Before vacancy rates reach pre-pandemic levels, there is “Ample Leeway” in the multifamily sector.

In the first half of the year, fewer than 80,000 new households were built, which cooled the market as economic headwinds accelerated.

After a protracted period during which the asset class was experiencing high demand, the third quarter saw a slight decline in demand for multifamily housing as household formation returned to normal and inflation started to affect consumer budgets.

According to a recent Marcus & Millichap analysis, the average effective monthly rent in the United States increased by almost 16 percent in 2021, with certain Sun Belt markets seeing increases of more than 25 percent in just the previous year. But as economic headwinds accelerated, 80,000 fewer households were generated in the first half of the year, depressing the market.

Nevertheless, the research observes that “even with a slower second half, vacancy at midyear leaves ample leeway before rates in most metros approach pre-pandemic levels.” Overall, according to Marcus & Millichap experts, the sector’s future is still promising.

“Despite the 60 basis-point rise in national apartment vacancy during the first half, approximately 20 percent fewer rentals available at midyear across the U.S. compared to year-end 2019,” they claim. “These circumstances and the steep barriers to homeownership support sustained momentum in the apartment sector.”

Over the past two years, the median price of a single-family house has increased by more than 30%, and mortgage rates have reached levels that many customers haven’t experienced in their adult lifetimes. Has a single-family median price. Additionally, according to the firm, “this is widening the affordability gap, or the difference between an average monthly payment on a median priced home and an average rent obligation.” The affordability gap is now more than $1,000 per month, which is roughly three times the size of pre-pandemic norms.

According to the research, “the cost-saving benefits, coupled with lifestyle elements, locational advantages, and flexibility, will sustain apartment demand.”

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RSM reported that sales volume and cap rates were slightly easing.

According to a study this week from RSM, real estate funds seem to be maintaining their path and accounting for a small overall cooling of the market.

The volume of sales transactions and associated cap rates realized in those transactions have both decreased, it was claimed, and fundraising is adopting the same mentality.

Since interest rate increases and inflationary pressures suggest that a possible impending recession may be imminent, investors are currently on the defensive and reevaluating values and strategy. RSM stated that capital is being directed toward core and core-plus assets, value-add investments, and less risky initiatives.

Real estate investment may have slowed down from its record-breaking rate in 2021, but prices are still significantly higher than they were before the pandemic, and there is still enough of money for investors to keep spending.

Finance Is Generally Affordable

According to RSM, property cash flow, particularly from multifamily and industrial properties, is still strong, and financing is still quite affordable.

According to the statement, “We anticipate transaction volume to pick up in the fourth quarter of 2022 or early 2023 as fund managers reevaluate their strategy and the return expectations of their investors, looking to deploy cash that has been sitting on the sidelines.”

Cap rate compression on a global scale

Even the “darlings” of the pandemic, multifamily and industrial, saw cap rates compressed.

Compared to an average reduction of 0.15% over the preceding three years, multifamily cap rates have decreased by 0.79% since the second quarter of 2020, according to CoStar.

RSM claimed that because of growing values, it has become harder for acquisitions to meet investment objectives.

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In addition, if compared to the past, would “high” inflation actually be that high?

According to a Bloomberg story, if you believe that rising inflation is only a transitory issue and that everything will return to normal before the pandemic, you disagree with some of the largest bond investors in the world. They believe that the Federal Reserve’s target of 2% inflation is essentially an impossible dream, which is why they have piled up on inflation-protected bonds, increased their exposure to commodities, and maintained a sizable cash reserve.

Cheap energy and labor kept inflation low over a protracted period of growing globalization. (A sober addition would likely be the long-term cheap monetary supply that central banks kept thinking would boost GDP.)
But it’s time to take a deep breath. Look up the U.S. yearly inflation rate for the past few years. The Fed’s goal inflation rate of 2% was greatly exceeded for numerous stretches. The commercial real estate market did not collapse.Looking at the recent past is something that might confuse people. According to Kevin Swill, CEO of Thirty Capital Financial, “to have a market, with low interest rates for more than 12 years, does not follow logic or the cycle that existed for decades.”

