A Q&A Session with Ivan Kaufman and Sam Chandan on multifamily construction, lending and the small balance apartment sector.
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 second 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, or read part 1/ part 2 of the Q&A.
I was citing some numbers in the introduction to today’s call from Real Capital Analytics in terms of what’s happening with the investment volume in the overall commercial real estate sector.
For all non-multifamily property, they actually measured a decline in 2016 of about 11% for core property types. Multifamily was the only sector to hold its own with a year-over-year increase of 3% in volume. That’s relatively smaller than what we’ve seen over the last several years. Is this a good place for us to be right now?
Transaction volume is driven in part by interest rates and cap rates. An extended interest rate rise could lead to an adjustment period in terms of sales. I think we’ll see a little bit of a decline in the number of transactions until there’s a price adjustment on the multifamily sales side.
When rates go up 75 basis points — which is significant relative to where they were — mathematically you’re going to have some level of price adjustment and cap rate expansion. Until that happens — and it might take a couple of quarters — the market could slow down a bit.
That is actually really interesting. When I’m having arguments with my friends about how cap rates adjust in a higher interest rate environment, I often hear an expectation that an increase in the interest rate will be absorbed into the spread. Can I tell them that Ivan Kaufman’s has my back if I’m arguing that it can’t all come out of the spreads, and we will actually see some adjustment in cap rates?
Yes, I definitely have your back on that Sam. I think you have to throw one other factor in there. Oil prices — a major component on the expense side — has recently gone up a little bit.
So now you have not just your interest rate going up — you also have a flat outlook on rents and perhaps a more expensive utility bill. Combine those factors and, in my opinion, you are looking a slight cap rate expansion.
As we wind down here, I want to take a quick moment to congratulate you and Arbor for being named Freddie Mac’s Top Small Balance Lender two years in a row. How has the small balance multifamily business changed in the last couple of years?
The small balance market was somewhat underserved. It was also very fragmented without any standardization. You’d have lenders coming in and out.
Fannie Mae and Freddie Mac have really stepped in to the market and created somewhat of a commodity. They’ve also lowered the cost to go buy these units. So we are seeing purchasers who are very active in the market. They know what their financing costs are, and they know how they’re underwritten. It has become a much more efficient process.
A portion of the market that was underserved from a lending standpoint now has a consistent source of liquidity.
How does small balance lending look compared to a $20 million or $30 million loan?
There are different risks associated with small property, and there are different risks associated with non-institutional buyers. We need to evaluate their credit capacity and capability to manage these properties. It’s more of a local business, and it’s more of hands-on management.
Some of the issues that you run into with the smaller properties is that you can’t spread the cost of a new roof in a small property with eight or 10 units like you can in a project with 100 units. So you have to underwrite it a little bit differently. You have to look at the liquidity a little differently.
A lot of these projects are not professionally managed by third-party management firms. A lot of these borrowers are local managers that live in, or near, the neighborhood where they have three, four, five or six assets.
What can we expect to see from Arbor moving forward in the small balance space?
That we will continue to be the market leader for small balance loans. Our pipeline is growing, and our technology is improving. What we are so pleased about is that we don’t really even take on that many new borrowers. Our core borrowers are just expanding their market share. I think that’s because our product offerings are giving them a competitive edge to be more effective in their acquisitions.