Despite the recession, the multifamily industry is, in
some ways, leading a charmed life.
The availability of affordable debt from Freddie Mac,
Fannie Mae, and the Federal Housing Administration has kept
cap rates from rising further, making the multifamily
industry the envy of other asset types. “Fannie
and Freddie are providing the grease that’s
lubricating the whole multifamily business,” says
Simon Wadsworth, CFO of Memphis, Tenn.-based Mid-America
But there are other forces at work helping to limit the
corrosive effects of the recession on the sector.
Floating-rate debt has been incredibly affordable this
year, which has helped to keep many short-term
floating-rate loans from going into delinquency.
Indeed, floating-rate debt can be a very effective hedge
against downturns. When floating-rate benchmarks like LIBOR
or SIFMA decline, so do rents, helping firms to offset a
decrease in NOI. And when those floating-rate benchmarks
tick up again, rent growth is also on the rise, helping to
offset the higher rates.
These days, cash is king. And the lower debt service
payment on floating-rate debt is one way that multifamily
firms are maximizing cash flow. The strategy is
particularly suited for a business that re-prices its rents
every 12 months: office or retail properties with long-term
leases are less likely to reap the short-term benefits of
AvalonBay has increased its level of floating rate debt
every year for the past four years as a hedge against
downturns. In 2005, just 2 percent of its capital structure
was in floating-rate debt; today, it’s about 11
percent to 12 percent, or 1.2 percent of the
company’s overall value. “We consciously
increased our use of floating-rate debt knowing
it’s a good hedge in terms of being positioned for
a downturn,” says Thomas Sargeant, CFO of the
Alexandria, Va.-based firm. Since rental revenue and
short-term interest rates are highly correlated,
“revenue declines that occur in a downturn can be
partially offset with lower interest costs,” he
Mid-America Apartment Communities keeps an even larger
part of its capital stack floating: About 20 percent of the
company’s $1.3 billion in debt is variable rate.
“We’re increasingly going to be using
floating rate,” Wadsworth says.
Private real estate firm (and former REIT) Gables
Residential has also become enamored with the low LIBOR
rate. The Atlanta-based company supplements its $250
million revolving line of credit with construction loans,
most of which have three-year terms with two one-year
extension options. “That can really get you five
years of financing,” says Dawn Severt, CFO of
Atlanta-based Gables Residential.
Those extensions are all getting exercised. Gables now
has about a third of its debt stack in variable rate.
“From a cash-flow perspective, we’ve
really benefited from the historically low LIBOR
rate,” Severt adds.
Still, LIBOR and SIFMA spiked to unprecedented levels at
the end of September 2008. LIBOR reached nearly 7 percent,
and SIFMA rates on seven-day variable rate bonds shot up to
nearly 8 percent. “When overnight LIBORs were
going up last September, that gives the CFO with hundreds
of millions of exposure in floating rate some
pause,” says Jay Hiemenz, CFO of the privately
held, Phoenix, Ariz.-based Alliance Residential.
“It’s been great to be in floating rate
over the last near term; at a half-point it’s
cash-flowing quite nicely. But that may not always be the
Though a short-lived phenomenon, the episode reveals the
importance of interest-rate hedges such as caps and swaps.
To create a swap, an outside investor guarantees a
fixed-interest rate to the borrower. The investor agrees to
pay the difference when the floating rate rises higher than
the guaranteed rate and receives the difference when the
floating rate is below that rate. Interest rate caps are
another derivative where the buyer agrees to a certain
strike price, say a LIBOR rate of 2 percent. That buyer
would get paid at the end of each period in which the rate
goes above 2 percent, for instance.