Reuters reported that construction starts for residential and commercial properties in Germany during the first half of 2023 plummeted by 47% compared to the previous two-year average. The nation’s largest real estate investor, Vonovia, lost $2.2 billion in second-quarter 2023. And German commercial real estate transaction volume in H1 2023 finished at one-third the level of its five-year average, Bloomberg reported.

All of this goes to show that German investors are being quite cautious these days about where they place their money. A normally reliable source of capital into U.S. commercial real estate, Germany recently posted one of the largest pullbacks in a global investment market that’s full of them.

Germany was the No. 3 source of foreign capital into U.S. commercial properties in 2021 and No. 5 in 2022, according to MSCI Real Assets. For the year ending in Q2 2023, however, it dropped to No. 9. During these 12 months, German investors purchased only 14 assets on U.S. soil and their aggregate volume of $696 million was down 91% year over year.

Still, there have been a handful of noteworthy acquisitions by German investors of late. The largest of these was announced in October 2022 when Frankfurt-based Union Investment and a Seattle-based partner bought an office complex in Sunnyvale, California, for $222 million. The property features a new four-story office building that boasts LinkedIn as its main tenant.

Class A multifamily properties remain highly prized targets for overseas investors, and the BVT Group (headquartered in Munich and Atlanta) got its hands on a sprawling apartment community that’s being built in Charleston, South Carolina. The project, which is expected to be finished in the latter half of 2024, will include 336 luxury units. The deal was valued at $96.4 million, MSCI reported. BVT’s U.S. division now owns 30 multifamily assets totaling 9,200 units.

German investors closed three other deals valued at $75 million or more during the year ending this past June, MSCI reported. Hamburg-based ParkProperty Capital shelled out $91 million in July 2022 to acquire a posh multifamily community in Atlanta. The property is within walking distance of many high-paying jobs at Piedmont Hospital.

In January 2023, Munich RE (a multinational insurance group) bought a similarly pedestrian-friendly mixed-use building in downtown Durham, North Carolina. The property is a repurposed tobacco factory and warehouse that now includes 247 apartments and 20,000 square feet of retail space. The price tag was $89 million, according to MSCI. And Munich RE teamed with CBRE Investment Management this past May to nab another Class A multifamily property in Dallas for $77 million.

Although German players have stayed on the sidelines of late, it’s a reasonable bet that they’ll return to action once market conditions improve. Notably, Commerz Real (the real estate wing of Commerzbank AG, Germany’s third-largest bank) recently opened offices in New York City and Washington, D.C. The company has had an on-and-off relationship in the U.S. dating back two decades, and according to one of its fund managers, it has an expressed interest in America’s gateway cities. ●

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The company now expects rent growth of 2.9% by the end of the year, down from 3.2% growth in its previous multifamily forecast in June. Next year’s rent growth outlook has been downgraded as well, sliding from 3.5% in the prior forecast to 2.8%. Yardi projects rents to pick up after the conclusion of a recession, with average increases in asking rents of 3.5% to 4% for a few years starting in 2025.

The downgrades reflect Yardi’s expectation of a minor recession in 2024 as more consumers begin to feel the impacts of Federal Reserve rate increases. Additionally, rents are expected to step back in many Southern markets for the rest of this year. In fact, some markets across the country that are replete with supply, including Austin; Boise, Idaho; and the southwest Florida coast, may be headed for rent decreases by the end of 2023. Yardi, however, expects the magnitude of any negative rent growth to be allayed by the challenging financing environment, which will likely stall some future expected deliveries and hinder further supply additions.

Despite the anticipated slowdowns, Yardi remains fairly optimistic in its near- to medium-term perspective. As of August, 16 of the key markets tracked by Yardi had asking rents that have declined since the beginning of 2023. Only nine of these 16 — urban and suburban Atlanta; Austin; Boise; Orlando; Phoenix; Portland, Oregon; San Antonio; and southwest Florida — saw negative month-over-month growth in August. Meanwhile, three of the 16 — metro Los Angeles; the east San Francisco Bay area; and Wilmington, Delaware — actually saw rents increase by more than 50 basis points month over month.