However, returning to normal does not guarantee that it will be painless, especially in light of the investment methods that were used in conjunction with those low rates. “Levered investors might struggle to cover debt service and secure loans if cap rates spreads to interest rates narrow,” said DWS Group’s U.S. Real Estate Strategic Outlook for July. “Real estate leasing could also retrench amid job losses and dwindling profits. Indeed, recessions have been the proximate cause of every broad-based decline in real estate prices since the early 1960s.”

Additionally, as the Fed attempts to restrain growth, increasing inflation will result in continuous higher interest rates. That will have an impact on the price of finance as a whole.

Peter Tuffo, president of the south region for Suffolk Construction, claims that the real-estate industry runs on credit and the fundamentals of real estate are out of balance. Real estate investment is tied to confidence, and some projects are simply not penciling out. Real estate responds negatively to higher risk.”
Rogelio Carrasquillo, managing shareholder and cofounder at Carrasquillo Law Group, tells GlobeSt.com that “this situation has a significant effect on bridge and short-term loans that become more expensive for developers. As a result, programs such as EB-5 and other alternative sources of financing that would not be considered otherwise, become viable alternatives for the financing and development of commercial real estate projects.”

Even said, not all is lost because, according to Zachary Streit, founder and managing partner at WAY Capital, “inflation could also mean higher rent growth and NOI that could offset some of the impact of higher interest rates.” Additionally, “We are seeing a trend of more deals getting done with fixed rate financings and some sort of partial recourse or creative financing structures like PACE to offset today’s higher rates offered by floating rate lenders.”

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1. INFLATION

The Consumer Price Index (CPI) rose by 8.5% year-over-year through July, but remained flat from the month before, according to the Bureau of Labor Statistics. It was the first time that inflation hadn’t increased on a month-over-month basis since May 2020.
A 7.7% decline in gasoline prices in July helped alleviate pressure on the broader index, while an increase in food and shelter offset some of that movement. Food costs rose by 1.1%, the seventh consecutive monthly increase of 90 bps or more.
Other declines were seen in airline fares, used cars and trucks, communication, and apparel.
Core CPI, which removes food and energy prices from the calculation, rose 30 basis points, the smallest increase in four months. Core CPI is up 5.9% year-over-year.

2. INFLATION REDUCTION ACT IMPACT ON CRE

On August 7th, the US Senate passed the “Inflation Reduction Act” bill, which now goes to the House of Representatives, and is widely expected to pass before being sent to the President’s desk.
While the bill primarily focuses on climate and health care policy changes, it also effectively closes the door on this congress’ attempt to boost Affordable Housing programs or amend how some real estate gains are taxed.
A proposal by the White House to change the tax treatment of carried interests, often used by real estate developers to reduce capital gains tax liability, was removed in the 11th hour to gain the support of Senator Kristen Sinema (D-AZ), whose vote was needed for the party-line bill to pass. The National Association of Realtors and other industry trade groups opposed the proposed change.
While maintaining the status quo for carried interest should stave off any direct negative impact on Commercial Real Estate investments, the final bill did not include an expansion of the Affordable Housing programs or incentives generally championed by the industry as a way to boost housing supply.

3. STAGFLATION RISK TO CRE

In a recent analysis of factors that could affect CRE valuations, Fitch Ratings finds that the combination of inflation and weak economic growth could soften tenant demand and cause upward pressure on cap rates, potentially resulting in a decline in net operating income.
The analysis, which looked at the historical relationship between interest rates and NOI, found that during a period of rising long-term interest rates, property-level cash flows tend to keep pace or grow
faster than cap rates. Still, a period of stagflation, which implies that we are in both a rising cost and falling growth environment, may result in prolonged elevated cap rates, likely softening CRE values.
The analysis notes, however, that the historical link between cap rates and the yield on the 10-year Treasury has weakened since the 1980s, making the circumstance of rising cap rates in our current tightening environment less certain. Still, evidence of upward pressure on some sector cap rates has surfaced since the Fed began hiking interest rates in the spring.

