By Michael D. Firsel
Partner-Ruben Firsel & Ross LLC
The boom in multifamily rental development rolled on unabated throughout 2013, and looks to continue into 2014 and beyond. The growth of this sector has resulted from a perfect storm of economic and demographic factors: continued high unemployment and tight mortgage policies have made home ownership inaccessible for many, while a growing number of baby boom retirees and echo boom young adults find the flexibility of renting to be an affirmative advantage. As a result, large numbers of developers – including many who previously would have focused on single-family residential, condominium or retail development – are looking at apartment development as “the answer” to jumpstart their stagnant project portfolios.
While the enthusiasm for this market is well founded, at least for now, development of multifamily residential property is a specialized area, with ever-evolving opportunities and pitfalls, which require significant equity, patience, and most of all, perseverance. Some legal issues faced in these developments are common to other types of commercial projects, but frequently have a unique twist in the residential rental context. Some of the top-priority legal issues to consider include stringent and burdensome guidelines for government loans (i.e. Fannie Mae and Freddie Mac), evolving trends in zoning plans, local municipality resistance to multifamily development, and when permitted, often expensive design requirements.
Fannie Mae and Freddie Mac loans: The money and low rates are there but so are the headaches
Over the last several years, the growth of multifamily housing has been partially fueled by the availability of low cost loans from government agencies fondly referred to as Freddie Mac and Fannie Mae. However, the strict documentation requirements and the time it takes to move through the process is often challenging and time-consuming. In addition, the loan documents created and used by these agencies are virtually non-negotiable. The significant restrictions on the transferability of equity interests often pose the greatest problems. The inability to limit representations and warranties to one’s actual knowledge, and the never-ending environmental liability exposure are but a few of the pills we have to swallow if our clients want to take advantage of these low interest rate loans.
Also, whatever time is negotiated in a sale contract for a Freddie or Fannie loan to either be originated or assumed needs to be doubled. The system simply has too many loans to approve and not enough qualified people to process them in a reasonable amount of time. Regardless of the above-mentioned issues and restrictions, these loans are still the “best game in town” right now. If and when the CMBS market returns to strength, the popularity of these loans will dwindle because of the competing CMBS interest rates and less red tape.
Zoning: Major cities re-examine old models
Several cities have gone back to the drawing board with their zoning codes, looking for new models to reinvigorate neighborhoods and streamline the approval process. The primary complaint about the traditional single-use zoning model arises from the constant need to request exceptions from the rigid framework of commercial, industrial and residential zones. Miami, Denver and Washington, D.C. are among the cities to overhaul their zoning codes in recent years, with Los Angeles embarking on its own long-term revisions. The new models focus on context-based zoning with an emphasis on transit, mixed-use properties, green space and the strengthening of neighborhoods. This trend should be hailed by developers who will face simpler, more flexible processes so long as their projects fit the character and needs of the surrounding communities.
The other side of this coin are the limitations placed on density, impervious surfaces, significant additional amenity and landscape requirements, the architectural standards and construction materials often required, and the Fair Housing Act requirements for individuals with disabilities discussed below. To the extent the demographics can absorb higher rents to cover these additional costs, the acceptance of multifamily rental communities is no longer the “black sheep” of the residential development sector.
Accessibility: Design requirements that open doors
Under the Fair Housing Act, many new multifamily construction projects must meet minimum standards of accessibility for individuals with disabilities. Under HUD regulations, covered properties include all units in buildings with one or more elevators and four or more units, or all ground level units in buildings with four or more units but no elevator. The standards include seven general requirements:
- An accessible building entrance on an accessible route
- Accessible common and public use areas
- Usable doors (usable by a person in a wheelchair)
- Accessible route into and through the dwelling unit
- Light switches, electrical outlets, thermostats and other environmental controls in accessible locations
- Reinforced walls in bathrooms for later installation of grab bars
- Usable kitchens and bathrooms
Additional requirements apply to developments receiving federal assistance. In such properties, 5 percent of the units must be accessible to mobility-impaired individuals and 2 percent must be accessible to individuals with vision or hearing impairments. State and local restrictions may also apply. Proper advance planning is essential in this area to avoid costly plan revisions or worse, construction tear-outs.
Bottom line: Is it worth the plunge?
Compared to other real estate development sectors, multifamily rental properties certainly look like the healthiest area for investment. The population of renters – some by choice, some by necessity – will continue to grow at least until job growth takes a significant upturn. At the same time, local governments are excited to entertain proposals from developers who offer high-quality additions to the community’s housing stock. Of course, this appealing market is likely to become oversaturated in time with inexperienced investors jumping in, but a measured approach that takes into account community demographics, attractive financing, and conscientious planning will offer great returns in the long run.
Michael D. Firsel, a founding partner of the law firm of Ruben Firsel & Ross LLC., specializes in commercial real estate law and business advice. With 40 years of experience as an attorney and real estate developer, his practice covers all aspects of real estate law including development, transactions, leasing, real estate tax reductions, governmental incentives and zoning. He can be contacted at [email protected] or (847) 582-9910.