Many of these 16 markets are grappling with the aforementioned problem of too much supply, but an inventory glut doesn’t necessarily signal market weakness, according to Yardi. Rather, these areas are simply “catching up in their efforts to meet the unexpected surge in demand brought during the pandemic, and operators are competing with each other to fill new units by trying to offer comparatively more attractive prices,” wrote Yardi senior research analyst Andrew Semmes.

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The recent groundswell for help to control rents has been building for the past few years across the country. According to a 2021 report by the Urban Institute, more than 200 U.S. municipalities have enacted some form of rent regulations, but rent control remains illegal in most states. In 2019, Oregon became the first state to implement a statewide rent-control program.

“If these buildings are regulated to the point of economic ruin, who is going to lend property owners money to keep up the buildings?”

– Michael Tobman, director of membership and communications, Rent Stabilization Association

Some municipalities that have recently joined the movement include Minneapolis and neighboring St. Paul, where voters passed rent-stabilization measures in November 2021. While St. Paul moved forward this year with a modified plan, the Minneapolis City Council has been unable to develop a consensus around its own policies. In March 2023, the Boston City Council passed a rent-stabilization plan that has reportedly run into roadblocks in the Massachusetts Legislature. Seattle officials recently voted down a rent-control proposal but are discussing other options.

Even the Biden administration is getting involved. This past January, federal officials released “The White House Blueprint for a Renters Bill of Rights,” a white paper that lays out a statement of principles that includes renters having access to safe, quality, accessible and affordable housing.

The paper notes that the Federal Housing Finance Agency (FHFA) will increase affordability by classifying certain multifamily loans as “mission driven” if they include covenants that restrict rents at levels affordable to households earning between 80% and 120% of the area median income. This year, the FHFA is requiring at least half of all Freddie Mac and Fannie Mae multifamily loan purchases to be tied to mission-driven properties. If these loans are granted at last year’s rate, this would equate to an investment in 700,000 affordable housing units.

Even if cities continue to fight over the details, it’s easy to see why the recent rent-control push has been so popular. The U.S. has recently seen dizzying increases in rents that far outpace inflation. According to the federal white paper, more than 44 million households — or about 35% of the U.S. population — live in rental housing. These families are facing rents that are rising much faster than incomes. The national median rent jumped by 17.4% during the year ending in January 2022, according to Realtor.com. And renters are demanding relief.

How to get this relief, however, is the subject of much debate. The commercial real estate industry has long held that rent controls don’t work, claiming that they stall new development, reduce supply, lower property values and, over time, harm the local economy. The National Association of Realtors says that while rent control may help some tenants for a short time, these programs increase rents for units outside the controlled area. Developers may be forced to leave an area that has rent controls or turn apartments into condominiums, which exacerbates the shortage of rental units.

Michael Tobman is experiencing the rent-control issue up close. Tobman is the director of membership and communications for the Rent Stabilization Association, an advocacy organization that represents more than 25,000 landlords who own more than 1 million apartments in New York City that are subject to rent-control measures.

Tobman says that rent increases aren’t keeping up with the rising costs of insurance, utilities and property taxes. He maintains that the city’s rent-stabilization program suffers from being politicized and is not means-tested. New York has many examples of wealthy people, even celebrities, living in rent-controlled apartments. One of his main frustrations is that the state’s Supreme Court has determined that rent stabilization is a public benefit. But this public benefit is being provided by private owners.

“Providing affordable housing should be a function of the government,” Tobman says. “And yet the government in New York state has shirked their responsibilities and moved it onto the shoulders of private owners.”