4. SURGING RETAIL INVENTORIES

A recent market analysis by Prologis projects that an additional 800 million square feet of warehouse space may be needed to handle excess inventories taken on by retailers in recent months.
According to a Wall Street Journal summary of the report, many large retailers, including Walmart, Bed Bath & Beyond, and Best Buy, have reported dealing with unexpected inventory increases as consumers move away from goods spending due to inflation. Meanwhile, supply chain bottlenecks continue to force retailers to stretch out buying cycles, incentivizing them to stock shelves earlier in the season than they would have previously, further increasing industrial space demand.
Demand so far is growing the most among discount retailers and liquidators. Still, some observers caution against being too bullish. Many retailers are also cutting prices and canceling orders to cope with the excess, a signal that higher demand for space may be unaffordable for some.

5. JOBS REPORT

The US economy added 528,000 jobs in July while the unemployment rate ticked down to 3.5%, according to the Bureau of Labor Statistics.
This month’s jobs report far exceeded most economists’ expectations, with widespread gains led by leisure and hospitality, professional and business services, and healthcare. Both employment levels and the unemployment rate have returned to February 2020 levels, recovering all jobs lost during the COVID-19 pandemic.
Nonfarm employment has increased by 22 million jobs since reaching a pandemic low in April 2020, with private sector employment 629,000 jobs above its February 2020 level.
Despite leading job gain metrics for much of the pandemic recovery, leisure and hospitality employment remains 1.2 million below its February 2020 level. Meanwhile, professional and business services employment is 989,000 jobs above its February 2020 level, and retail trade is 208,000 above its February 2020 level. Construction employment is 82,000 jobs above its February 2020 level and manufacturing is 41,000 jobs above its February 2020 level.

6. LAW FIRM LEASING ACTIVITY

According to Savills’ latest quarterly report on law firm activity, leasing activity among law firms ticked up by more than 43% in Q2 2020, a turnaround from COVID-era lows reached in Q2 2021.
Data shows that 1.6 million square feet of office space were leased to law firms in Q2, returning leasing volume to the quarterly average seen over the past four years.
Seven of the ten largest leases completed so far in 2022 were in the most recent quarter and exceeded 100,000 square feet. 63% of activity year-to-date, measured by square footage, has been relocations.
The report suggests that there is evidence that flexible in-office work schedules represent a longterm shift, with firms moving away from dedicated office space but towards denser, shared use and collaboration spaces.

7. CAP RATES

Cap rates on office properties ticked up slightly in Q2 2022, rising ten basis points to 6.3%, according to data from MSCI Real Capital Analytics. Office cap rates remain close to historical lows met in the previous three quarters. A 10 bps rise in CBD and Suburban cap rates in Q2 led to the overall increase. Meanwhile, cap rate compression in Suburban offices has driven much of the reduction in the broader sector over the past year.
Industrial assets saw cap rates rise on average by 20 bps to 5.7% in Q2, led by a rise in Warehouse cap rates, while Flex spaces compressed by 60 bps.
Retail cap rates were unchanged quarter-over-quarter, remaining at 6.3%. Over the past decade, retail cap rates have steadily compressed, though at an increasingly slower pace in recent years.
Apartment cap rates continue to post all-time lows, dropping 20 bps to 4.5% in Q2 and down by a halfpercentage point year-over-year.

8. INVESTMENT VOLUMES

Quarterly transaction volumes averaged across all commercial real estate property types rose in Q2 2022 to $190 billion, up by $5 billion from the previous quarter, and up 17% year-over-year. Transaction volume year-to-date is roughly 38% above the total volume registered in 2021.
On a year-over-year basis, Apartment and Retail transactions represent the bulk of the increase in activity. Retail led all sectors with a 46% year-over-year increase in transaction volume; however, current growth in retail activity is dwarfed compared to the triple-digit increases seen throughout the early parts of the pandemic recovery. Still, on a quarter-over-quarter basis, Retail transactions ticked up marginally. Meanwhile, Apartment transactions rose by $18 billion in Q2 2022 and are up 42% year-over-year.
Industrial volume rose 8% year-over-year through Q2 2022 but declined by roughly $4 billion quarterover-quarter. The annual increase in volume was pushed by a rise in warehouse demand, while flex
space transactions remained unchanged.
Office transaction volume fell by $8 Billion from the previous quarter and is down by -9% year-over-year.

