Lument: Heard at CREF: Consolidation, Cap Rates and More
This year’s Commercial/Multifamily Real Estate Finance (CREF) conference, coming almost two years after the pandemic lockdown, feels like a return to some sort of normalcy. It was a welcome opportunity to get back out into the world, spend time with colleagues from across the industry, and get a better sense of where the sector is heading. By common agreement, CREF attendees believe the fundamentals are sound and that the commercial mortgage industry will continue to perform well as the year progresses.
But there are always some wrinkles that make any year unique, and 2022 will be no exception. Here are some observations from CREF to keep in mind:
The Consolidation of the Commercial Real Estate Industry Will Continue
During the last six months, we have seen a series of joint ventures and acquisitions. They include Cushman & Wakefield’s investment in Greystone, Marcus & Millichap’s joint venture with M&T Realty Capital, and Regions Bank’s acquisition of Sabal Capital Partners.
It is not just an issue of scale and size. There was a growing consensus at CREF that we will see more of these deals because the days of single-specialty shops are fading fast. Simply to remain competitive, firms will need to offer a well-rounded, complementary suite of capital solutions and services.
Part of this has to do with the evolution of the market. With heightened competition, transactions are becoming more complex and more time-sensitive. As a result, investors may need an evolving menu of products, for instance preferred equity, a mezzanine or bridge loan, and agency finance, to make a deal work. At the same time, the efficiencies of going to a single firm for a variety of needs are increasingly attractive to them.
But acquisitions and joint ventures are more easily said than done. Their success depends critically on having a common culture. Time will tell how these integrations will fare.
Rising Prices and Rents May Complicate the Traditional Relationship Between Cap Rates and Interest Rates
Although the war in the Ukraine and its impact on the economy could sway the Fed’s determination to unwind quantitative easing and gradually raise rates, the overriding sense at CREF was that if the Fed stays its course, cap rates will eventually expand. When this might occur and by how much, however, remain open questions.
The performance of commercial real estate — especially multifamily and industrial — during the pandemic and the traditional view of real estate as a hedge against inflation has attracted an influx of capital to the industry through REITs, mortgage REITS, life companies, and other structures. This could act as a countervailing force on rising cap rates, as competition leads to higher valuations. And with rents rising rapidly in many markets, income could support these higher prices.
FHFA Mission-Driven Requirements Could Lead to More Favorable Pricing as the Year Progresses
The pandemic increased the focus on the nation’s affordability crisis — and the ambitious goals FHFA has set for 2022 are an indication of its commitment to do its part. FHFA is increasing its mission-driven business requirements. It is devoting 50 percent of the agencies’ multifamily business to properties with rents up to 120 percent of area median income (AMI), depending on the market, half of which must be affordable at 60 percent of AMI.
Although FHFA maintains that its targets are based on last year’s performance, there is no guarantee that 2022 will unfold the way last year did, especially given the pace of rental increases in nearly every market. As a result, some observers at CREF believe that the agencies may become more aggressive on pricing as the year progresses.
Turnaround Times Are a Priority for HUD and the Agencies
The prospect of interest rates has placed a premium on speed of execution. At CREF, the view was that the steps HUD has taken to reduce the length of its underwriting queue are beginning to take hold. Their third-party contract underwriters have started with simpler 223(f) and 223(a)(7) refis, freeing up HUD staff to focus on more complex affordable, tax credit, and new construction transactions. HUD is currently negotiating a five-year extension of the original one-year agreement, which bodes well for the future. Speed of execution is a critical priority for the agencies as well, but they have not been immune to staffing issues that have disrupted organizations across the economy. Fannie and Freddie are both focusing on hiring, but, for the moment, turnaround times are a bit slower than they would like.