The FHFA recently sent out a request for information concerning the agency’s proposed actions to promote renter protections and limit “egregious rent increases for future investments,” according to the White House. Some 18 real estate trade associations joined together to provide feedback. As expected, the agency got an earful. In a press release, the industry coalition warned that rent-control mandates disincentivize multifamily investments across markets and will exacerbate housing affordability issues, including the fact that supply has not kept pace with the nation’s population growth. Whether coalition efforts can blunt the growing power of the rent-control movement is unclear.

“What we are seeing in certain cities and states is that press-savvy activists have turned this issue into a sort of political organizing cry,” Tobman says. “They are doing this without really discussing the broader economic impact of the policies they are trying to enact. Rent is income from buildings. If these buildings are regulated to the point of economic ruin, who is going to lend property owners money to keep up the buildings?” ●

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The organization’s updated Dollar of Rent analysis, which used the newest data from operating statements for federally mortgaged rental properties, found that 46 cents of every dollar go to mortgage payments, comprising by far the largest allocation for each rental dollar.

Rental housing providers in Colorado (where 56 cents of every dollar go toward a mortgage) and Utah (55 cents) send the largest shares of each dollar of rental income toward their mortgage costs.

Operating expenses, ranging from ongoing maintenance to utilities and insurance, make up the next largest share at 27 cents, on average. Eleven cents out of every dollar go toward property taxes, while employee payrolls account for 7 cents and capital reserves (tucked away for future upgrades and repairs) make up another 2 cents.

Only 7 cents of every dollar are realized as profit by rental housing providers, quashing what the NAA called a common misconception that such entities reap large profit margins.

“Just like every sector of the economy and countless American households, the rental housing industry has grappled with escalating costs in the face of record inflation,” said Bob Pinnegar, NAA president and CEO. “Rental housing is a narrow-margin industry that is often mischaracterized, but the data shows the truth – 93 cents of every rent dollar keep apartments running and support the local community.

“As we continue to contemplate housing affordability challenges, it is vital to keep these necessary expenses in mind,” Pinnegar added.

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At 122 points, the South Florida hub had the highest competitiveness score of the 139 markets evaluated by the rental website. RentCafe’s competitiveness metric is based on five measurables: average vacant days per unit, share of apartments that are occupied, prospective apartments per vacancy, the lease-renewal rate and new apartments as a share of total stock.

Developers continue to deliver new rental inventory into Miami, as newly built apartments represent 1% of the city’s housing supply, a relatively high percentage. But demand in Miami is so high that 73% of apartment renters renewed their leases during the peak summer rental season, helping to keep the city’s occupancy rate at a sky-high 97.1%.

Moreover, Miami has a whopping 25 prospective renters per vacant unit, easily the most among the 20 markets that RentCafe ranked as the most competitive. And the renter pool in Miami got more crowded as the summer wore on, with this figure rising from 24 prospective renters at the beginning of the summer season. Miami apartments also average just 30 vacant days after hitting the market, one of the lowest rates among the top 20 markets.

Notably, despite Miami’s status as a rental hot spot, only three Florida markets were listed in RentCafe’s summer top 20, down from five one year ago. Broward County, in the Miami metro area, ranked ninth, followed by Orlando in 10th.

The Midwest was the nation’s most competitive rental region, with three markets in the top five: Milwaukee (with a score of 116) at No. 2; the Chicago suburbs (112) at No. 4; and Grand Rapids, Michigan (108), at No. 5. Northern New Jersey (113) finished in third place.

Also of note is that 54% of the markets analyzed by RentCafe were less competitive across all five metrics compared to the same time last year. The most noticeable shifts were in the increase in the number of days that apartments stayed vacant, as well as the dip in the number of renters per available unit. Nationwide, there were typically 15 renters competing for a vacant apartment during the peak rental season in 2022, compared to only 10 this year. And rentals were vacant for an average of 32 days last year, but that figure grew to 37 days in 2023.

