Real Estate Financing: What to Expect in 2018

Essex Realty Group’s Douglas Fisher summarizes the evolution of the real estate market in 2017 and sets the direction for the coming year.

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The real estate market benefited from inexpensive financing and a significant supply of equity capital in 2017. Despite the slowdown in rent growth, increase of supply and the new tax reform, investors should benefit from stability in the coming year as well. Douglas Fisher, principal & managing director of Essex Realty Group, discussed his predictions for the next 12 months.

How was the real estate market in 2017, compared to what was initially expected?

Fisher: 2017 began with cautious optimism in the multifamily sector. Coming off a tumultuous election year with a radically different administration, the desire for tangible, relatively safe investments was extremely robust. Multifamily, buoyed by 10 years of low occupancy and increasing rents, benefited from readily available, inexpensive financing and a deep supply of equity capital. These factors led to an almost insatiable appetite for institutional investors, private equity and lenders alike.

Many elements of what was projected played out as expected. Homeownership, supply, purchases and values remained depressed. Millennials, the largest generation in history, preferred the flexibility and affordability of renting. The availability of capital was strong and inexpensive. An abundance of capital, unmatched by the amount of investment opportunities, supported unprecedented values. 

Even so, investors and lenders had growing concerns. The supply of new development, rising cost of construction, affordability of rents, the number of renters to absorb and afford the new supply, increasing taxes and job creation to name a few. These concerns proved justified. Currently, there are more than 6,000 units under construction and in lease-up. During the third and fourth quarter of this year, it became a renter’s market. Increasing vacancies led to landlords reducing rents and offering substantial concessions in new developments as well as existing properties. 

What can you tell us about the multifamily lending environment in 2017?

Fisher: Borrowing costs rose, but remained low and very attractive. Lenders continued to be disciplined in their underwriting of borrowers and projects and, I believe, did not demonstrate the abandon of lending standards seen prior to the last downturn. With that said, there was a visible pullback in new construction financing. Lenders turned down or significantly scaled back funding for many new projects. There continued to be high demand for existing, stabilized properties from agency, insurance and traditional lenders.

Douglas Fisher, Principal & Managing Director, Essex Realty Group
Douglas Fisher, Principal & Managing Director, Essex Realty Group

What do you expect from multifamily financing in 2018?

Fisher: I believe borrowing costs will continue to increase, but remain affordable. There will be primary interest in existing, stabilized properties. However, it will be difficult for traditional banks to compete, so there will be substantial competition for short-term, value-add projects. Non-traditional lenders such as debt funds will play an increasing role in providing financing, albeit at higher costs, to optimistic developers for new construction.

Could you highlight a few industry trends we should expect to see in 2018? 

Fisher: I believe rents have stabilized and may decline in 2018—in many cases because they were overstated and too aggressively underwritten in the first place. There will continue to be an abundant supply of affordable capital. I believe the pursuit of new construction opportunities will decline due to increased labor and commodity costs combined with the implementation of the Affordability Requirement Ordinances. Overall, it appears the new tax reform will be very beneficial to the real estate investment industry.

There is a lot of discussion on the possible elimination of the EB-5 program, 1031 exchanges and the private activity bond deductibility. How would these changes impact the multifamily industry?

Fisher: I have never been involved in an EB-5 transaction and am not an expert. Still, I have read about the call to reform the program. The 1031 exchange appears to have survived the tax reform bill. Although it is heavily used and our investors transact a tremendous amount using the 1031 exchange, many would be OK or even prefer eliminating the rule in lieu of lower capital gains rates.

Image courtesy of Essex Realty Group