When the single-family residential market boomed from the late 1990s through the mid-2000s, builders were so flush with cash they could afford to overpay for raw land, thus crowding out those who wanted to build multifamily rental housing.
The pace of rental housing construction quickly fell behind the 350,000 units needed to maintain balance in the market. Things got even worse during the Great Recession, when only between 100,000 and 170,000 new units were constructed annually.
So the recent boom, which saw almost 230,000 new multifamily units constructed in 2012, is about catching up to demand.
To get to that number and, hopefully, beyond, capital has to be readily available, and at least one major lender to the industry believes that although demand is there, the recovery is fragile and it wouldn’t take much more than a rise in interest rates to cause considerable problems in the whole sector.
First, the good news.
Of the top 180 metros in the country, 44 doubled the amount of multifamily construction in 2012, according to a study by John Burns Real Estate Consulting that was released toward the end of last year.
To quote the study, "Among the major markets, the growth is staggering."
I checked in with Lesley Deutch, a John Burns vice president, who worked on the report.
One has to look closely at the data, Deutch said, because smaller markets are included and, on a percentage growth basis, they can distort the picture.
For example, Bend, Ore., saw only two multifamily permits in 2011, but issued 120 in 2012, so the percentage of growth looks astronomical. The same would be for cities such as Huntsville, Ala., Pensacola, Fla., and Prescott, Ariz., all of which had fewer than 30 permits in 2011, but more than 100 in 2012.
This isn’t to say some larger markets weren’t showing extraordinary growth.
Durham, N.C., saw multifamily permits increase more than 400 percent in 2012 compared to 2011; West Palm Beach, Fla., close to 250 percent; and such cities as Charlotte, N.C., Jacksonville, Fla., Austin, Texas, Fort Lauderdale, Fla., Fort Worth, Texas, Raleigh-Carey, N.C., Atlanta, Ga., and San Jose, Calif., more than 100 percent.
In terms of number of permits issued in 2012, Austin and Atlanta led the pack, issuing almost 5,000 permits in 2012; and then came Charlotte and San Jose at about 4,200 units.
"In certain markets, we are seeing more multifamily construction than single-family construction," Deutch said. New York leads that group, but there is always more multifamily than single-family built in New York. Nevertheless, this list is a long one, including such markets as Los Angeles, Dallas, Seattle, Miami, Denver, Chicago, Columbus, Baltimore, Daytona Beach and Newark-Union, N.J.
One of the big reasons for the growth, Deutch said, "is that banks are starting to loan again to multifamily. There is a lot of private equity out there because lenders realize how strong the sector is. The banks were a little nervous at first, but they opened up their lending windows for multifamily."
Despite all the construction, "rents are still going up," which is a positive signal for lenders, Deutch said.
With good times abounding, one would think the multifamily lending market would all be on the same wagon, but that’s not the case.
At the end of 2012, the National Multi Housing Council and National Apartment Association issued a white paper outlining key principles to stabilize financing for the multifamily sector.
The white paper makes a number of key points: the industry supports a return to a system dominated by private capital; private capital-only finance distorts the market because it mostly plays in the high-end side of top-tier markets; and Fannie Mae and Freddie Mac even out the market.
One of those private lenders in multifamily is CIT Group Inc. of New York, and Matt Galligan, group head of CIT Real Estate Finance, said his company expects to do $150 million in lending to the multifamily market in 2013.
Although CIT Real Estate does new-construction financing, Galligan has been focusing more on refinancing B-quality apartments with experienced developer/owners that are trying to upgrade to A.
"We like the fact that these apartments might trade at a 6 percent or 7 percent cap rate (capitalization rate, or rate of return on an investment property based on expected income property will generate)," Galligan said.
To which he added, "If you are going to be building new units, those are going to be Class-A; and that is where the competition is, and cap rates are at 4 percent," which is a small return that could be endangered if mortgage rates rise even a small amount, say, 100 basis points.
Despite private equity back in the multifamily lending game, to some extent Fannie and Freddie have been the dominant players, setting mortgage rates low.
Galligan doesn’t trust the two GSEs, and believes they should not be in the multifamily market.
"They are subsidizing the multifamily lending business, causing all sorts of wildness. People are flooding the market because of below-market rates." Galligan said. "Either do something with the GSEs or crank rates up by 200 basis points. If these things are being underwritten at a 4 percent cap rate, you now have yields at 2 percent. Then all you need is a little bit of vacancy or a decrease in reserves and you have problems."
When I told Galligan about the John Burns numbers, he was more concerned than thrilled.
"Fourty-four markets? Let’s make the assumption there are 12 primary markets in the country, that leaves 32 other markets with a lot of new construction," he said. "You are probably going to need $1,200 to $1,500 a month in rent to make new construction work, which is harder to get to in secondary cities. And there’s competition in those cities already. Maybe your product steals market share, but it is going to force a glut."
He added, "At a 4 percent cap rate, all you need is rates to bounce by 100 basis points and you are going to wipe out an investor’s equity. That’s been our concern."