9. LOAN MATURITIES

A recent report by Moody’s Analytics investigates how rising interest rates create refinancing challenges for CMBS loans approaching maturity. The analysis finds that there has been an increase in loans past their maturity dates but have not yet paid off, as lending headwinds impact performance.
Comparing 2012 vintage CMBS loans, many of which are maturing this year, to 2011 vintage loans that matured last year, Moody’s analysis finds that, on average, the 2012 batch has performed better. However, they note that a higher amount of outstanding 2012 vintage loans are due in the latter half of 2022. As rising interest rates cause additional pressure on refinancing activity in the coming months, non-performance among 2012 vintage loans could increase.
Additionally, the report finds that higher LTVs and the resulting decrease in reappraisal activity appear less prevalent among Hospitality and Multifamily loans than in others. The findings are consistent with space and capital market trends, apartment rent growth, household formation, and income fundamentals.

10. ADAPTIVE REUSE ON THE RISE

A recent article by Multi-Housing News details how Adaptive Reuse projects are on the rise across the US, mainly targeting under-occupied office properties and the industry’s challenges.
In addition to the opportunities presented by falling urban office demand and rising urban apartment demand, financing options, including Low-Income Housing Tax Credits (LIHTC), Historic Tax Credits, and other federal programs, are helping incentivize adaptive rescue efforts.
Challenges include building, mechanical, and electrical system conditions and weatherproofing. Additionally, inspecting environmentally hazardous materials and removing costs can present
unpredictable obstacles.
Interestingly, some architects believe that older, pre-1950s office buildings may be better suited for conversions than those built in the latter decades of the 20th century due to more nuanced attention to detail on interior design features. Building shape matters, too, with some suggesting that narrower buildings have easier access to outside light and air often desired by apartment tenants.

SUMMARY OF SOURCES

(1) https://www.bea.gov/news/2022/gross-domestic-product-second-quarter-2022-advanceestimate
(2) https://s3.documentcloud.org/documents/22122291/summary_of_the_energy_security_and_climate_change_investments_in_the_inflation_reduction_act_of_2022.pdf
(3) https://www.fitchratings.com/research/corporate-finance/us-commercial-real-estate-valuesthreatened-by-rising-rates-stagflation-risk-sluggish-noi-will-likely-harm-values-10-08-2022
(4) https://www.wsj.com/articles/retailers-seeking-more-warehouse-space-to-stow-excessinventory-11659460929
(5) https://www.bls.gov/news.release/empsit.nr0.htm
(6) https://www.savills.us/research_articles/256536/331757-0/savills-u.s.-law-firm-activityreport-q2-2022
(9) https://cre.moodysanalytics.com/insights/cre-trends/loans-reaching-maturity-without-payingoff-more-trouble-ahead/?cid=YJZ7YNGSROZ5414
(10) https://www.multihousingnews.com/why-multifamily-adaptive-reuse-is-on-the-rise/

When is it more advantageous to raise equity capital through a fund structure as opposed to one transaction at a time?

One of the most crucial pieces of a real estate investment and development firm is raising equity funds. Numerous smaller and mid-sized real estate corporations have a main operating organization and a number of affiliated limited partnerships and limited liability companies that own the real estate assets and contain equity investments from different investor groups. Typically, the general partner or managing member of these investment firms is an affiliate of the operating company.

The operating entity is typically owned by a family or an entrepreneur and serves as the public face of the business. In spite of the abundance of capital in today’s booming real estate market, it can be quite difficult for smaller and midsized businesses to raise equity financing. The associated flow-through organizations that own the individual properties often handle it deal by deal. Take for instance, a well-established medium-sized CRE investment business on the West Coast, may have any number of associated partnerships and limited liability corporations that collectively control $300 million worth of CRE properties, with $200 million in debt and $100 million in equity.

