It’s been an intense 18 months for commercial real estate lenders. Thanks in part to low interest rates, many lenders have achieved record volumes. However, it’s not just volume that’s creating all the activity—it’s also rapidly evolving consumer preferences, coupled with increased complexity in the due diligence process. Since the start of the COVID-19 pandemic, renter behavior and preferences have been changing faster than ever before. This constant introduction of new behavior and decision-making considerations requires a heightened emphasis on underwriting and due diligence, particularly when considering factors such as market supply and demand, consumer migration and employment trends.
Nearly all asset classes were at least temporarily disrupted by the pandemic, including multifamily, though you wouldn’t know it today. Multifamily fundamentals soared back into place, as indicated by healthy rent growth, tight vacancy rates and beneficial migration patterns nationwide. At 13.5 percent, average U.S. multifamily rent growth in 2021 was almost double that of any previous year, according to the Yardi Matrix National Multifamily Report.
Amid market uncertainty in other commercial real estate product types such as office and retail, lenders have increased their exposure to multifamily asset classes—including student housing, manufactured housing and self-storage tied to resident populations. Across the board, due diligence has become more complex and nuanced as lenders acknowledge shifting populations and consumer preferences caused by the pandemic. This shift applies not only to traditional permanent mortgages but also to multifamily refinancing, redevelopment loans and all forms of recapitalization.
The emerging single-family rental market
Demographic trends and household income have always been factors in multifamily due diligence, but SFR communities have added a new twist. If SFR units are priced at premium rent levels, the question is whether employment, household income or in-migration trends point to continuing demand for the project: will local consumers be able to afford the rent? For instance, a community with a growing finance or technology industry sector is likely to create the kinds of highly paid workers who could afford premium rent.
Another consideration is whether any luxury apartment properties are located nearby to compete with the SFR project. Conversely, the presence of SFR affects lenders’ consideration of luxury apartment projects. However, renters at SFR communities are looking for a suburban single-family lifestyle that luxury multifamily apartment living will not provide.
Student housing is on a roll—in the right locations
Even when colleges and universities shifted to online-only learning, many students chose to remain in their apartments and continue college life, however limited because of COVID-19 restrictions. Some leases were undoubtedly prepaid by parents or the student themselves, creating an incentive to stay put.
For new construction, pre-leasing is, on average, back to pre-pandemic levels. Lenders and investors are aware, however, that student housing assets are performing differently around different institutions, and proximity to a thriving institution is key. Some colleges and universities have suffered enrollment declines that translate into less demand for student housing—a trend that began before the pandemic. The higher education sector is experiencing continued consolidation, closures and retrenchment, with higher-rated, large and financially strong institutions continuing to thrive.
Manufactured housing communities
Historically misperceived as having low-quality housing and sometimes-questionable residents, manufacturing housing has seen a renaissance over the past decade. Today, many MHCs offer amenities not unlike those found at mid-priced apartments, including swimming pools, tennis courts, playgrounds and clubhouses. Unit quality also can be high, with attractive layouts and interior finishes.
Perhaps most important, MHCs offer consumers—including many retirees—and affordable home ownership option with shared amenities. From an investment and lending standpoint, MHCs are often attractive because of the reliable income streams from pad leases and, in some instances, limited home rentals.
Lenders’ MHC due diligence considerations have remained largely unchanged since pre-pandemic days. Naturally, a lender will scrutinize the operator’s track record and business plan for the property. Resident turnover is less important than the acquirer’s ability to improve the property, raise pad rents and increase cash flow and appreciation.
What has changed over the past decade is the typical ownership profile. MHCs are a maturing asset class, as professional owners and managers continue to consolidate properties from “mom-and-pop” operators who may lack the vision, experience or capital to make improvements and raise rents, or who are looking to exit the business. Corporate owners are better equipped to transform under-performing assets into productive assets and improve the overall quality and desirability of a park.
Fundamentals of due diligence remain the same
In the multifamily sector, work-from-home dynamics will continue to motivate lenders to more closely consider average unit size and on-site amenities when evaluating a project. As behavioral shifts continue, lenders will need to keep a finger on the pulse of consumer behavior trends and preferences to help the sector thrive.
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