As managing director of Midloch, a private real estate investment company with offices in Milwaukee, Chicago and Minnesota, Tim Donovan understands the Midwest’s multifamily market and the demand for it. And his prediction? Investors will continue to sink their dollars into multifamily assets in 2025.
Why? Despite the challenge of high interest rates, the multifamily sector remains an attractive one for investors, especially as the demand from tenants for apartment units continues to rise.
We spoke with Donovan about the strength of the multifamily sector and what investors are looking for from this investment type. Here is some of what he had to say.
Are investors still looking at multifamily properties as a home for their investment dollars?
Tim Donovan: It certainly remains a popular investment choice. I was at the National Multifamily Housing Council conference in Las Vegas last month. The amount of positive buzz around the conference was strong. The industry is adapting to the new reality that interest rates might be higher for a longer period. That has not taken the wind out of the sales of people’s interest in it as an asset class.
If anything, investors’ interest in multifamily is picking back up. The industry had been a little turbulent during the last 12 to 24 months. With that comes a lot of opportunity for investors. Investors will see some of the better buying opportunities in multifamily during the next 12 to 24 months.
Why is this such a good time to buy multifamily properties?
Donovan: It has been more challenging for investors to find compelling opportunities in this space in the last year than it had been for quite a while. The gap between sellers’ expectations and what buyers were willing to pay has been a very real challenge for the last 18 months. Sellers wanted pricing from six months prior, while buyers wanted pricing that was more indicative of the here-and-now environment. Now that we are in a more stable interest rate environment, the bid-ask spread has come down a bit. Sellers realize that this is the new normal for the time being, so they are being more realistic with their pricing.
There are also quite a few multifamily buildings that buyers purchased in 2021 and 2022 that were financed with too much leverage. People are forced to sell these properties because of the way interest rates have moved. They are forced to sell at prices below what they bought these multifamily properties for a couple of years ago. Prices now look more like they did in 2017 and 2018 than they did in 2020 and 2021. That is a little alarming for the investors who closed these deals in the early 2020s. But it is also refreshing for investors today to see these opportunities to buy at the pricing of five to six years ago, especially when new construction costs are so high.
Tim Donovan, managing director, Midloch
I suppose that if the costs of new construction remain elevated, that makes investing in an existing multifamily building even more attractive, right?
Donovan: Construction pricing remains well above what it was five or six years ago. At the same time, the pricing of existing product has been pulled back. If you think that construction pricing isn’t going to fall significantly in the next few years, and that new buildings being built today are more expensive to build, it does feel like a good time to buy existing multifamily properties at a discounted price.
Are there any parts of the United States in which you prefer to invest in multifamily properties?
Donovan: It depends. We do tend to favor the Midwest, though. We have our hometown bias, of course, but this is a good time to invest in places that routinely miss the highest highs or the lowest lows. In some of the more popular Sunbelt markets today, markets in which we saw historically strong rent growth, we see that the new supply there is showing some occupancy weakness. We are not seeing that in the Midwest markets. In the Midwest we see stable occupancy.
We are most excited about Midwest markets with long-term stability. You are still able to get those good value buys in the Midwest. There is also less competition with other investors in the Midwest historically. We are a fan of the slow-and-steady Midwest markets. At times like this, you are glad to have those reliable cash flows.
It look like preferred equity is playing a big role in helping some of these investment deals close today.
Donovan: Yes. We are starting to see deals now in which the buyers can’t get the leverage they historically would have gotten because of the interest rate environment. Private equity helps fill the gap. Traditionally, senior debt would have covered about 70% to 80% of a deal. Now it might only cover 60%. Private equity can fill the gap that this leaves.
We are also seeing deals coming out of construction loans or that were financed with a shorter-term bridge loan. Private equity can help pay the debt down and recapitalize the deal, set it up with more success going forward.
What are you seeing with multifamily investors who must now refinance their existing loans? What challenges do they face now that interest rates are so much higher than they were when they originally took out their loans?
Donovan: We are seeing that lenders are being amicable to working with owners when they are missing a loan covenant here or there. Lenders are doing everything in their power to work with their borrowers, which is refreshing to see. But that is also keeping deal flow from hitting the market. Lenders are not forcing their hands on making people realize a paper loss in today’s world. Lenders might give you a nine- or 12-month extension to give you time to get your operations in line. Lenders understand the circumstances of today’s market. They are not in the business of owning real estate. They are giving owners more time to let the market work itself out.
There are some instances where lenders would not be made whole in a market sale. If the deal was to go to market, the lender would only get 70% or 80% of the loan amount back. Lenders don’t want to take a loss. Instead, they’ll roll up their sleeves and let the market work itself out. In that instance, everyone gets to the other side and gets their capital back.