The operational company and the general partner or managing member of these organizations must manage all the different mortgages, equity offers, private placement memorandums, partnership agreements, subscription agreements, etc. throughout time. For example if there are 25 deals and 400 different investors in the twenty-five deals, the typical equity investment is $250,000.

When does it make sense to start raising equity money in a fund structure as opposed to one deal at a time? This is a topic that many of these smaller and mid-sized real estate enterprises need to consider as their business grows. For equity capital, a fund structure is more effective. It’s less expensive in terms of fees, paperwork, and legal costs, and takes less time to complete. Raising equity for 25 different projects one at a time may potentially result in missed investment opportunities if the general partner is unable to swiftly obtain the necessary equity capital to take advantage of good agreements that call for a speedy closing. In contrast to the six to ten years it may take to accumulate twenty-five independent real estate acquisitions, the general partner might have placed all the properties in the fund if the fund had a $100 million equity raise.

As with any investment program, gravitating to a fund structure is not an easy undertaking, and the first one is always the most challenging. However, for any seasoned real estate investment firm, the advantages exceed the disadvantages by a wide margin. Who will sell the fund’s equity is the main issue with a fund structure. Only accredited investors, such as high net worth individuals, pension plans, endowments, registered investment advisors, and wealth managers, are often catered to by CRE private placement funds. A minimum yearly income of $200,000 ($300,000 if a joint investment) or a net worth of at least $1 million, excluding the investor’s primary residence, qualify as accredited investors. To market the fund’s units, the majority of companies will need to work with an experienced securities firm, broker-dealer, or other placement agency; the cost of this service ranges between 5% and 7% of the fund’s equity raised. As placement agents for third-party funds, there are a lot of independent broker-dealers and real estate brokerage companies.

The unit size of the offering is the next crucial factor. Depending on the fund’s investors, unit sizes will vary. If mostly people, then $100,000 per unit is typical. $250,000 per unit or more is typical if the fund targets multiple institutions. What is the fund’s investing strategy, which is the following crucial question? For instance, would the fund diversify throughout the four main CRE sectors of office, retail, flats, and industrial, or will it invest in a single type of property, such as apartments? Will the fund invest in or engage in development in specialized CRE markets like senior living, modular housing, and self-storage? Will the investments in the fund also be diversified by industry and by geography? This is important and a means of lowering portfolio risk. For instance, a fund that buys office buildings in No. California and Silicon Valley lack industry, geographic, and property type diversity. These regions’ economies are driven by the technology sector, therefore any downturn there will be disastrous for the portfolio. Additionally, any fees or payments from the fund, the investor desired return, and ownership interests must be decided by the fund’s sponsor or general partner.

For organizing the private placement, locating the properties to be purchased, and setting up the financing for the properties, the sponsor of many private placements is charged an upfront fee of 1% to 2%. Additionally, there is an annual asset management fee for managing the fund of.5%-1.5% of the equity raised. A quarterly fee for asset management is charged. The preferred yearly return on investment for the investors will normally range from 5% to 10%, and they will own between 70% and 80% of the fund. In addition to receiving a carrying interest of 20% to 30%, the general partner or sponsor will also be expected to contribute.5% to 5% of the stock offering in cash. It is necessary for the sponsor to make an equity investment in order to put some money, even if it is little, at risk and to better align its interests with those of the investors. A crucial step in the development of the rising medium-sized CRE investment firm into a more institutionally focused investor is raising capital in a fund structure.

The SVN Vanguard team can help with your Commercial Real Estate Investment needs. We can help you find the ideal commercial property for sale or lease. Interested in discussing a sale-leaseback? Contact us.

Banks with a high proportion of commercial real estate loans will be subject to more scrutiny from the Federal Deposit Insurance Corp.

According to American Banker, the government agency cited uncertainty surrounding labor and commerce following the coronavirus outbreak as the primary reason for the increased checks and balances.

The FDIC’s Summer 2022 Supervisory Insight bulletin states that there will be a greater emphasis on new loan activity, as well as subsectors and geographical locations suffering difficulty.

