How finance officers are dealing with inflation and higher interest rates. 

As the Federal Reserve continues to tease a reduction in interest rates and inflation remains stuck above the target amount, multifamily housing owners and operators are tweaking budgets to stay ahead of the curve. Squeezing pennies out of purchasing decisions is always a sound strategy. 

“We’ve allocated more budgeting resources towards revenue management, purchasing national contracts for maintenance supplies, and managing our debt service given the current interest rate environment,” said Wesley Wilson, Partner & CFO at Avanath Capital Management. “With the continued strong demand and long length of stay at our communities, we are able to keep advertising, leasing and turnover costs at a nominal amount.” 

Maintenance supplies are just one of many essential areas that have seen price bumps. “Significant increases have been seen in the arena of insurance, and some of our properties have seen reassessments on their real estate taxes this year as well,” said Jackson Baughman, Finance & Capital Markets Manager, Rookwood Properties. 

Marketing budgets are coming under tighter scrutiny and being measured against results. “We carefully watch metrics around marketing spend to make sure dollars spent are producing leases,” said Cindy Clare, COO, Bell Partners. “Decisions around capital improvements are focusing more on the ‘need to be done’ versus the ‘nice to have.’”  

Human resources are also being squeezed, especially in the affordable side of the business. “Post-COVID, there’s been a rise in vacancies in site-level positions within the affordable housing industry,” said Laura Yanushpolsky, Director of Asset Management at Hudson Valley Property Group. 

Location, Location, Location 

Different regions of the county are dealing with their own unique situations including an insurance shortage in Florida. “Insurance costs in Florida are likely to be around double, if not triple, the costs in Texas,” said Antonio Parra, Acquisitions and Development Associate, The Lynd Company. The issue has become so pronounced that some insurers have stopped doing business in the state. 

City-based properties versus suburban locations also affect the prices of items on the balance sheet. “Urban properties often incur higher security expenses, and some markets may face greater challenges with collection losses due to a combination of local policies and economic factors,” said Yanushpolsky. 

Legal matters also play a larger role, depending on location. “Differences in how the local courts view landlord/tenant disputes can have a significant impact on credit verification costs, eviction expenses and court costs as well,” 
said Baughman. 

Value-Add = Not Quite Dead 

Back in the old days before inflation was a thing and the price of capital was cheap, the mergers and acquisition side of multifamily housing was overstuffed with value-add possibilities. Class Cs were turned into Bs. Bs became As with rent growth covering the renovation costs. Things are different now. 

“Capital allocation has certainly been impacted by the inflationary environment that we are in now,” said Baughman. “Acquisition costs have dipped some but have yet to find a steady balance with interest rate run-ups. Deal flow continues to be slow moving because of this gap. Expense items continue to creep up over time with inflation.” 

Working on the affordable side of the business tells a slightly different story thanks to lending power of the Government Sponsored Enterprises. 

“Entities like Fannie Mae, Freddie Mac, FHA and numerous banks offer specialized lending platforms for affordable housing, providing financing rates that surpass the market average,” said Yanushpolsky. The federally backed programs are also tied to yearly quotas which incentivizes them to support acquisitions. 

Some owners and operators believe the dip in value-add may have finally bottomed out. “Deal activity is slowly increasing, and buyer interest is active in many Bell target regions,” said Clare. “Suburban assets remain in high demand, especially for differentiated, hard to replicate assets.” 

Bell is seeing opportunities from owners facing refinancing challenges from the increased cost of capital and reduced lender pool availability. In some cases, the value-add opportunity may appear in the form of moving into property management, looking for changing demographics in the surrounding area or a well-targeted renovation. 

Making a tight deal pencil can happen with some help from capital flowing in from insurance companies. “Many groups have moved to utilizing lower leverage life company debt or agency debt to finance an acquisition and then funding improvements out of cash flow or equity injections from investors,” said Baughman. 

