CRC’s Ari Abramson Lends Expert Advice to ULI’s Multifamily Product Council

Abramson recently spoke with Commercial Observer about the Multifamily Product Council, the multifamily market and his firm’s approach to investing in 2023.

This interview has been edited for length and clarity.

What are the goals of the Multifamily Product Council for 2023?

In 2023, we will hold two Product Council meetings in conjunction with ULI’s spring and fall national conferences. At the upcoming spring meeting, we will discuss the current state of the multifamily cycle as it relates to the transaction marketplace, new development, new technologies and potential governmental regulations. 

As we enter Q1, the most pressing issue I see is how the market will respond to changing interest rates and what those rate changes will mean to our acquisition financing and underwriting projections. The recent increases in short-term interest rates negatively impacted the yield curve, valuations and investor sentiment. Rates are reshaping the multifamily landscape, and the council will share our respective viewpoints and strategies as we respond accordingly.

What are some of the concerns of the council for this year?

When the cost of debt increases, valuations must adjust. For investments to achieve the same leveraged yield with increased debt costs, the capitalization rate must expand in tandem, and as the cap rate widens, valuations decrease. In multifamily real estate, the process is more complex because fundamentals within the asset class remain solid: Effective rental rates are rising, and occupancy is stable. 

In 2022, rising interest rates and sound fundamentals collided to create uncertainty in true valuation with a disparity between buyer and seller valuation expectations, a bid-ask spread, resulting in a pause in general transaction volume. With limited sales taking place, the marketplace was in a period of pricing discovery.

Investors began to lack conviction and they acted with caution, while sellers continued to appreciate the fundamentals of the asset class and sought stability in interest rates. Sellers who capitalized acquisitions with short-term loan structures at high leverage points utilizing floating interest rates will face a challenge. 

How would you characterize the multifamily sector in the Baltimore region in early 2023?  

Baltimore has a stable of solid employers such as T. Rowe Price, University of Maryland, Johns Hopkins University and Under Armour. In theory, this employment base would represent the target renter cohort for either newly developed Class A or recently value-added Class B-plus communities. The Baltimore employment base is steadfast, but the in-migration in the Baltimore metro has lagged the Washington, D.C., metro. Fundamentals have performed in line with comparable metros in the mid-Atlantic with flat to moderate rent growth. 

In 2023, effective rents may see more modest rent growth with development activity in Downtown Baltimore and Towson, and new supply may surpass demand in the short term. Suburban submarkets surrounding our region’s major metros which offer walkability to outdoor recreation or a town center may outperform compared to traditional dense, urban submarkets. In Baltimore, these suburban submarkets include Towson, Columbia, Owings Mills, and Annapolis. Surrounding the metros of Washington, D.C., these submarkets include Tysons, Arlington and Reston, along with Bethesda and Silver Spring.   

What are investors looking for?

Investors are looking for what they’ve always been looking for — great real estate at a great basis and execution on a thesis that drives value. And as little risk as possible. 

What impact will rising interest rates have on the segment?

When the cost of debt increases, valuations must adjust. For investments to achieve the same leveraged yield with increased debt costs, the capitalization rate must expand in tandem, and as the cap rate widens, valuations typically decrease. However, in multifamily real estate, the process is more complex because fundamentals within the asset class remain solid: Effective rental rates are rising, and occupancy is stable. 

Academically, there should be a correlation between interest rates and cap rates; however, the shifts take time. In the coming months or quarters, the bid and ask spread should narrow to allow for the transaction market to unfreeze. In my opinion, we have experienced a general flatness of cap rates across vintage and location. Most recently, we have seen cap rates inverted between value-add and core investing. The recalibration of today’s cap rates to a logical metric associated with the appropriate risk profile, inclusive of the cost of debt, should allow for positive leverage acquisitions with the same fundamentals. The guiding principle for determining valuation needs to be cap rate over replacement value, as investors can’t achieve cash flow from replacement cost but can underwrite total return. 

What areas do you expect to be strong in 2023?

We see opportunities in both core and value-add multifamily investments. Groups that can move quickly should see some interesting short-fuse opportunities. And on the flip side, as I mentioned earlier, groups that have the patience and qualifications to navigate loan assumptions will also make good buys this year. In the last few years, Continental has closed a deal as quickly as 15 days from deal award to settlement, and we have bought several deals through loan assumptions, including a HUD loan assumption. The acquisitions landscape will be notably different than in years past, but there are always great buys to be had.

In 2022, Continental Realty Corporation sold Riverstone at Owings Mills, a 324-unit apartment community located in the Baltimore suburb of Owings Mills, following the execution of our value-add business plan. Carter Funds purchased the property for $92.9 million, which is approximately $31 million more than our 2016 basis. This transaction showcases how our investors have been able to achieve strong returns in the Baltimore area. 

What is Continental Realty’s strategy for the year ahead?

For multifamily investment in 2023, we will continue to allocate on behalf of our core multifamily partnership fund, an open-ended fund structured that targets Class A properties located in the Southeast portion of the U.S., and constructed within the past four years for long-term holds. We will also continue to allocate on behalf of our series of closed-end funds targeting value-add multifamily properties throughout the mid-Atlantic and Southeast. Our unique dual long-term hold and fixed-rate debt strategies for value-add and core investment allows for sustainable activity throughout various cycles and periods of volatility.    

Keith Loria can be reached at Kloria@commercialobserver.com.