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Interest Rates Squeeze Some Apartment Buyers

Interest Rates

With rising rates, slowing rents, high prices, some would-be buyers struggle to find acquisition opportunities.

During a 12-month period from April 2017 to April 2018, Blackfin Real Estate Investors acquired more than 2,000 apartments. It was an impressive start for a company that was just formed in August of 2016.  

While Blackfin still looks to be very active moving forward the rising interest rate environment has made it more difficult to achieve higher leveraged returns.  “The rising interest rate environment has forced us to work harder to find good deals,” says Doug Root, Co-Founder and Managing Partner of Blackfin. “Fortunately, we have been able to still find good opportunities.  We think that we will continue to find good deals and we plan on spending more time looking for opportunities with attractive assumable in-place financing to improve our leveraged returns.”

Part of the reasons apartment buyers are working harder for deals, according Madison Marceau, President of Acquisitions at Kairoi Residential is that despite the recent increases in the baseline rates Fannie Mae and Freddie Mac have been slower to lower spreads.

“As a result, they are squeezing the gap between purchase cap rate and the debt constant of the new loan,” Marceau says. “This is largely eliminating cash return on equity during the hold period.”

Fortunately, other bridge lenders, such as hedge funds, private equity funds and private pure play CRE debt funds, have become more aggressive. “Essentially they're doing their best to absorb the increases in Libor by lowering their spreads to solve to a similar overall interest rate,” Marceau says. “They also have more flexibility on sizing, which is helpful particularly on assets where there is a value-add business plan.  As a result, we have steered some new business their direction.”

Increasing rates are only part of the problem. Bobby Lee, President and COO of JRK Property Holdings, says the biggest challenge he faces going into the second half of the year is how to make returns work in this environment--when cap rates are staying low, borrowing rates and operating expenses are rising and rental growth is slowing.

Buyer and sellers are not necessarily accounting for these trends in the same way, which means an increasing disconnect in price. “Buyers will have to accept lower returns if cap rates do not adjust,” says Matt Ferrari, Managing Director of Acquisitions of the East Coast for TruAmerica Multifamily.

What that means, ultimately, is that borrowers have little margin for error when they’re underwriting new deals.

“Many deals are priced to perfection,” Ferrari says.

JRK will be more selective adding assets in 2019, focusing on conservative leverage, infill locations in major Sunbelt metros (no tertiary) near major demand drivers (which are generally considered defensive plays) and mid-1980's assets experiencing significant distress that's showing up in the pricing. 

“We hope to add more assets in 2019 than in 2018 but it will depend on the opportunities available in the market,” Lee says.

Even if people, such as Lee and Root are not as aggressive, there are still groups eager to buy apartments, which makes it unlikely that sellers will be lowering their price expatiations anytime soon.

“I think the market will keep plotting along as there is too much capital out there chasing a lower volume of deals so a market is being made,” he says.

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