As financing for real estate development tightens, institutional equity investors are becoming more selective in their funding and developers are exploring new market segments such as the over-70 sector, said panelists speaking at the 2016 ULI Spring Meeting.
Damian Manolis, head of U.S. transactions for Prudential Real Estate Investors, the global real estate investment business of Prudential Financial, told attendees that his firm is becoming more selective with its funding. “We are definitely more meticulous about our multifamily decisions as capital is now more precious,” he continued. “Multifamily is a significant part of our U.S. business—about 30 to 40 percent of our capital placement each year is with multifamily. We partner in projects, taking the market risk with local and national developers, typically in urban areas. We are focused on longer-term strategies rather than the short-term ‘build and flip’ deals.”
At present, Prudential is less attracted to deals that are more commodity in nature—where barriers to entry are low and in some suburban markets, Manolis added. “We were pretty energized in 2014 and 2015, but now we’re backing off a little,” he explained. “We are sensitive to the trade-off of incremental yield for incremental risk.”
Capital is still largely available, emphasized Paul Keller, founding principal and chief executive officer at Mack Urban, a privately held full-service real estate investment, development, and management firm based in Los Angeles that operates in Seattle, Portland, Los Angeles, Orange County, and San Diego. He recalled “groveling” for funds 11 years ago when the Seattle office was opened. “When we first opened the Seattle office, the first question lenders asked was, ‘What’s going on with Boeing?’ ” Keller remembered. “Today, lenders talk about Amazon and other tech companies and no one asks about Boeing! Seattle has not only strong economic growth, but a strong job market that allows people to pay solid market rents.”
Mack Urban plans its residential developments in advance to keep costs low, and the firm often banks land. “A couple of years ago, we bought a lot of parking lots in Los Angeles and Seattle,” Keller said. “That enabled us to absorb some of the pressure on the hard cost side, which is increasing. Along the West Coast, we’re seeing moderate inflation on hard costs.”
Competition for capital is certainly growing, added Toby S. Bozzuto, president and chief executive officer of the privately held Bozzuto Group, a Greenbelt, Maryland–based real estate development and construction company that develops three to four projects a year, mostly in urban markets, and manages 55,000 apartments—about 60 to 70 percent for third parties.
“There is a big difference in public and private capital, especially with the real estate investment trusts [REITs],” said Bozzuto. “We just competed on a request for proposals in Maryland for a multifamily project, and we were up against a very good REIT. As a public company, they were able to say, ‘Look at our balance sheet. We don’t need the equity market, and we barely need the debt market.’ But, as a private company, Bozzuto won the deal, so there is a place for family-owned business. I think they picked us—a firm run by my father and me—because the land seller was looking for a long-term partner with an excellent local reputation and a history of doing things the right way. Even with a public company’s access to theoretically cheaper capital, we can offer extremely competitive pricing while also adding intangibles such as the ability to have a local family-owned business as a partner—whose entire reputation rides on each deal and how it treat others.”
The U.S. multifamily market is improving, he added. “We’ve seen flat apartment rents over the past couple of years and under one model, it would be depressing, but under another model—since there was a large supply of apartments out there—flat rents are not the worst thing that could happen,” Bozzuto said. “We like to hear lenders are getting [pickier] with funding because as prices increase, the banks and lending institutions become the governor of growth. We feel that our projects, our sponsorship history, and our conservative underwriting will stand up to even the most finicky lenders. In other words, we feel our deals speak for themselves.”
Builders such as Bozzuto are always exploring new markets and are now beginning to consider residential products aimed not only at millennials but also for the other end of the age spectrum—the market for renters in their 70s and beyond. “If you just aim for the millennial market, you are only designing products for 50 percent of the audience,” Bozzuto said. “So we are looking at the 70-plus market. If you look at the baby boomer population, there is a large baby boomer bump as they mature. We want to create beautiful projects that serve the specific needs of that demographic.”
All in all, concluded moderator John J. Healy Jr., a ULI trustee and principal of Hyde Street Holdings, the economy continues to move forward, with certain markets having supply issues offset by a less robust for-sale housing sector. “Interest rates remain low, with the ten-year Treasury bond today the same as it was in April 2012,” he continued. “Since the economy does not appear to be overheated, we may still be two to three years from a correction, and then perhaps only a modest reset. The key is to keep the leverage low and be selective in projects.”