Although the majority of the banks under the FDIC’s supervision are smaller organizations, these businesses have made sizable loans to the sector. During the previous year, banks under FDIC supervision owned 41% of the $2.7T in commercial real estate loans.

FDIC inspectors noted that, “The dollar volume of CRE loans is at an historic high, and a growing number of banks report CRE concentrations…The majority of banks with CRE loan concentrations are satisfactorily rated. Nevertheless, CRE loan concentrations add dimensions of risk that necessitate continued attention from banks and their regulators, especially as the pandemic lingers and uncertainties remain.”

Sectors are not being impacted evenly. According to the analysis, pandemic trends like the shift from in-person to online buying, particularly in denser urban regions, might pose problems for the portfolio health of banks.

FDIC inspectors are still circumspect even if default rates for homes affected by the pandemic are not double-digit high as they were in 2020.

“While more recently improved, the delinquency rates remain above pre-pandemic levels. The [FDIC Quarterly] article indicates that economic stress caused by the pandemic is one of the challenges facing the CRE industry and the lending landscape,” the FDIC bulletin states.

Several local banks have begun to keep an eye out for any industry weak spots. Executives at Fifth Third Bank increased reserves in their commercial real estate portfolio, citing “key risks” such rapid rate increases and labor shortages.

Since the majority of its transactions have been with small CRE clients in the previous six months, First Republic Bank Chief Banking Officer Michael Selfridge stated during an earnings call that the bank has also been extra cautious and selective.

Between the first and second quarters, bank lending into the commercial real estate sector decreased by more than $8 billion, according to Trepp data cited by The Wall Street Journal.

Inflation has accelerated at its quickest rate in 40 years. As the second half of 2022 begins, inflation has some borrowers rethinking borrowing.

Borrowers are turning toward alternate sources such debt funds, bridge funds, community bank loans, and life company loans. With advantageous conditions offering more revenues to fund value-add or other investment plans, these alternative methods of funding are becoming more attractive.Fannie Mae and Freddie Mac still provide funding because these agency loans continue to be a popular choice for many borrowers in spite of the competition. Agency lenders may wish to be mindful of the following factors impacting multi-family borrowers in addition to inflation-related worries:

Updated Standards for Radon Testing & Mitigation
In Colorado and New Jersey, American National Standards Institute (ANSI)/AARST (American Association of Radon Scientists) standards have been approved. The new rules went into effect in Colorado on July 1, 2022, and they go into force in New Jersey on December 3, 2022. To be deemed a Radon Professional qualified to conduct testing and undertake mitigation, both states require state-specific licensing. Additionally, for multifamily complexes, these states will call for sampling of all ground-level units in addition to 10% of upper level units. Minnesota, Iowa, Indiana, Illinois, Ohio, Pennsylvania, and Maine are among the states that have already embraced the ANSI/AARST criteria for multifamily properties. Every state, with the exception of Colorado, has an exemption code. Ask your provider of due diligence if your property qualifies for that exemption code.

Numerous federal and state agencies, including the Department of Housing and Urban Development (HUD) and the Environmental Protection Agency, use the national consensus ANSI/AARST Radon Standards of Practice (EPA). Here is a list of national consensus standards for various building types.

California SB-721 Deadline Approaching

By January 2025, owners of multifamily buildings in California must abide by SB-721. 2018 saw the signing of California Senate Bill 721, sometimes known as the Balcony Bill. After a balcony collapse in Berkeley, California claimed the lives of six students and seriously injured another seven, SB-721 was passed into law. The law mandates examination and retrofitting of Exterior Elevated Elements (EEE) such balconies, decks, staircases, and pathways in multifamily structures with three units or more. The assessment of a piece of EEE by an engineer, architect, or other certified provider is required by building owners in order to identify any urgent hazards and suggested countermeasures. The initial inspection shall be done for each and every impacted building prior to January 1, 2025. Timelines for reporting, obtaining permits, and making repairs apply, and subsequent reviews are required every six years. More detail on SB-721 can be found here.

