Finance pros: Multifamily market still booming, overbuilding not yet a concern in Midwest

A joint venture of CA Ventures and Keith Giles LLC is building 1136 South Wabash, a 320-unit mixed-use development in Chicago’s South Loop.

by Dan Rafter

Minneapolis’ Dougherty Mortgage has been busy, fielding plenty of financing requests from investors who want to acquire and developers who want to build apartment complexes in the markets this commercial lender serves.

Dougherty Mortgage isn’t alone, either. The multifamily market continues to boom across the Midwest, with investors sinking their dollars into existing properties and developers rushing to build new apartment towers in urban downtowns.

Tim Larkin, senior vice president in the Minneapolis office of Dougherty Mortgage, says that the apartment market continues to keep him and his fellow lenders active. And he doesn’t see any slowdown in multifamily financing requests in the near future.

“Rents have been rising and will continue to rise. The economy is in good shape. Payroll is up and unemployment is down,” Larkin said. “The country’s median income is up. All of those strong factors are still in place, so there doesn’t seem to be any reason for a slowdown in the multifamily market.”

That is good news for the brokers, developers and investors who continue to flock to this busiest of commercial sectors.

National factors fueling local multifamily markets

Why has the multifamily market been so strong for so long? Larkin points to larger trends within the residential market.

As Larkin points out, the national homeownership rate has fallen in recent years, ever since the housing bust that started in 2007. More consumers chose to rent as housing prices fell. Many of these consumers have continued to choose rental housing over owning.

There is also a lack of single-family homes available on the market. This lack of inventory is forcing some consumers who might have chosen to own into renting.

“The Millennials are out there renting for longer periods of time,” Larkin said. “We didn’t anticipate that or expect that. But that has been the case, and it’s provided a boost to the multifamily market. At the same time, Baby Boomers are downsizing. Their kids are out of the house. Many of them are turning to renting, too. They can be a little more mobile when they’re renting instead of owning. So on the demand side, the fundaments are strong for renting.”

Frank Lutz, senior vice president with Berkadia, said that apartments play an important role in the United States housing market. Lutz says that the country needs a greater amount of affordable places for its residents to live.

Rental housing often fills that need. It’s true that much of the new apartment product being built today qualifies as luxury housing, rentals that are too costly for median-income renters to afford. But Lutz said that much of the existing apartment stock throughout the country, the Class-B and Class-C buildings, are far less expensive, and offer consumers a more affordable alternative to owning a home.

“The less expensive apartments really are the bulk of the product out there today,” Lutz said. “There is a tremendous need for affordable housing in America. I think that is why the multifamily market has remained as strong as it has.”

These strong fundamentals are why neither Larkin nor Lutz are overly worried that developers are building too many apartment buildings, especially in Midwest markets.

Larkin said that there might be some overbuilding in markets such as Boston, Los Angeles, New York City or Washington, D.C. But in the Midwest, even in such hot apartment markets as Chicago and Minneapolis, supply has kept pace with demand, Larkin said.

Larkin points to his home market of Minneapolis-St. Paul. He said that the apartment vacancy rates here average about 3 percent to 3.5 percent. Those are low rates, and an indication that the supply is not outpacing demand in the Twin Cities.

“I’m not worried about the Midwest at this time,” he said. “You do have to be careful and keep a close watch on some of the hotter markets across the country. In the Midwest, I’m not concerned yet. There’d have to be something really big to throw a monkey wrench or cause problems, in my opinion. And I don’t see anything that big on the horizon.”

Lutz said that apartment overbuilding so far has not materialized.

“There are some pockets around the country where there might be a little bit of softness,” Lutz said. “But to be honest, I don’t feel that it is of any particularly strong threat to the business. Demand for rental housing remains very strong. The long-term fundamentals for multifamily housing and the demand for multifamily housing remains strong.”

Lenders are cautious today, too, before loaning investors and developers acquisition or construction financing, Lutz said. That is preventing developers from oversaturating markets with apartment units, he said.

“I think underwriting standards, unlike the last time we got into trouble in this business, remain reasonable,” Lutz said. “I don’t want to say they are conservative. But they are reasonable. The long-term demand outlook for rental housing in America looks very good.”

Loan approval

What do investors and developers have to show companies such as Berkadia and Dougherty to gain approval of their financing requests?

Larkin said that Dougherty lenders take a long look at the previous experience of a loan request’s sponsor or key principal.

“What is their track record in developing, owning or managing the product type that they are looking to get financing for?” Larkin asked. “We will ask more questions if it’s something they’ve never done before.”

Dougherty also studies the financial capacity of sponsors. If a problem pops up, will the sponsor have the financial ability to resolve the issue?

For a new-construction project, Dougherty lenders study the members of the project team. Who is the architect? Who is the general contractor? The people working on a project matter, Larkin said.

“It’s all about putting the pieces together,” he said. “We put a lot of work, time and effort into the credit side of things. Lenders do that. They have to.”

Dougherty lenders look carefully, too, at the project itself. If an investor seeks funds to acquire an existing building, Dougherty will consider how well the property is doing and where its vacancy rate stands.

“Is there a positive or negative trend in terms of operations?” Dougherty said. “If it’s a negative one, we will ask more questions. You have to be able to answer them, to get back to us with an appropriate response. Otherwise, we might pass on the deal. Our staff and underwriters do that work. They look at the feasibility of the entire project.”

Lutz said that it’s important for lenders to consider the particular market that a developer or investor is targeting, Lutz said. That’s because a sponsor who has thrived with apartments in St. Louis might falter when moving to a new market such as Indianapolis or Chicago.

“You might have a guy who is a terrific owner of multifamily products, a star in, say, Philadelphia,” Lutz said. “But if he shows up with plans for an 800-unit complex in Indianapolis, we might be hesitant. We might like him for an 80-unit deal in Philadelphia. But we might not like him as much with an 800-unit deal in Indianapolis.”

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This entry was posted in Chicago Commercial Real Estate, Illinois, Illinois real estate, Indiana commercial real estate, Indianapolis commercial real estate, Minneapolis commercial real estate, Minnesota real estate, multi-family, St. Paul commercial real estate and tagged , , , , , . Bookmark the permalink.

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