of 4.5% even while the 10yr Treasury (T10) falls back below 2% for the first time since May 2013. This is causing the 120 day average spread to begin bending upwards. Currently it’s 2.178% on the back of a 2.46% weekly spread as of Monday when the T10 was passing through 2.04% on its way to 1.96% yesterday:
The ULI <60 LTV rate has been bouncing in the 3.5-3.6% range but that’s a function of it being quoted on a spread basis and the only change there since the middle of November was when it dropped 1 basis point (1bp) in the middle of December; chalk it up to holiday season hibernation.
It really looks like The Great Columbus Day Apartment Loan Rate Massacre was the Read more
The 10 year apartment building investment loan rate we track has returned to its old boundary of four and a half percent despite Treasuries in the two and teens again at the end of November. On the 28th the T10 was within 1pb of the mid-October Massacre low of 2.17. Something had to give for the loan rate to get back to the 4.5% range and it was the spread which jumped above 2.25 last week for the first time since February:
The spread has gone from the Massacre low of 1.93 to 2.28, a 35bp climb in only seven weeks. Meanwhile the ULI <60%LTV last week was 3bps below its mid-October low, tracking the Treasury with a consistent spread of 1.38 in four of the last five weeks.
It’s interesting that the spread plunged below 2% at the same time the T10 was falling back to levels not seen since May of 2013 but more pressing is why the spread has been widening the last several weeks. Is just the year end, a time to get business wrapped up, AKA don’t bother us with new loan requests while we’re trying to lock in our bonuses for this year? Or is it really just the old 4.5% is the lowest we’ll go no matter what Treasuries do coming back into play after a momentary lapse?
With the Euro and Yen falling Treasuries are very attractive and are likely to remain that way for the foreseeable future, meaning the T10 could be hanging around in the low 2s for a while. In Jan. 2013 the loan rate was 4.5 and the spread was 30 basis points higher than today and got as wide as 2.8% in the end of April that year while the Treasury got all the way down to 1.7% so my thinking is it’s the boundary not seasonal.
Speaking of the spread between the T10 and the apartment building rate we track, the green line on the chart represents the six months trailing average spread. We track changes in the trend for signs apartment lenders becoming more or less competitive. Note that since rates are only quoted on business days the chart averages the last 120 business days which roughly equates to six calendar months.
We track the 10 year Treasury (T10) because that is the benchmark most lenders base their long term rates on. In order to lure investors away from Treasuries to buy mortgage bonds lenders have to offer a premium (AKA ‘spread’) over what can be earned on the Treasury. So when the T10 moves, rates on all kinds of longer term loans including on apartments tend to move also. As you can see in the chart, the spread also widens and narrows as market forces make an impact.
Notes about the apartment loan rates shown in the chart above: The rates shown here are from one West Coast regional lender for loans on existing apartment buildings between $2.5 – 5.0M. The rate quote they send every Monday that I track is a 30 year amortizing loan with a fixed rate for 10 years (They also have other fixed periods at different rates). The max LTV for this loan is 75% (they have an even lower rate on their max 60LTV loans) and the minimum Debt Cover Ratio (DCR, aka DSR or DSCR) is 120. Note too that these are ‘sticker’ rates, LTVs and DCRs and ‘your millage may vary’ depending on how their underwriting develops. I usually figure that we’ll end up at a 70LTV which also helps the debt cover and provides a larger margin of safety, which is half the battle from a value investing standpoint.
The prepay fee is 5,4,3,2,1% for early repayment in the first five years and you do have the ability to get a 90 day rate lock. The minimum loan is $500k (at a slightly higher rate for less than $1M loans) and they’re pretty good to work with as long as you go in knowing that it takes up to 60 days to close their loan. If you are looking at acquiring an apartment building in California, Oregon or Washington I’d be happy to recommend you to my guy there for a quote. Send me a message through this link and I’ll make an introduction for you.
The other rate we track is the from the Trepp survey which the ULI (Urban Land Institute) reports on. According to the ULI the Trepp rate is what large institutional borrowers could expect to pay on a 10 year fixed rate, less than 60% LTV loan for a “crème de la crème” core property located in a gateway market. We track this rate as a barometer of what the largest lenders are offering their best customers on the most secure loans for any advanced warning about future rate and spread changes. Note that the spread we chart is between 10yr loan we track and the T10.
How the St. Louis Fed calculates the 10 year Treasury rate displayed above: “Treasury Yield Curve Rates. These rates are commonly referred to as “Constant Maturity Treasury” rates, or CMTs. Yields are interpolated by the Treasury from the daily yield curve. This curve, which relates the yield on a security to its time to maturity is based on the closing market bid yields on actively traded Treasury securities in the over-the-counter market. These market yields are calculated from composites of quotations obtained by the Federal Reserve Bank of New York. The yield values are read from the yield curve at fixed maturities, currently 1, 3 and 6 months and 1, 2, 3, 5, 7, 10, 20, and 30 years. This method provides a yield for a 10 year maturity, for example, even if no outstanding security has exactly 10 years remaining to maturity. For even more detail see: http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/yieldmethod.aspx
As a reminder, one basis point or 1bp is equal to one-one hundredth of one percent or .0001. When you hear ‘fifty basis points’ that’s one-half of one percent; ‘125bp’ would be 1.25% or a percent and a quarter, sometimes referred to as ‘a point and a quarter’. A bp seems like a tiny number, too fine to make a difference but in the debt world if you can squeak out an extra 20bp on a 100 million dollar deal (like a pool of apartment building loans) that’s $200,000.00 in your pocket. To paraphrase Everett Dirksen: 20bp here, 20bp there and pretty soon you’re talking about real money. If you did that every week for a year that would be $10,000,000 and you’d still have two weeks for vacation!