Lastly, some would wonder if agency lenders will adhere to the 2022 loan limits. In order to boost the multifamily sector, the Federal Housing Finance Agency (FHFA) raised the multifamily loan purchase caps for each entity in October 2021, totaling a combined $156 billion. The FHFA required that, in addition to the caps, 50% of the loan volume be used for mission-driven, affordable housing or other mission-oriented businesses. This made sure that affordable housing and traditionally neglected markets received adequate investment. We have seen an increase in Fannie/Freddie lending activity over the past few weeks. Agency loans are now slightly more competitive as a result of market pressure and the requirement to reach the cap. Considering the current pattern, we do anticipate that the 2022 caps will be met.

The SVN Vanguard team can help with your multifamily real estate needs. We can help you find the ideal multifamily property for sale or lease. Interested in discussing a sale-leaseback? Contact us.

Examples, accounting adjustments, and short-term loan accommodations are all modifications mentioned in a new policy statement.

Examples, accounting adjustments, and short-term loan accommodations are all modifications mentioned in a new policy statement.

According to a notice published in the Federal Register, the Office of the Comptroller of the Currency, Treasury, Federal Deposit Insurance Corporation, and National Credit Union Administration are debating a new policy statement. The change would modify a policy that was initially put into place in 2009 following the financial crisis of the time.

The announcement states “the agencies are proposing to update and expand the 2009 Statement by incorporating recent policy guidance on loan accommodations and accounting developments for estimating loan losses (proposed Statement).” The notification goes on, “In developing the proposed Statement, the agencies consulted with state bank and credit union regulators. If finalized, the proposed Statement would supersede the 2009 Statement for all supervised financial institutions.”

The focus of the proposed statement stresses the value of “working constructively with CRE borrowers who are experiencing financial difficulty and would be appropriate for all supervised financial institutions engaged in CRE lending that apply U.S. generally accepted accounting principles (GAAP)” and acknowledges that accommodations and workouts are frequently in the best interest of both parties.

Two important themes from the 2009 declaration continue to be supported by the statement, which is significant. One is that, even if the amended loans have flaws, a lending institution won’t face criticism for making a “prudent CRE loan accommodation.” The second is that because the value of the collateral is smaller than the loan total, the modified loans won’t be classified negatively as long as the borrower has the ability to repay under fair circumstances.

The suggested amendments would affect three areas. These arrangements are described as tools “to mitigate adverse effects on borrowers and would encourage financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations during periods of financial stress” in a new section on short-term loan accommodations.

Secondly, beginning in 20009 there have been modifications to GAAP accounting, including CECL, or current anticipated credit losses. “In particular, the section for Regulatory Reporting and Accounting Considerations would be modified to include CECL references.”

The Financial Accounting Standards Board (FASB) “ASU 2022-02, Financial Instruments—Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures” is also mentioned. Financial institutions won’t be required to classify and account for loan modifications as troubled debt restructuring, once this standard is implemented.

Lasty, CRE exercise examples would be modified. “The examples in the proposed Statement are intended to illustrate the application of existing guidance on (1) credit classification, (2) determination of nonaccrual status, and (3) determination of TDR status.”

Even if demand declines, the industry will be able to survive because to limited multifamily building.

Despite worries about a recession, analysts believe that slower building will likely maintain a balance between supply and demand for multifamily housing for some time.

Three Moody’s economists argue in a recent analysis that “housing substitutability” can shift demand to the sector, so even if multifamily demand cools, restricted multifamily building will help preserve the sector. As the average property is currently approximately 44% more expensive than in 2019, would-be buyers of single-family houses are choosing to rent rather than buy, which in turn is boosting demand for multifamily units. The increase in short-term rates and their effects on mortgage rates are further exacerbating it, and Moody’s observes that there are already indications of markets cooling in several of the areas where prices rose most swiftly during the pandemic.

The Moody’s report states: “Although this may not lead to a widespread slashing of housing prices everywhere, housing price declines are a real possibility in the next few quarters or years depending on how severe and how long the next recession will be if there is one. Multifamily rents, on the other hand, are generally slower to respond to rising interest rates and remain more stable. If the substitutability within housing matches the Great Recession’s strength, then multifamily rents may remain elevated for some time until single-family housing stabilizes. Based on the past few recessions, the effect on multifamily performance may not begin until near or after a recession ends.”

