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Bisnow: Financial Modeling With Untrended Rents Protects The Bottom Line. But At What Cost?

Bianca Barragán | Bisnow | February 17, 2023

With roadblocks piling up for the recently high-flying multifamily industry, a bit of financial modeling that helps lenders predict an asset’s profitability is adding more fuel to a growing pileup that could hinder development pipelines — and new housing supply — for years to come.

As economic conditions worsen for real estate, developers are asked with increasing frequency to use a more conservative set of income assumptions in their pro formas that reflect the slowing demand for apartments, called untrended rents.

In other words, as one source put it, they’re being asked to build at tomorrow’s cost for today’s rents.

“If you’re not trending rents, you’ll have less proceeds,” Parkview Financial CEO Paul Rahimian said. “That’s going to cut developers in a way that some of them just can’t proceed to build — they don’t have enough equity. They were expecting more loan dollars.”

Using trended rents refers to the generally accepted practice among developers to assume a certain amount of rent growth, usually based on current market conditions and rental trends in the recent past, to forecast the profitability of a project. Accordingly, when economic conditions change, lenders want to see those changes reflected in modeling, meaning that developers must instead assume that rents will remain unchanged.

Developers have enjoyed years of consistent, reliable rental rate growth, with the average rent growing 13.5% in 2021 and another 6.2% last year, according to Yardi Matrix. That trend is moderating, with rents inching up just 0.4% year-over-year in January, according to

When added to climbing interest rates, surging construction costs and cap rates that keep ticking up, untrended rents often mean that deals simply don’t get done, causing ripple effects.

Many of the CRE professionals who spoke to Bisnow agreed, especially in markets where supply is already low, a period of widespread use of untrended rents, along with other challenges to multifamily development, could have an impact a few years into the future, when projects that should or could have come online don’t open, further exacerbating the supply-demand divide.

An estimate from the Mortgage Bankers Association predicts that nationwide multifamily mortgage lending will decline 16% this year, dropping to $384B from 2022’s $459B total. That’s not entirely attributable to conservative assumptions of rent growth, but it’s certainly an additional factor complicating the process of getting deals done, sources told Bisnow.

Developers whose financing hopes were dashed would have seen their projects come online in two or three years, Rahimian said, so that’s the time the market will see the effects of what’s happening now. There won’t be an immediate impact, but something “we’re going to feel in a few years, when we're past this recession.”

A tamped-down development pipeline in a time of record low housing inventory also spells higher prices down the road when the market bounces back, Cityview CEO Sean Burton said.

“In supply-constrained markets, we need to be building more housing, not less,” Burton said. Cityview’s strategy is to develop in those supply-constrained markets, such as Southern California.

Though this has presented challenges to multifamily developers generally, Burton says that Cityview has been fortunate and has gotten all the financing it needs to keep its projects on track and moving forward.

For lenders, though, the use of a more conservative approach with untrended rents protects the bottom line — and investors.

A good manager is going to look at both trended and untrended rents when evaluating a project, Origin Investments principal Michael Episcope said.

Episcope said his firm’s cost of capital is based on untrended rents, but it also looks at trended rents “because they capture the long-term potential growth of an investment” and can help mitigate risk of a downside, as rental growth can be used if something goes awry, such as blowing through a budget or a rise in cap rates.

Episcope also emphasized that, as an investment manager, it’s his job to see the potential for things to go awry on a project, to anticipate that and to make moves that protect the money of investors.

Developers are optimistic by nature, they believe that the glass is half full and they want to present their project in the best light possible because they’re in the business of seeing their projects built, Episcope said. But investment managers are “trained to believe there’s doom and gloom coming down the pipeline,” and act accordingly. That includes anticipating that maybe rent growth isn’t a given.

Some lenders that are still open to the idea of rent growth and are factoring in modest upticks when they lend, but certainly not at the levels seen during the last three years. They are applying greater scrutiny to the assumptions presented to them by would-be borrowers.

Before the first interest rate increases last year, too many investors and owners assumed that just holding on to an apartment building would end up making a profit because the property type was in such high demand, said Brian Good, CEO at iBorrow, a national private lender of short-term bridge financing for existing multifamily properties. Now, he’s changed the way he scrutinizes deals.

“Before, we were relying more on the asset, now we’re relying more on the borrower: Can they pull the right levers to get the value up on the property?”

In the hierarchy of factors complicating the lives of multifamily developers, owners and lenders, Parkview’s Rahimian said the use of untrended rents is high on the scale but high interest rates still get top billing as they increase the cost of capital and pose the threat of making the exit cap rate higher.

“At the end of the day, you can’t trend rents more than a few percent a year,” Rahimian said, adding that the double-digit rent increases of the pandemic were never the norm.

When rents, the economy and wages are growing, Burton said, developers can weather other impacts on the marketplace, such as rising costs of construction and materials or higher interest rates. But when there’s economic uncertainty and rent growth isn’t a given, everything becomes more challenging.

And as the challenges pile up, the deals fall apart.

Construction costs, cap rates and rental rates “make up the value equation, and one or two moving in the wrong direction will negatively impact supply. When deals no longer pencil out, the shovels stop digging,” Episcope said.

Bianca Barragán



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