By the Numbers
Good prospects for price appreciation and multifamily prepayments
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Over long periods of time, prepayment speeds for multifamily loans out-of-the-money to refinance average about 2 CPR. But in markets with high cumulative price appreciation, prepayments for some vintages of Ginnie Mae project loans have ranged from 5 CPR to 10 CPR. Those faster speeds can increase returns for owners of the interest-only classes that collect the prepayment penalties. And prospects are good for continued appreciation in multifamily properties.
Two out-of-the-money Ginnie Mae project loan pools recently prepaid when Blackstone bought the properties as part of a $300 million low income housing portfolio deal focused in South Florida. One of the pools (GN CJ1915, original WAC 2.68%) paid off with 10 points of penalties, and the other (GN BX7716, original WAC 2.24%) paid off with 9 points of penalties. This is unlikely to be a one-off event, as outlined in our recent piece, High property price appreciation could lift prepayments in OTM loans.
Despite a recent stagnation and slight downturn in commercial real estate property price appreciation across most sectors, multifamily fundamentals and the long-term outlook remain strong (Exhibit 1). Commercial real estate prices peaked in the fourth quarter of 2021 on exceptional transaction volume, then fell in the first quarter of 2022 by 1.3%. Compared to pre-pandemic levels of February 2020, CoStar’s U.S. composite commercial price index is up 26.2%. Multifamily property prices fell 1.0% during the first quarter, after notching an 18.2% rise year-over-year to close 2021, while other major sectors were roughly flat.
Exhibit 1: Commercial real estate property price indices
Note: Quarterly data through March 2022.
There are two factors driving continued investment in commercial real estate and the multifamily space in particular. First, economic research has shown that commercial real estate is one of the few asset classes that can serve as an effective hedge against inflation over medium to long periods of time (see Which asset classes effectively hedge inflation?). Second, multifamily leases typically renew yearly, so rent growth can keep pace with inflationary trends easier than, say, office or retail leases which can have 10-year terms. A decade of underbuilding across the housing market collided with pandemic, driving prices higher. New home construction has picked up significantly in both single- and multifamily sectors, but it will take years, if not a decade, for supply to catch up to projected long-term demand.
A note of caution
Although CRE markets are taking a breather and property price appreciation should slow markedly, land prices continue to accelerate (Exhibit 2). Raw land prices increased 6.8% in the first quarter of 2022 and are up 17.5% year-over-year and 26.2% compared to pre-pandemic levels. That move seems reasonable in context of similar price increases in single- and multifamily properties overall but is reminiscent of the run-up during the housing bubble.
Exhibit 2: Land prices surge higher
Note: Indices are quarterly, data through March 2022.
The drivers of the price increases are obviously very different this time around, and not due to easy credit standards or otherwise loose lending contributing to a speculative wave. However, there is well established body of economic research, referenced in the CoreLogic article Land Values Drive Home Price Volatility, indicating that volatile land values were primary drivers of home price dynamics during the crisis. Areas where the price volatility of land was highest, tended to have the biggest post-crisis busts in home prices. One point made in the research that is distinct from the current environment is that home prices were not primarily being driven higher due to high costs of construction, but due to the increase the land values themselves, which later declined. This could be an issue to monitor in SunBelt and other areas where the increased cost of land is outweighing higher construction costs.
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