The demand for multifamily housing is also likely to be sustained by low unemployment and a competitive labor market, which was not the case in prior recessions (as in the 1980s, when unemployment topped 9 percent ). However, while household balance sheets are usually doing better than they did during prior downturns, personal incomes with disposable cash are declining.

“As the multifamily and single-family home affordability crisis intensifies across more and more metros nationwide, this diminishing financial safety net is troubling, even for multifamily,” Moody’s notes. “Job losses or affordability issues could force some renters to find roommates or put off that move to single living.”

Strengthened financial regulations “may be a godsend” for multifamily, according to Moody’s analysts.

“Even if the Federal Reserve fails to engineer a soft landing this year or next, these rules will likely prevent the real estate market from sliding into a deep and long recession or suffering large aftershocks,” the trio wrote. “While many single-family markets will likely see small to moderate prices decline in this situation, multifamily’s positive performance should hold up relatively longer, as in previous downturns. Overall, in a mild recessionary environment, we would expect only a moderate vacancy rate increase and rent growth to simply decelerate. A slight and short-lived dip into negative territory towards the end of the recession is possible, but a free fall is highly unlikely.”

The SVN Vanguard team can help with your multifamily real estate needs. We can help you find the ideal multifamily property for sale or lease. Interested in discussing a sale-leaseback? Contact us.

Experts say the cost of financing will keep rising to unprecedented levels.

The benchmark interest rate set by the Federal Reserve has increased by 75 basis points for a second consecutive month. The goal range for overnight interbank lending is 2.25 percent to 2.5 percent, and as it rises, so do many other interest rates, including those that commercial real estate companies will have to pay to get credit.

According to Kevin Fagan, head of CRE economic analysis at Moody’s Analytics, “The Fed announcement of hiking their target Fed funds rate by 75 basis points was highly expected.” The majority of market participants in commercial real estate are likely to have anticipated this, especially lenders as they have seen loan interest rates climb by more than 50 basis points in 2022, primarily in the second quarter. As a result, asset values are under pressure, and lender profits and borrower returns are constrained. Therefore, [as the industry evaluates the near-term future], [we predict] both loan issuance and commercial real estate sales volume to decline in Q2.

The Federal Open Market Committee of the Federal Reserve, which is tasked with containing both inflation and unemployment, justified its actions by highlighting recent steady job growth, high inflation, widespread pricing pressures, and Russia’s ongoing invasion of Ukraine.

Stephen Bittel, founder and chairman of Terranova Corporation, says there is a clear gap between expectations of buyers and sellers in our current investment climate. “..sellers seek the price attainable last year, while buyers expect a discount because of a higher cost of debt capital,” says Bittel. He adds, “Development deals that were already contending with higher construction costs are now also hurt by a higher cost of debt, coupled with an expectation of a higher equity yield.”

Commercial real estate is already feeling the effects. According to Adil Hasan, director of real estate at Yieldstreet, “The CRE market has seen a significant slowdown in transaction volume over the last couple months and the trend is expected to continue until there are signs of stability from the Fed.” Hasan notes that, “The inability of CRE investors to determine market value of assets primarily due to uncertainty around debt capital markets will keep many investors on the sidelines.” He also argues that the, “…rising cost of debt will hurt cash flow for properties that have floating rate debt, forcing many property owners to be forced sellers.”

Investors who made real estate purchases three years ago and are trying to roll over financing are getting one-year extensions from their lenders, according to Bill Doyle, co-founder and managing director at Equity Oak Ventures. Due to a significant decrease in appraiser valuation, he says, “All forms of lenders, especially debt funds, are in need to rebalance those notes.” The continuing rate increases only put more pressure on the need to rebalance mortgages. Experts note that in the debt market, the next 90-120 days will determine whether existing mortgages will need to be extended, refinanced,or ultimately handed back to lenders.

Some, however, do stand to benefit from the current state of the lending market. Hasan points out that, “This could present some attractive acquisition opportunities for investors that have the capital available.”