2012 Outlook: Bright Prospects Mixed with Overheated Markets and Debt Pricing Volatility

Apartment fundamentals are looking strong as we move into 2012.  As in 2011, volatility will be a factor, but rates will remain attractive.  We expect the agencies to be as active as ever in 2012, despite the attacks they can be expected to endure during an election year.  2012 will bring more aggressive pricing for rental properties.  With demand outstripping supply, a bigger gap between debt and purchase prices may result given agency coupon floors making deals debt service constrained.  This may lead to more preferred equity which requires a thoughtful approach with the agencies.

Expect the Usual Volatility 

As in 2011, volatility will be driven by the unfolding European debt crisis.  Similar to last year, we will see dramatic moves in treasuries as markets move up and down with the latest from Europe.  For instance, in recent weeks we have seen intraday treasury moves in excess of 20 bps.  That said, spreads over treasuries are likely to be stable with a slight bias toward tightening.  My advice for borrowers: if you like the coupon, don’t try to play the market.  Just pull the trigger. 

The Agencies Are Here to Stay 

The attacks on the GSEs by pundits and politicians will only increase as the election progresses.  But for all the pummeling they’re going to take this year, my view is that the agencies will carry on regardless and continue to dominate the multifamily debt space. In fact, they may even pick up market share. 

Last year, we estimate the GSEs did $48 billion in business.  By their own standards, the life companies were particularly active in the market (though this represented less than a quarter of the agency business). It’s unlikely that they can sustain this kind of activity in 2012, and the banks and the conduits will back out in a dime if things get the least bit rocky.  Still, you may see coastal banks providing small loans for projects in places like New York and Los Angeles.  As a result, Fannie and Freddie are going to be your best first stop, and FHA will still be your best option in lagging markets and an option for construction loans.

The Market Heats Up 

Strong fundamentals will further increase demand for multifamily, surpassing supply in 2012. Higher valuations and lower cap rates will create a gap between debt and purchase prices given debt-service constraints.  

Borrowers who can’t bridge the equity gap by themselves may have to partner up with preferred equity sources. If you’re in this situation, it only makes sense to structure the arrangement ahead of time to maximize your execution with the agencies.   

Beech Street is here to help you navigate the volatile and ever-changing markets. While we can’t be 100 percent sure of what 2012 will bring, we promise to help you make the most of it.