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The following article appeared in this months issue of National Real Estate Investor and I thought it was a good snapshot of many investors feelings on Multifamily investments.  Enjoy.

Players in the real estate industry are operating in a challenging new environment. This includes those of us in the multifamily sector, which has had a long run of strong operating fundamentals, an abundance of liquidity and competitive equity investment.

Every day we tune in to see how the financial news and economic indicators are affecting the real estate capital markets. The changes influence acquisitions and our ability to capitalize transactions.

We want to believe there are opportunities in all sectors to buy deals at distressed prices. However, the multifamily sector, particularly in the West Coast’s infill markets, is still showing persistently low cap rates of 5% to 6%. Consequently, more discipline is required in underwriting in this new age of turbulence.

As we underwrite value-added opportunities, we need to be aware of the trends 12 to 24 months down the road. That could mean slower job growth, less leverage for buyers upon exit, fewer equity partners willing to gamble on higher market rents, and exiting cap rates that are stabilized above 6.5%.

Multifamily setbacks

Despite these shifts, there remains a disconnect between the perceptions of buyers and sellers, and the realities of today’s multifamily operating fundamentals. In certain cases, this has led to deals coming back to the market and sellers unable to pull the trigger.

Markets like Las Vegas, Phoenix and the Inland Empire in Southern California have been negatively affected by the “shadow market” supply of condominiums and homes available for rent. This will likely affect vacancy assumptions and the ability to grow rents. Other factors that will dog multifamily include interest rates and the availability and cost of mortgage financing.

With regard to interest rates, we anticipate that the Federal Reserve will continue to favor liquidity over inflation-fighting measures. Thus, we see short-term interest rates remaining at less than 6% over this period. While mortgage rates will also remain low, lenders have returned to fundamentals. Debt coverage ratios need to be 1.10 at a minimum, while loan to values range from 65% to 70%. Lenders have also begun to implement rate floors on quotes.

I think the most telling fact in this article is the 65-70% loan to value ratio, as this is what we are seeing in our local area as well as lenders wanting at least 1.20 or better debt coverage ratios in our local market.  All this shows the importance of using the due diligence period on a property to the fullest along with using a qualified commercial broker.

 Peter J. Barnett, CCIM