QE is the most destructive policy for housing in world history. – Dr. Peter Linneman Good for apartments?
Filed under: Apartment Building Investment Cycle, Apartment Finance, Commercial Real Estate, Multifamily Investments
Was on NAI Global’s call with Peter Linneman, their chief economist who had some very interesting things to say for apartment building and commercial real estate investors yesterday. Note he’s an actual real estate guy as well as a Wharton professor and I would have lobbied for a better job title at NAI with his background.
First is about the bombshell quote from above. Linneman said there are many studies about home buying that show the down payment is the issue not the mortgage payment and disputes the whole people buy a monthly payment thing.
If I don’t have the downpayment it doesn’t matter what the interest rate is.
Young people are having a very hard time saving for a downpayment at zero percent interest and their parents and grandparents can’t afford to help at zero percent interest on their savings either. Linneman summed it up by putting it in a golfing context: It’s not the green fees it’s the club membership that make it expensive. Japan is the poster child for this bad policy, they’ve been doing QE for twenty five years and it’s done nothing to fix their problems.
The most interesting thing from a multifamily perspective was that he believes we’re at the beginning of the capital cycle for CRE including apartments:
He also believes that cap rates will Read more
Filed under: Commercial Real Estate, Multifamily Investments, The Economy and Current Affairs
As apartment building investors it’s easy to get so deep into the trenches of our market sector that we get blindsided by political events that don’t make any sense from an economic or investment perspective. With every market being so local and at the same time now subject to institutional interest it’s a stretch just to be able to track what’s happening in the lending environment at the same time. But this is the biggest risk we face; how to avoid Nassim Taleb’s ‘Black Swans’ that could destroy our investment plans. As an options trader Taleb could very easily have been overtaken by black swans if his vision was limited to the distance from his eyeballs to the trading screens he stared at. How wide is yours?
Short of an asteroid strike from another time dimension there really aren’t as many black swans as there are limited perspectives. Many people considered the mortgage meltdown a black swan but there were also quite a number with wider vision who understood how it would all end and some of them made fortunes putting their insights to work. Since we’re multifamily and CRE investors, not leveraged derivative traders we probably don’t spend a lot of time thinking about how to go short the apartment building in that bad neighborhood but how do we develop that wider perspective and still have time to do any investing?
The easy answer is Read more
Filed under: Apartment Finance, Apartment Rates, Multifamily Investments
What a month it was for apartment building investment loan rates. The week we were all wondering How is Columbus Day Still a Thing? The 10yr rate we track fell to a low of 4.139% with the spread between it and the 10yr Treasury (T10) breaking below 2% to 1.929 (See below for details on both). I have to hand it to the ULI, they’re good. They had just said:
It only lasted a week but the rate stayed below 4.5% through the end of the month:
As you can see, that one week the spread was also well below its six month average while the T10 got as low as 2.15%, territory it hadn’t seen since the middle of June 2013. We finally got some updated numbers on the ULI rate which would have been nice to have in real time as it was stepping down consistently for six weeks starting in the middle of September, foreshadowing the Read more
Filed under: Apartment Building Investment Cycle, Apartment Markets and Demograhics, Multifamily Investments
The National Multihousing Council’s (NMHC) latest apartment investment survey out today has market tightness falling to 52 from 68 last quarter. With 50 representing the better vs. worse divide, results show respondents are feeling the bite of new supply plus a bit of seasonal slowdown as well I sense:
While the Sales Volume and Debt Financing measures both improved, Equity Financing also slipped. As you can see from the charts above the results tend to be noisy and I suspect that with the survey format it carries a few behavioral biases as well. You can see that the world was ending according to Read more
Filed under: Commercial Real Estate, Multifamily Investments, Neuroscience and Behavioral Economics
The latest ULI/EY (Urban Land Institute/Ernst & Young) Commercial and Apartment forecast shows that respondents expect price growth to slow during the next three years but they expect better growth than when queried in April this year:
Back in Q2 the economists and real estate pros thought prices would appreciate 7% this year and 5.7% in both 2015 and 2016. Now they expect 10% growth this year and 5.7% next year falling to 5% the year after. These kinds of surveys and charts usually set off all kinds of behavioral economics warning bells in my head but I’ll let you be the judge… The web piece is here, the full report here.
That said, this chart probably is the clearest depiction of how the statistician drowned in water that averaged only three feet deep. What happened to those deals underwritten with the average growth number when 2008 and 2009 came along? To avoid this fate I highly recommend reading Sam Savage’s The Flaw of Averages: Why We Underestimate Risk in the Face of Uncertainty (http://amzn.to/PKIaOc on Amazon)
Filed under: Multifamily Investments, The Economy and Current Affairs
Video: Dr. Philippa Malmgren explaining the connection between your investments and all the geopolitical wrangling taking place right now.
The exec sum:
- Leading industrialized nations carry (and continue to pile on) unsustainable levels of debt
- Most options for reducing the debt are non-starters:
- Reduce current spending- Not good for re-election in a democracy
- Reduce future spending by cutting retirement and healthcare benefits- Also politically untenable
- Repudiate debt- Advanced economies run on debt and can’t afford to be cut off from debt markets
- Restructure debt- Again advanced economies can’t afford to cut off from debt markets
- But there is one tried and true method