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According to data from RentCafe parent company Yardi Matrix, a total of 10,090 apartments in the U.S. were converted from other uses in 2022, down from 11,422 in 2021. That’s also down from the two years prior, when the practice was ascendant: 12,487 converted apartments were delivered in 2019, with another 13,530 in 2020.

But with commercial real estate undergoing a weak period and the office sector lagging, conversions are on an upswing in a big way. A whopping 122,000 units are currently undergoing conversion into rental apartments, with 45,000 of these coming via the repurposing of office space.

Interestingly, while much has been made of the potential (as well as the challenges) of converting offices into residential spaces, office conversions have actually hit their lowest point in a decade. Such transformations hit their all-time high in 2020, when 6,874 apartment units were converted from square footage previously zoned for office space. In 2023, only 3,390 apartments were converted from former office buildings.

“Office-to-multifamily conversions target smaller, older properties, yielding limited sector effects,” said Doug Ressler, senior analyst and manager of business intelligence at Yardi Matrix. “Based on the latest research by CBRE, the conversion of office spaces into multifamily units will primarily be restricted to smaller, older office properties due to factors such as construction costs and regulations related to residential construction.”

Despite the decline, former offices still made up roughly 33.6% of all adaptive-reuse projects last year, the largest share among all property types. On a hard charge to the top, however, are former hotel spaces, which made up 29.3% of converted apartments in 2022. That share represents a five-year high for the asset class and was up 43% compared to the previous year.

Per Yardi, the share of hotel conversions is growing for a variety of reasons. For one thing, hotel-to-apartment conversions are understandably easier than office or industrial conversions as the unit footprint and electrical, kitchen and plumbing layouts are more conducive to the switch. Additionally, RentCafe called the decline of some hotel markets as “a significant catalyst behind the current wave of hotel makeovers.” While the hospitality industry is recovering from pandemic-related travel declines, the substantial pullback in hotel occupancy rates during the depth of the health crisis still led to many properties eventually being marked for conversion.

Kissimmee, Florida, presents an interesting case. With 648 converted apartments delivered in 2022, the Orlando suburb was second to Los Angeles in adaptive-reuse completions, with 85% of these units coming from former hotels. Osceola County, which encompasses Kissimmee, offers multiple incentives for adaptive reuse by providing financial support to property owners and developers who want to jump into the apartment conversion pool.

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Last year saw $480.1 billion in new multifamily mortgages (for apartment buildings with five units or more) from 2,242 different lenders, per the MBA. The organization’s figures came from surveys of larger multifamily lenders, as well as recently released small lender data acquired via the Home Mortgage Disclosure Act.

“Multifamily borrowing remained strong in 2022, largely as a result of lending by banks,” said Jamie Woodwell, the MBA’s head of commercial real estate research. “Beginning in last year’s third quarter, rising and volatile interest rates, uncertainty about property values, and questions about some property fundamentals led to a fall-off in borrowing and lending across commercial property types, including multifamily.”

Large banks were the most prolific sources of multifamily funding last year, led by JP Morgan Chase. Wells Fargo, Walker & Dunlop, Berkadia and Capital One Financial Corp. rounded out the top five multifamily lenders.

Roughly a third of active lenders made five or fewer multifamily loans over the course of 2022. With ongoing turmoil in the banking sector and many banks adopting more stringent lending criteria, the MBA projects a step back in multifamily lending from large institutions this year.

“Most capital sources saw a significant decline in lending activity in 2022, but bank activity increased by an almost equal amount. It’s unlikely that this momentum is occurring this year, given current evidence that banks have tightened underwriting standards and borrower demand has weakened.” 

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Much of this direct investment goes into commercial real estate, especially in the U.S. Per figures from MSCI Real Assets, companies with Swiss connections invested $1.84 billion into American commercial properties last year. While that was down 13% compared to 2021, it was still good for fifth place among all countries for cross-border investments into the U.S. That’s familiar territory for the Swiss, who were No. 6 in 2020 and No. 7 in 2021 on MSCI’s rankings.

