What Is Next For Multifamily Transactions?
What Happened. The Federal Reserve began a cycle of interest rate hikes in Q1 2022 to stem the tide of inflation. Since then, SOFR has spiked approximately 500 bps and the 10-year Treasury has increased 225 bps, with the consequence that:
The average cap rate on multifamily real estate (MFR) transactions have widened almost 100 bps to 5.7%;
The quarterly dollar volume of MFR transactions in Q1 2024 plummeted to $21.2B from $73.1B in Q1 2022.
We believe transaction volume plummeted because (i) borrowing costs greater than cap rates created ‘negative leverage’ that drove prospective MFR buyers out of the market and (ii) sharply lower MFR property valuations caused prospective sellers to defer liquidity exits for as long as possible.
Liquidity Cannot be Deferred Indefinitely. During the 2020-2022 period, when new construction of MFR increased and transaction volumes were high, developers and acquirors took advantage of SOFR rates at ~25 bps and funded their projects and acquisitions with 75-80+% advance rate, three-to-five year floating rate debt. These loans are now maturing in significant volumes but, with SOFR now at more than 5%, these loans cannot be refinanced in the amount of the outstanding debt because loan-to-value and fixed charge coverage ratio covenants are not achievable without a significant equity capital infusion.
What’s Next. Prospect believes that the pending maturities of MFR mortgage debt is creating a window over the coming 12-24 months where current owners, after exhausting lenders’ patience with forbearance extensions, will be forced to recapitalize or sell MFR properties in order to avoid foreclosure. We expect to see prospective MFR buyers that have liquidity begin to jump into the market to provide the liquidity that these ‘unwilling sellers’ require to avoid foreclosure, albeit at prices that reflect price capitulation reflective of what we see as becoming a distinctly buyers’ market.
Disclosures
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