A Q&A Session with Ivan Kaufman and Sam Chandan
For over 20 years, Arbor has helped multifamily real estate investors achieve their financial goals. In March 2017, Ivan Kaufman, Chairman, President & CEO of Arbor, sat down with Sam Chandan, Silverstein Chair of the New York University SPS Schack Institute and Founder of Chandan Economics, for an in-depth conversation on the state of the multifamily market. Here is the first part of that conversation.
(The following is excerpted from the March 10, 2017 episode of The Real Estate Hour, a weekly SiriusXM Business Radio show powered by the Wharton School of Business. The text below is edited for clarity and brevity. You can listen to the full show by clicking here.)
Ivan, the inauguration is behind us and the President is well into his first 100 days. Based on what you’ve seen so far in terms of this administration’s policy priorities, are there any changes in your outlook for the economy overall in 2017?
We all understand that interest rates have risen — and they’ve risen significantly. The 10-year Treasury rate, for example, has gone as high as 2.6%, and it’s floating in the 2.4% to 2.5% range. So it’s up 75 to 85 bps, and there’s an expectation that there will be some level of further increases on a quarter-to-quarter basis. Higher rates certainly have a direct impact on the valuation and underwriting of multifamily assets.
With respect to the other policies that are being discussed, I think it’s early. Clearly, there is the sense that there is going to be some level of economic prosperity and job growth within the United States. These factors have positive influences on rental growth and homeownership. But I think it’s too early to really understand the impact of some of the proposed policies.
I think we economists have a very similar sense of things. It is still unclear as to the exact policies that will be enacted. But there does seem to be this sense of optimism. When we look at things like the consumer confidence indices or measures of sentiment — people are fairly confident. I think that’s part of what’s feeding into the higher interest rate environment.
As you have pointed out, we have seen signals from the Federal Reserve that they anticipate a series of rate increases over the course of 2017.
How does optimism for the economy feed into expectations for multifamily demand drivers? Here I’m thinking about growth in the number of rental households. What is happening with job growth? Do you see it potentially moving in tandem with income growth over the next year?
Wage growth and rental growth have not run in tandem. Rental growth has clearly outpaced wage growth. When thinking about job growth, we already have somewhat of a tight labor market in terms of unemployment. It’s logical to take the position that additional job growth will yield some wage growth. This has an impact on underwriting multifamily assets.
Most lenders project flat rental growth when looking at property. We’ve had unprecedented rental growth over the last five to seven years. We’ve seen that in spite of the fact that the wage growth has not been that dramatic. If in fact we see some real job growth — which will translate into some wage growth — perhaps there will be some additional growth in rents.
But on a macro basis, flat rent growth is the way creditors are viewing rental income streams for the future. There are pockets with supply and demand imbalances which will see some rental growth. But overall, a flat to modest increase is the outlook.
Higher interest rates obviously have a direct impact on the mortgage rates that we pay in the United States. So much of the dynamic following the housing crisis has really been about the interplay of the questions: Do I want to own a home? Can I get a mortgage? Do I want to be tied down? Do I want to be in a suburban area?
I think you have continuing demand for rentals. But as mortgage rates go up, do you see this potentially having a significant impact on the balance of renting versus owning? Higher interest rates make home buying more expensive.
I think first you have to understand how quickly the affordability factors have changed since the election. Rates went from 3.5% or 3.75% up to 4.5%. That’s a 25% increase. Most people buying homes are fairly stretched as is. So I think either they can’t afford the home they were looking at before, or there will be some level of price adjustment.
If they can’t afford the home they were looking for, then perhaps they will look towards rental housing. There could be a little bit of a boost in rental housing. I don’t think home prices will adjust down in such a short period of time. Maybe we are looking at a short-term demand driver for rental housing until interest rates are sorted out — or until home pricing has adjusted accordingly.
We do tend to focus a lot of our attention on the relatively younger renter — the Millennial demographic — that wants the walkability and the flexibility that comes with being a renter instead of an owner. But on the other side of the demographic spectrum, we’ve also got Baby Boomers that are increasing in numbers very rapidly. We might conflate Baby Boomers with empty nesters who have seen their youngest children move on to start their own families. Is this group part of the demand equation right now?
Well, it’s interesting. I think the dynamics of the empty nester, later household formation and the psychological impact of the housing crisis have all combined to contribute to higher demand on the rental side of the market.
With later household formation, apartment living and urban demand may begin to translate back into homeownership at some point. We haven’t seen it yet, but we’ve heard from people who have been renting that are now starting to have families. They are looking back out to the suburbs. But we haven’t seen the full materialization of this trend yet.