Two Swiss companies were among the top 20 cross-border buyers of U.S. commercial assets in 2022, according to MSCI. Stoneweg SA ranked No. 12, while UBS, which has real estate investment operations but is more prominently known as the largest private bank in the world, was 13th.

Stoneweg, in particular, has been active in the U.S. apartment sector and has its stateside multifamily operations headquartered in St. Petersburg, Florida. Its current portfolio includes more than 40 properties, many of them in large U.S. cities and their suburbs. Stoneweg’s acquisitions since October 2022 alone include 161 units in Dallas, 178 units in Cincinnati, and 348 units in Kansas City, Missouri. Prior to that, the company also deployed funds last year to secure multifamily assets in cities such as Houston, Jacksonville and Charlotte.

With commercial real estate trending downward as the calendar turned to 2023, Stoneweg has been relatively quiet so far this year. Rafael Cerezo, the company’s chief investment officer, acknowledged this past March that the environment is “very much wait and see” while adding that the market is due for a repricing. When that happens, the company will be ready, he said.

“We look to invest or anticipate market trends to offer our investors compelling returns at a period of time in products that are likely to become of significant interest to institutional buyers over the course of the next three, four, five years,” Cerezo said. “That means that we need to be at the forefront, really, of investing in new typology of assets, or assets that are going to come on trend. In the U.S., that for us means primarily focusing on the multifamily industry.”

UBS, meanwhile, recently made headlines for entirely different reasons. In March 2023, the company stepped in to buy fellow Swiss banking giant Credit Suisse, preventing its collapse after a long downward spiral. The transaction is gigantic in terms of its international finance impact, but it also has huge implications for commercial real estate as well. The new company will have more than $100 billion in combined real estate assets under management, as well as a commercial property loan portfolio of $80 billion.

Take it all together and you’ve got a major overseas player in U.S. property investment finding itself in interesting waters of late. Clearly, there remains plenty of money to be deployed via Swiss investors, who have traditionally been a shrewd and active bunch. How Switzerland’s biggest investment companies handle the navigation of these aforementioned waters will go a long way toward deciding Switzerland’s outlay into U.S. assets in 2023 and beyond. ●

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The increase brought asking rents to $1,716, up $18 (1%) since January. Annualized rent growth among major metro areas continues to be led by cities in the Midwest and Northeast, with Indianapolis (where rents are up 7% from May 2022) topping the list. Kansas City, Missouri, is next at 6%, followed by New York (6%), Boston (4.8%) and Chicago (4.6%).

Chicago and New York led all cities in monthly growth at 1% and 0.9%, respectively. West Coast cities San Jose (0.9%), Denver (0.8%) and Seattle (0.7%) joined them in the top five.

The national occupancy rate remains stout at 95%, with New York leading all major cities with a 98% occupancy rate.

Yardi’s apartment data, however, isn’t as rosy as it has been for much of the past few years. Cracks in multifamily momentum are beginning to show as rent increases are slowing on both a yearly and monthly basis. May’s annualized growth rate was down 70 basis points from April and down 300 basis points since the start of the year, while eight metros tracked by Yardi were posting negative rent growth. Las Vegas (down 2.8% from May 2022) and Phoenix (-2.6%) have been in the red for months, with Austin (-1%), Seattle (-0.9%), San Francisco (-0.4%), Atlanta (-0.4%), Sacramento (-0.4%) and Orange County, California (-0.2%) joining them in May.

The decreases in several of these cities can be chalked up in part to a regression to a pre-pandemic mean, but there are other factors at play, according to Yardi. For one thing, new deliveries pose a headwind in some areas as red-hot apartment demand in recent years led to a surge in construction. Yardi estimates approximately 1 million apartment units currently under construction, with nearly 900,000 units set for delivery by the end of 2024.

Combine the influx of new space with slowing household formation, corporate layoffs and lack of affordable units, and there may be broader drop-offs in rent gains on the horizon. Market tone remains positive, Yardi reported, but the multifamily realm may see its long-standing unshakable resilience heavily tested in the months ahead.

