By Adam Pagnucco.
According to a nationally known real estate writer, Montgomery County and the Maryland D.C. suburbs were just called out at a national conference of the biggest players in the multifamily industry. His use of the terms “redlined” and “exit strategies” do not bode well for us!
Last week, the National Multifamily Housing Council (NMHC) held its annual meeting and apartment strategies conference in Las Vegas. In attendance was Jay Parsons, a former journalist and real estate economist whose newsletter is read by industry players across America. Last Thursday, Parsons wrote a post on X in which he summarized discussions at the conference. His account describes a nationally challenging multifamily environment and goes on to specifically name our county. I reprint his post below and have bolded the language pertaining to us.
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Multifamily’s biggest investor event, NMHC Annual Meeting, wraps up today. Here are some takeaways:
1) Lots of short-term uncertainty due to rates, but mid/long-term bullishness with strong demand and falling supply. A 50-year peak in supply is currently pushing rents negative, but completions are now trending downhill and should be below average by next year.
2) But deal flow is stagnant because of rates. It appeared 3-4 months ago that we could see sales volumes rebound as 10-year treasury yields dipped into the 3s, but now we’re back in mid-4s. This creates a math problem b/c few deals pencil out with higher debt costs unless prices fall, and sellers are holding firm on prices.
3) Lots of groups raised capital targeting newer assets well below replacement cost, and as much as that strategy looks good on paper, it’s proven (so far) very difficult to execute at any scale. There’s little of it on the market, and the discounts aren’t that big (especially in suburbs) unless you’re buying in less-favored, high-risk markets like Los Angeles or Oakland.
4) More broadly: There remains a gap between what institutional capital is targeting and what distress exists (older assets in less desirable submarkets, often with economic occupancy and cap ex challenges).
5) More value-add strategies, but with very narrow buy box focused on higher-income suburbs in good school districts etc. (Few apartment renters have school-age kids, but school quality tends to be correlated with favored demand drivers.)
6) Some capital is looking at new development again given challenges of buying existing Class A, but don’t expect a big flurry of new starts. Few projects pencil out. What does is typically lower-cost suburban garden, “cookie cutter” product. Challenge to build to today’s market rents without subsidies, so big focus on construction costs.
7) Banks are getting back in the game on construction loans. They’re not looking to gain exposure, just to maintain it. As current projects finish and refinance to permanent debt, banks have little in the pipeline so are competing again on terms (but nothing crazy).
8) Regulatory risk is MUCH bigger variable than ever. Some groups are even trying to figure out how to model future regulatory risk that could torpedo pro formas and exit strategies as occurred in places like St. Paul, MN, and Montgomery County, MD. Some coastal cities (LA, SF, OAK, NYC, DC’s Maryland suburbs) have been redlined by many institutions that previously favored gateway cities, for both development and acquisitions. “Gateway adjacent” markets (i.e. Orange County, Northern New Jersey) and politically stable suburbs remain favored.
9) Lots of bullishness on 5-year outlook for Sun Belt as supply drops off but demand expected to remain strong. One panel listed DFW as only U.S. market favored to outperform in both 3- and 5-year outlooks.
10) Still big focus on occupancy and retention and resident experience. Vacant units = zero cashflow. Continued momentum on various tech to give residents and prospects on-demand service and faster solutions to basic processes/requests.
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Parsons is a nationally known real estate writer who is telling his audience that we are viewed as a pariah by his industry. He refers to “exit strategies” from our county and says we have been “redlined” by many institutions. He also writes that “politically stable suburbs remain favored.” The message here is clear: because our elected officials have targeted the real estate industry with damaging tax increases and regulatory policies, we are not considered “politically stable.”
Last week, I began asking my sources in the local real estate industry about the combined effects of rent control and state and county building energy performance standards (BEPS) laws on housing development. I also asked them for their opinions about the county council’s new proposed housing package. Parsons’s comments came at a fortuitous time because many of my sources have been saying similar things. Following are excerpts from their responses, which have occasionally been redacted to protect their identities.
