Multifamily residential investment has long carried regulatory risks for institutional capital, given the property type’s vulnerability to political tremors. But recent populist movements in major markets are causing even greater-than-normal concerns.
Renters in Barcelona, Berlin and Paris have succeeded in winning tighter caps on prices from their local governments in the past year. Last month saw a sweeping package of bills passed by the New York legislature. The new regulations cut off the primary mechanisms for landlords to raise rents on stabilized properties: individual apartment improvements, vacancy bonuses and a deregulation threshold.
In response, Blackstone, one of the largest private affordable housing owners in the city, has halted all improvements on Stuyvesant Town-Peter Cooper Village, its 110-building rent-stabilized complex on the east side of Manhattan. The powerhouse manager told a local business publication that it needed time to figure out the ramifications of the new regulations.
Blackstone partnered with Canadian investor Ivanhoe Cambridge to acquire the 11,000-unit property for $5.3 billion in 2015. At the time, the firms agreed to preserve more affordable units than it needed to with the understanding that those covenants would be phased out starting in 2025. It is yet to be explained how those pacts will co-exist with the newly adopted state rules.
The New York-based manager is acutely affected by this uncertainty, but it is not alone. Last year, manager Rockpoint Group partnered with Brooksville Company to buy the 46-building Starrett City complex in Brooklyn for $905 million; Avanath Capital Management is another notable manager in the space. It owns 389 affordable units, also in Brooklyn. Brookfield Properties avoided rent regulations in its 4,000-unit Upper Manhattan portfolio, but the firm has agreed to include affordable components in its new developments elsewhere in the city in exchange for tax breaks and development rights.
Fundamentally, all owners of affordable housing units face the same issue: they have underwritten their investments assuming a level of rent growth. But as the regulatory landscape shifts, not only can those expectations be disrupted, they can be cut off at the knees, effectively prohibiting managers from delivering returns promised to investors.
Such an impediment comes at an inopportune time for institutional capital. Thousands of otherwise attractive properties are effectively being removed from the investible universe when they might otherwise be in peak demand. US-wide, the multifamily sector saw $38.3 billion of transactions during the first quarter of 2019, according to JLL, an uptick of 13 percent year-over-year. Private capital accounted for 72.2 percent of that investment total, driven largely by demand for class-B assets.
Investor appetite for housing has been evident in the sector’s fundraising numbers too. Through the first six months of the year, 26 funds targeting multifamily assets closed on $22.5 billion, nearly 30 percent of the $75.5 billion total haul, according to PERE data.
It is no surprise that capital is flocking to this part of the market. The number of renters is climbing and a secular shift toward urban centers is causing middle-income housing supplies to run dry. Yet, these dynamics are precisely why housing has become so politically charged. Affordability crises are prevalent throughout the US and Europe, and constituents are foisting their frustrations on elected officials. Developers blame burdensome regulations and litigious neighbors for driving up the cost of construction. This assessment is not wrong, but it provides little solace to investors. Instead of hoping for wholesale regulatory change, managers could do better to look elsewhere in the capital stack.
In this case, strong returns may be achieved in New York’s affordable housing market by investing in its distressed debt. As sponsors subsequently fail to hit their rental growth targets, savvy investors can swoop in with refinancing offers or possibly have their pick of non-performing loans.
Bain Capital Credit, for instance, expects to find many such opportunities following the new rent regulations. This week, the Boston-based firm announced a $500 million joint venture with SKW Funding, a New York-based lender that also has a property management arm. Bain plans to leverage SKW’s local knowledge to identify opportunities and its owner-operator credentials should it have to take ownership of any defaulted properties. The strategy seems nicely timed, given the circumstances.
While the capped upside of such a strategy might seem somewhat consolatory, the greater certainty that comes with credit plays should have concurrently greater value in these uncertain times for multifamily investing at the institutional level – particularly when the entry point is attractively discounted.
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