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To get his take on the market, Scotsman Guide caught up with Kraut recently while he was on a visit to the Dallas-Fort Worth area. He’s been a skeptic of the fast-paced growth in apartment complexes and says it was apparent that one of the capitals of the Sun Belt growth movement was beginning to see some stumbling blocks.

“That’s going to be an interesting situation where the rubber meets the road. How many people have the money to resize their loans?”

– Joel Kraut, co-founder and managing director, BRRRR Loans

Like many major cities, the Dallas area has been building multifamily properties as fast as possible to meet the growing population demands. It is estimated that between 2010 and 2019, nearly 687,000 people moved to the Dallas-Fort Worth-Arlington metro area. But even with that growth, Kraut says apartment rentals are slowing down and landlords are beginning to have trouble renting at the prices they need to make the cost of these new buildings pencil out.

“They aren’t breaking price on rent, but instead are giving one month free or two months free for a 12-month lease, so it doesn’t affect their continuous rental (income),” he says.

This may seem like a small thing — a mere blip on the screen that will pass next season — but it links to much larger problems that loom on the horizon for commercial real estate. The latest wall of worry for the mortgage finance industry to climb is a major refinancing risk that is coming. But this potential new crisis is not in the office sector, which has its own seemingly endless set of woes. This refinance problem is in the once bulletproof multifamily sector.

The recent regional banking crisis has raised worries about the commercial real estate sector’s ability to refinance maturing loans. Data provider Trepp reported this past April that an estimated $940 billion in multifamily loans are set to mature in the next five years, with banks accounting for $344 billion of this total. Trepp notes that the only other commercial property type with more bank loan maturities during the same period is office, which is expected to face approximately $400 billion in maturities. Across securitized debt, a total of about $82 billion in multifamily loans are scheduled to mature this year and next.

Although multifamily has done very well in recent years, many developments were financed during a low interest rate climate. Even then, many developers were counting on rents and property values to keep rising in order to cover the costs of refinancing.

But if apartment rents slow or decline, and properties lose value, then developers may find themselves squeezed while trying to refinance debt deals that no longer makes financial sense. A few casualties have already appeared, including Applesway Investment Group, which lost four Houston apartment complexes to foreclosure in April. According to The Wall Street Journal, most of the company’s loans to buy the properties were originated in the second half of 2021, just before the Federal Reserve began raising rates. At least two of the properties were financed with about 80% debt while the interest rate on at least one loan rose from 3.4% to 8%.

This type of problem is certainly more of a worry in the office sector, where the market has already seen a number of high-profile properties go into foreclosure as borrowers walked away, either unable or unwilling to make loan payments. But it could become more common for apartments if the rental market continues to cool down.

Real estate analytics firm Green Street estimates that apartment values have dropped by more than 20% from their recent peak. At the same time, rent appreciation is slowing. Apartments.com reports that rents increased 2.5% year over year in first-quarter 2023, down from 3.8% annualized growth in the prior quarter. The company also reported that more than 1 million units were under construction at that time, with supply likely outpacing demand. Each of these factors seem to lead to a market that is about to put the squeeze on borrowers seeking a refinance.

“I think you are going to see a lot of foreclosures,” Kraut says. “As rates reset on some existing newer properties and the groups that raised the money for those properties come back to make deals two years later, they will find things have changed dramatically and the math doesn’t add up.”

Kraut doesn’t expect the foreclosures to be a major crisis for the mortgage industry. But he does think that the next 24 months may present an opportunity for certain lenders willing to fund deals. With debt-service-coverage ratios and debt yields on these loans being difficult to support, many owners and operators will be forced to bring fresh capital to the table to reset their loans.

“That’s going to be an interesting situation where the rubber meets the road,” Kraut says. “How many people have the money to resize their loans? Some clearly will — but not a lot.” ●

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