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Source 1: So I want to build a 200-unit multi-family project. It will cost roughly $100M. Ideally, I would get 60% bank financing, which means I need to raise 40% or $40M in equity (cash). A typical developer only puts up 5-10% of the required equity so we have to get 90% of the equity or $36M from pension funds, life companies, family office, high net worth, etc. That’s the problem. Equity has choices, they can invest anywhere or as close as across the river and not take on the risks of rent control, vacancy control and likely to be suggested in the future, just cause eviction. It’s equity that is down on MoCo. They’ve told me we are not investing in MoCo when they can build new in DC, PG or VA and not be subject to rent control.
[Note from Pagnucco: D.C. and Prince George’s County have rent control laws but, unlike MoCo, they fully exempt new construction.]
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Source 2: There is a storm brewing on the cumulative impact of all of this and we continue to hear about it from colleagues. These two policies that will either run up the cost of doing business (BEPS) or remove the ease or ability to recoup costs (rent control) are running up against skyrocketing assessments, the specter of property tax increases, and the dramatic rise of homeowners and property insurance… If you are a lender or an investor, these policies do not make Montgomery County a safe harbor for your money when neighboring jurisdictions simply don’t include those risks.
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Source 3: As to the current issues with financing new development in MoCo, the problems are myriad: high interest rates, high equity requirements from lenders, high construction costs, expensive new energy and environmental standards, stagnant (and higher than preferred) prevailing rents that are depressing tenant demand, and rent control, probably in that order. These problems are not unique to MoCo—except perhaps for rent control and the excessive costs of new energy standards; they exist in most metropolitan areas.
What is unique to MoCo are the unknown future effects of rent control on new projects, the county’s continuing lukewarm reception to new development (reflected in difficult entitlement standards, a slower entitlement process than most jurisdictions, a long permitting process), and just recently the unknown future effect of the behavior of the president on the local economy (loss of federal jobs and federal grants, evolving world economic conditions, general domestic economic chaos).
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Source 4: True story, I spoke with a big fund with properties around the country who had called for advice on a project in MoCo and had one in Virginia at the same time. We reasoned through pros and cons of one political jurisdiction vs another. The conclusion was it dropped MoCo due to specter of rent and vacancy price controls, and now looking for a second site in Virginia. Reasoning was, “Why have a new but certain schedule of wasting asset in value in 23 years (with a hostile political regime) vs. a clean asset in Virginia?”
Virginia 2, Mayland 0.
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Source 5: Undeniably, in current environment getting construction loans for apartments is hard. Loans in MoCo are doubly hard. Investor equity for MoCo apartments is impossible. No Va. is the go-to market. MoCo will see a dramatic reduction in apartment construction going forward. I built [number redacted] units in MoCo over the last 10 years. I will never build another. When do you think someone will build in challenging markets like Silver Spring/ Wheaton. It will be just like Takoma Park… NEVER.
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Source 6: The financial world largely runs in other directions when encountering rent control in a municipality, which justifiably scares the dickens out of them. The recent BEPS regulations add stringent icing onto the now poisoned cake.
The new housing package announced by the county council will do little to mitigate their underlying legislative damage, producing relatively few units on the margins given the existing cumulative layering of multiple, and high, taxes, fees, and regulations enacted by the county this quarter century.
This is a great county. It has much to be proud of. Unfortunately, its political leadership has no idea what they are doing in terms of both short term and long term fiscal and economic impacts. Montgomery’s tax base, and consequent public services, are headed towards a fall.
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The above is typical of what I have been hearing for months. In describing our county real estate investment market, the word “radioactive” has come up more than once. Rent control and BEPS appear to be playing different roles, with rent control discouraging new construction and BEPS creating mammoth costs for existing owners. Both contribute to an environment of investment instability, in which major players ask, “What will they do to us next? It’s best to avoid them entirely.”
As for the housing package just proposed at the county council, my sources had varying opinions. Many said it would have little to no impact. One gave it a “C minus.” A couple thought it might be modestly helpful. None said it was harmful but none said it would have a major positive effect on housing production.
Overall, a critical fact of which most of our local politicians appear ignorant is that our county housing market depends on national players in lending, equity and development. These folks can invest anywhere they want. They have access to vast information comparing economic performance and regulatory regimes for every locality in the U.S. and many others beyond our borders. When they read about our rent control law in the Wall Street Journal and hear about “redlining” against us at a national conference and on X, what do you think they will do?
You know the answer to that. Do our county leaders?