Value-add can also be viable when the renovation costs are subtracted from the equation. “As real estate valuations normalize, we’ve adapted our approach to identify opportunities in acquisitions and dispositions,” said Wilson. 

“Currently, we’re strategically acquiring properties, leveraging both on-market and off-market opportunities enabled by favorable interest rates available for affordable housing. Additionally, our dispositions do not occur as frequently as our acquisitions as we intend to hold properties long term, but we still see significant interest from potential buyers, which affirms the continued relevance and profitability of value-add transactions in the market.” 

Class Waterfall 

Some owners and operators are seeing a migration from one class to the next. “As the economy tightens on consumers, one of the first things you see in the rental market is [residents] moving from higher grade housing to lower,” said Baughman. “I view this as somewhat of a waterfall.” 

The typical progression has residents in a Class A property moving to Bs as Bs move to Cs. Baughman believes that one of the first signs of the markets beginning to tighten is a dip in Class A occupancy. 

“As each class of property falls into a different spot in the waterfall, they all have different needs,” he said. Baughman noted that Class A is seeing increased advertising costs and concessions to keep occupancies elevated. B-Class is enjoying the rental run up from these move-ins now but may eventually be in the same position as Class A.  

Workforce versus affordable housing is another way to divide the budget considerations of individual classes of properties. “Operating both affordable housing and workforce housing properties presents diverse budget considerations,” said Wilson. “Affordable housing properties often benefit from property tax abatements unavailable to workforce housing properties.” Wilson points out that rent structures also differ. Affordable housing rents are tied to area median income and CPI growth, while workforce housing rents follow market conditions. 

Parra believes that each class of property has its own set of budgetary challenges. “Class A properties typically incur high operating costs due to their premium amenities, finishes and additional staffing,” he said. “Class B properties usually have moderate maintenance and repair costs. Although they may not require the same level of immediate repairs as [workforce housing] properties, they still need significant investment over time to remain competitive and maintain their value. 

“[Workforce housing] properties face distinct budget challenges, including higher maintenance and repair costs due to the age of the properties. Additionally, they typically experience increased [resident] turnover rates, leading to leasing costs and potentially higher vacancy periods.” 

Conversions 

As housing prices remain high and the value of downtown office space continues to spiral down in many markets, the possibility of converting offices to apartments beckons to policymakers, urban planners and developers. Reality-based discussions quickly pivot to basic budget questions. How much would it cost to convert the building? What’s the land worth? How much would rent revenue bring in? 

The buck typically stops at the finance department’s desk. “These projects create their own unique challenges, and the scope of each project can vary widely depending on the physical building,” said Baughman. “One of the biggest hurdles to consider when exploring this opportunity is the cost and effort to get utilities into each unit.” 

Baughman has analyzed some deals where building from the ground up on the land may be the best option. The locations of many office buildings are not conducive to municipality zoning requirements which can add another wrinkle to the proposition. 

Computer Power 

It’s no surprise that the multifamily housing budget chiefs rely on software to help guide their decisions. Many of them are using a hybrid approach that leverages their own in-house data along with third-party solutions. 

Parra says they use various computer programs to help make informed forecasts and decisions, and “when it comes to expenses, Lynd relies on our proprietary in-house data, which is based on our more than 40 years of operational experience.” 

“We use budgeting software that allows us to look at historical data as well as forecasting,” said Clare. “In addition, we incorporate data analytics from our in-house research team into our budget decision-making. Our process does not change based on the market. We use the same tools.”   

The current economic conditions are still tied back to the pandemic that changed the way the world works and lives. Stimulus money saved the economy but produced inflation that led to higher interest rates. The multifamily housing industry had to adapt, just like everybody else. 

“Because of increased demand for larger floorplans, suburban locations have become more popular since residents are not commuting as often,” said Clare. “On the revenue side, we now provide small commercial spaces for rent in some of our communities in response to demand.” 

 

Scott Sowers is a freelance writer.