(Stay tuned for Part II of Ivan Kaufman and Sam Chandan’s conversation on the multifamily market.)
(The Small Balance Multifamily Q&A — Part 2b)
Arbor has helped shape the small multifamily loan market into what it is today, partnering with Fannie Mae to develop the first-ever agency small loan program over 20 years ago. More recently, Arbor helped develop the Freddie Mac Small Balance Loan program that launched in 2014 — and was the program’s top lender in 2015 and 2016.
Ivan Kaufman, Chairman, President & CEO of Arbor, recently sat down with Stephen Johnson, vice president of the Small Balance Loan business at Freddie Mac, for a conversation on the sector moderated by Sam Chandan, founder of Chandan Economics and the Silverstein Chair of the NYU SPS Schack Institute. Here is Part 2 of that conversation, which examines the role of small balance loans in the multifamily housing sector.
(The following is excerpted from the December 9, 2016 episode of The Real Estate Hour, a weekly SiriusXM Radio show powered by the Wharton School of Business. The text is edited for clarity and brevity. You can listen to the full show by clicking here. Part 1 of the Q&A is located here.)
The following is part 2b. Please click here for part 2a.
Sam Chandan: $2.6 billion isn’t a bad place to start for your first year in business. Now one of the things that I want to make sure folks understand in terms of the scope and scale of Freddie Mac’s activities, is that when you are working with partners like Arbor, you are not limited to a handful of markets. You are a presence in every market, ensuring some degree of liquidity. Is that fair?
Steve Johnson: We are a nationwide program. So when the sun comes up in the morning and it goes down at night, we are here. We are in the markets. We don’t — as I have seen people commonly refer to it — redline. Again, regardless of what the conditions are, we are in this business every day to provide liquidity. That means coast to coast, north to south.
We have offices all over the country, and we do that because we are a prior approval model. We believe in making our own credit decisions. We inspect every property, and we underwrite every loan. So we have got boots on the ground out there. When you combine that with a player like Arbor, who has reach across the country, you have something extremely powerful — an originations engine and our ability to make the right credit decisions.
Sam Chandan: Ivan, you have the benefit of a long-term perspective that most of us don’t. You have seen the small balance lending market grow over the past year and we are expecting 2016 to be the biggest small balance year on record. What is behind that? How much is Fannie Mae and Freddie Mac, and how much is underlying momentum and demand for small balance properties?
Ivan Kaufman: As financing and liquidity comes to this part of the market, I believe it will be a much more active sector moving forward. So, I think the standardization, the streamlined products and the growth in the market will make it more attractive. And clearly, outside of some of the gateway cities, financing has become a little bit less accessible with regulation and cutbacks from the banks. The agencies just fill a tremendous void here to keep the market moving at a very robust pace.
Sam Chandan: Ivan, as someone who is also active in the larger multifamily loan market, how do these small balance loans look different in terms of pricing, borrowing costs and leverage? Am I still going to find low interest rates and healthy underwriting? What does the loan package look like for me?
Ivan Kaufman: They are somewhat similar in terms of pricing. Because of Freddie Mac and Fannie Mae’s commitment to effectively serving this sector of the market, they have come up with price reductions to make it extremely attractive.
In terms of underwriting, small loans lend to have a different type of borrower. They are often not as sophisticated and lack the same kind of financial capabilities that larger apartment owner/operators have. They might, for example, lack audited financial statements. So there is some flexibility on the documentation. We have to spend a little bit more time getting to know the borrowers and getting to know their properties. So it requires a little bit more insight, and is a little bit more of ‘relationship lending’.
Sam Chandan: Ivan, you have talked about how the borrowers are different, can you tell us how the renters are different?
Ivan Kaufman: What we find on these small balance loans is that the renters are typically essential workers. They are firemen, teachers, police officers and young professionals — all critical components of the communities they reside in.
These professionals are not as interested in amenity space as long as the housing meets the needs of their family.
Steve Johnson: Ivan is absolutely right. If you look at the small balance business and apply an identity, it would be workforce housing.
Roughly 70% to 75% of our business is being done with renters who make less than 80% of area median income. And a large portion of it is for renters making less than 50% of area median income. That is our target audience. That’s where the affordability crunch is occurring in the market and that’s where we are looking to provide liquidity.
(Stay tuned for a future Q&A from a March 2017 episode of The Real Estate Hour on SiriusXM Business Radio featuring Ivan Kaufman and Sam Chandan discussing the state of the greater multifamily industry.)
In this infographic, Ivan Kaufman discusses how renter occupation affects apartment size. Research found that renters inhabiting larger apartments tend to be employed in STEM jobs. In comparison, small property renters have lower average wages. Read the infographic to learn more!