Market Recap & Investment Outlook

Q2 by the Numbers: Key Multifamily Stats

Inflation & Interest Rates

By most measures, it appears clear that Jerome Powell has succeeded in the Fed’s stated mission to tame inflation, with year-over-year declines across the board. This paves the way for widely anticipated cuts to the Federal Funds Rate beginning in September.?

“Inflation should continue its slow descent and return to 2% by the middle of next year. If, as expected, inflationary pressures ease through the summer, the Federal Reserve should feel comfortable cutting rates twice this year, delivering a first cut in September.”?

– David Kelly, JP Morgan Asset Management

The service sector is currently driving inflation. This is important because the Core Goods basket appears to have fallen back in line with historic trends. The impact to American consumers on items like milk and eggs seems to be finally abating.?

Capital Markets

While debt capital has remained readily available, a wide bid/ask spread between lenders and borrowers, specific to debt service coverage and, ultimately, property valuations, continued in Q2. This has strained investment transaction volume, as owners who do not need to sell have opted to hold on until the market can meet their pricing. Other stable, well-performing investments have been unable to refinance without bringing significant equity capital to closing.?

Consistent with prior months, development financing has been particularly challenging, with many banks pulling out of the space entirely and others becoming ultra-conservative on their underwriting.?

Market Conditions

KKR, a well-respected global private equity investment company, believes these conditions create a compelling environment for aggressive investment into the real estate space. According to their Co-CEO, Scott Nutall, KKR has closed or is under contract for over $10 billion of real estate equity deals since April 1, with a pipeline largely driven by owners seeking liquidity and now willing to part with their best assets. Large wagers like this seem to foretell that increased transaction volume is on the horizon.

“2024 feels like it could be a sweet spot year, where values are attractive and activity levels are high. This is in contrast to last year when values were attractive, but transaction volumes were more muted as owners of mature assets didn't want to sell or finance them in a closed market. In real estate, the credit opportunity remains compelling with banks on the sidelines and the equity investment opportunity is very attractive. We believe we will take share over the next several years and will benefit from the current and coming dislocation.”

– Scott Nutall, Co-CEO KKR

Widening Gap on Class A to Class C

Another trend that has continued is the distress seen in Class C properties. These older communities have seen the compounding impacts of deferred maintenance and capital items, functional obsolescence, and widening cap rates significantly impact valuations and accordingly, the access to equity capital. As most Class A assets remain full and stable, we anticipate increasing distress in these older vintage Class C assets.

Supply

DLP continues to believe that today’s headlines of multifamily “oversupply” is only a moment in time, and that the US remains structurally under-supplied in terms of housing stock. The lending environment for new development finance has crippled new starts in the short term, and we will see headlines of the “housing shortage” in 2025-26.?

Despite rising interest rates and recession fears, single-family home prices have not slowed considerably in most markets. After a brief dip following the aggressive rate hikes, average home values have continued their steady climb. Homeownership remains as unattainable as it has ever been for many would-be homeowners, to a multi-decade extreme.

“Taken together, [the factors in today’s market: a robust economy, a tight single-family market, higher rates, and a credit crunch] make a strong case for real estate private credit investing: an excess of demand over supply for debt capital, and high prevailing rates. This means that private-market lenders can command higher rates for lending to more credit-worthy borrowers, secured by higher quality assets, at more conservative overall leverage. In other words, potential for outsized risk-adjusted returns.”

— EquityMultiple 2024 Outlook Whitepaper

DLP Outlook

Generally, DLP agrees with KKR’s assessment that the current environment is producing a sweet spot for patient capital acquiring great real estate. DLP’s evergreen funds and access to capital are perfectly aligned for this strategy, and we are actively targeting newly-built communities in our target markets across the Sun Belt and Texas at deep discounts to replacement cost.?

As of early August, the 10-year treasury rates fell below 4.0%, a positive indication for real estate values and the availability of debt capital to size appropriately. For the first time in nearly 2 years, we are seeing investment opportunities with accretive leverage on day one (i.e., the going-in yield is improved via a lower interest rate on the debt).?

On the lending side, DLP is expecting to fund $300-350MM in loans in Q2 and remain confident in achieving our goal of $1.5 billion for the year.

We are also expecting to invest around $500MM in deals as equity investor-as developer, buyer, or preferred equity; rescue capital provider, primarily on Newer Assets in which we can invest at a significant discount to the replacement market, in markets we really believe in.

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