As senior vice president on Capital One’s Commercial Real Estate Finance team based in Chicago, Tom Reynolds understands the Midwest’s multifamily market. After all, Capital One fields plenty of financing requests for multifamily transactions. That’s why Midwest Real Estate News recently spoke with Reynolds about the state of the apartment sector in 2020 and what the future might hold for this still-booming asset class.
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Now that we are in 2020, do you expect the multifamily sector to remain a strong one?
Tom Reynolds: I do. We had a very strong 2019 in the Midwest and across the nation in the multifamily space. The underlying fundamentals of the multifamily sector are solid. We have low interest rates. There is plenty of capital in this space. That will keep activity very strong. We see that continuing this year.
As always, there are global geopolitical concerns that could slow the market. Despite that, the underlying fundamentals and the demand for apartments remains strong. At the same time, apartments are lower risk compared to other asset classes. Because of this, we expect the multifamily market to remain an active one this year.
Is demand for multifamily strong in the Midwest, too?
Reynolds: It is. Institutional and international capital are playing in the Midwest today more than they have in years and decades past. There is a strong appetite and interest in both the primary markets in the Midwest, such as Chicago and Minneapolis, and in the more secondary and tertiary markets. We expect that to continue as investors keep chasing yield, something they are having a more difficult time finding on the coats.
This demand will keep the Midwest region strong. We expect that to continue in 2020 and perhaps beyond.
How important is this chasing of yield you are seeing from investors?
Reynolds: Yields are compressing across the country. The returns that someone might see in Kansas City five years ago are nowhere near what they can get today. But yet, those yields are still at a premium compared to what you are getting on the coasts. That is driving activity in this space in the Midwest. As long as we continue to see a healthy job market and low unemployment, that will ensure strong performance and activity in multifamily.
Why is the Midwest multifamily sector so attractive today?
Reynolds: The Midwest has always been steady. You don’t see the peaks that you see on the coasts. The Midwest doesn’t have as much overbuilding. There are some rumblings of overbuilding in places like Chicago. And Chicago does have its share of concerns with reassessment on the tax front and the fiscal stability of the city and the state of Illinois. But what helps the Midwest in general is that you don’t have the big ebbs and flows. It is steady. You won’t get double-digit growth rates, but you will see steady growth rates and steady occupancy. You will have a clear picture on where returns are going to be.
Investors are looking for low-risk returns. Those investors will be attracted by the Midwest and the overall multifamily sector.
What are some of the multifamily trends you are seeing right now?
Reynolds: Everybody at the multifamily housing conference in Orlando was very positive and bullish. A theme was that investors are looking for value-add opportunities. The cost to build new product, and the labor costs associated with that, continue to spike. It is becoming more challenging to make the numbers work on a new-construction deal. We are seeing people trying to find yields through value-add, through buying older buildings and adding more value to them. That is getting harder for people to find, too, though. The cap rates are getting pretty tight. It is harder to make those numbers work, too. This is all keeping some discipline in the market.
We are also seeing a great need for affordable rental housing in the Midwest. The agencies are very focused on this space. The challenge with new affordable housing is finding a way to make the numbers work with the growth in labor costs, land costs and materials costs. To make affordable housing work, we’ll need to see more financial incentives by municipalities. You need those incentives to make affordable housing work for developers. Developers are in the business of making money. They have investors they have to answer to. Most developers want to build more affordable housing and be as altruistic as they can. But they also have to make the numbers work.
Are you seeing much overbuilding in the multifamily sector?
Reynolds: We aren’t, and we are still seeing the rental-based population continue to increase. Young folks are moving out who might have lived with mom and dad for five years. The renter-by-choice model is still very much alive. Everyone is looking for that flexibility that comes with renting.
What amenities are important in new apartment space?
Reynolds: Everyone still wants a gym. But the amenity that people really want is strong wi-fi connectivity. The wi-fi has to be strong. There are so many people who work from home in their apartments or in their buildings’ common spaces. Wi-Fi is key. There is also a greater focus on work-area spaces in apartments for those people who work from home. Those spaces are more important today than a theater space that doesn’t get used. Bike storage areas and dog-wash stations are becoming more important, too. Increased storage space for package deliveries is another amenity that renters want today.
When you get a financing request for a multifamily deal, what factors do you look at when deciding whether it’s a good request?
Reynolds: The market fundamental are key, of course. We look at absorption, employment and local economic factors. When we look at the sponsor, we look at the history and the sponsor’s ability to survive cycles. There are a lot of developers we work with who are newer. But their track record is critical. We want to see how they handled some tougher situations.
We do think we are in the later stages of this current cycle. We want to make sure we are all disciplined. We want to work with folks who are honorable and who have a solid track record, sponsors who we expect to weather cycles.