Like all commercial financing professionals today, Colin Callaghan, senior managing director with the Southfield, Michigan, office of Berkadia, is keeping a close watch on the multifamily market. That’s because the requests for financing from developers and investors eager to play in this sector are still coming at a rapid clip. But there’s a trend with all those requests for multifamily construction financing: Developers are hoping to build luxury apartments, not those catering to renters with more modest incomes.
The reason is simple: Construction costs are high, and it’s a challenge for developers to make a profit unless they build apartment projects with high-end monthly rents.
Midwest Real Estate News recently spoke with Callaghan about the state of the multifamily market and the shortage of workforce housing. Here is some of what he had to say.
Are the requests for commercial financing still coming in at a rapid pace?
Colin Callaghan: The short answer is “absolutely.” We do a lot of multifamily business at Berkadia. We are seeing quite a bit of velocity in that sector. The multifamily market has been so healthy for so long, and multifamily projects have seen a lot of increase in value. So this is still a very viable market. We have continued to do record business.
Why has multifamily remained so strong?
Callaghan: There are certain things from a macro standpoint that are generally accepted wisdom today. People are holding off on buying homes until later in life. They are buying at a more advanced age than they used to. Single-family homes are still a fairly expensive proposition for younger buyers. Renting is more flexible.
What challenges does multifamily face today?
Callaghan: There is a shortage of this product in many markets largely because of construction costs. Whether it is land, raw materials or labor, it is expensive to build an apartment complex today. The supply is artificially suppressed. If you look at occupancy rates in multifamily, they are exceptionally strong. Short of the higher-end, class-A space, it is hard for developers to build new multifamily.
What can be done to make it more financially viable to build lower-cost apartments?
Callaghan: Government bodies at all levels have come to the realization that there is this severe shortage in workforce housing. This can’t be addressed through historic, traditional sources. Traditionally, affordable housing is augmented by the Low-Income Housing Tax Credits program. But that doesn’t do anything for people who are above that income level but who can’t afford the higher-end, luxury apartments. In the market, then, you have affordable apartments and you have higher-end apartments. But there is a gap in the middle for renters like teachers and firefighters, for a huge segment of society. There is a limited amount of new product coming in for them.
Are municipalities putting programs in place to make this kind of multifamily product financially viable for developers?
Callaghan: Municipalities are doing what they can. But they do have limited resources. Look at Detroit as an example. The government likes to induce developers to build affordable units here. The government likes to use tax abatements, for example, as a way to make it easier for developers. But, really, there is no good solution at this point in time for boosting the supply of workforce housing. It does come down to what municipalities can offer.
When you get financing requests, what do you look at before deciding to approve them?
Callaghan: It’s pretty straightforward. We look at the asset first. Is it fundamentally good real estate? Then we look at the borrower or sponsor. Those are the two things you start off looking at. What makes for fundamentally good real estate? It needs a good location. Is the area in which it is located growing, stable and diversified? Are there high barriers to entry?
When looking at the asset, we look at whether it is a well-maintained project. It doesn’t have to be new, but it does have to be free from functional obsolescence. Does it have a solid operating history? In the absence of that, what is the borrower’s plan to turn that asset around and stabilize it?
What do you consider when looking at the borrower?
Callaghan: We look for someone with a good net worth, good liquidity and a good credit history. Do they have a track record? Have they been successful previously? Are they knowledgeable about a specific product type? That is even more critical when talking about a specialized type of housing. When you are looking at mixed-use, seniors housing or something specific like that, you want to make sure the borrower knows that space and knows intimately.
Are borrowers prepared for this scrutiny?
Callaghan: I think they are. But we do dig a bit deeper than they might expect. They might not anticipate that we want to look at their schedule of real estate. We want to see every property they own. We want to see their average debt service coverage ratio. We want to see when their loans are maturing. We don’t want a borrower who will have a massive liquidity issue because all of their loans are maturing at the same time. Borrowers might be unaware that we delve that deeply into their records.
It is not uncommon to see borrowers who have had issues in the past. Maybe they had to give a property back. We have to dig into that. It doesn’t mean that financing is a non-starter. But we do have to look at how the borrowers dealt with their past issues. Did they deal with them in good faith? How long ago did the problem happen? Where there mitigating circumstances that the borrowers had no control over? Sometimes, borrowers are surprised when we get into that level of detail.
Do you think financing requests will continue at a quick pace in the near future?
Callaghan: I do. Yes, interest rates are going to increase. But that has already been priced into the market. People anticipate it. And rates aren’t anticipated to go up so dramatically that they’ll shut off the spigots. We absolutely will remain busy for the next 12 to 24 months. After that? I’m not that smart. I don’t have a crystal ball to see that far out. In general, the people I have spoken with believe there will be a steady, predictable increase in interest rates but an increase that’s not severe enough to curtail the market.
