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What Lies Ahead: Interview with Tom Wright, Vice President of NorthMarq Capital’s San Francisco Office

03.01.19

In December, we had the privilege of speaking with Tom Wright of NorthMarq Capital. Tom has underwritten and closed $2 billion of debt and equity transactions. NorthMarq has close to 200 mortgage brokers nationwide and is very active in the Bay Area. Tom shared his views on where he sees the markets in the near term.

As we look to the New Year, what do you see as to the availability of debt for real estate?

Looking at it from the perspective of the Agencies (Freddie Mac and Fannie Mae), it is business as usual. The Agencies are mandated by the FHFA [Federal Housing Finance Agency] to lend to a cap. If you look at that cap, some expected the cap to be lowered from $35B each, but in fact, it was kept constant. That says the FHFA still thinks Freddie and Fannie will be lending at same market share as before. Not increasing the cap says something too—they think it is going to be similar to 2018.

Where do you see interest rates going in the next 12-18 months?

Many people think rates will end 50 basis points higher by next year. With that, you can start to see cap rates going up. If that happens, then values will remain flat or go down. It could limit the number of transaction that are taking place if there is a 50 basis point jump. There is still a lot of business for refinance. When borrowers see that interest rates are rising, they want to lock in long-term fixed rates.

With your clients, are you seeing higher investment in secondary versus primary markets now?

We have already seen some of our borrowers going outside their traditional comfort zone of gateway markets to get higher yields in secondary markets like Salt Lake City, Portland and Denver. Those markets are growing very rapidly. I don't think, necessarily, the Bay Area will struggle as much as other markets because of the incredible demand drivers in tech. Something to keep in mind, Freddie and Fannie have a mandate to provide affordable workplace housing regardless of where that market is (whether Reno, Sacramento or Livermore). The Agencies are still going to be very active in lending in those areas. However, we have started to see that people are priced out and are moving to secondary markets- to the point now where even Oakland is not so much of a discount as it was.

With Square, you are going to see Oakland continue to grow. The number of housing units and amount of office being built in the Uptown neighborhood is incredible. We also might see some more creative development that explore ideas such as micro-units and co-living. We have clients looking for financing on both. Agencies are already financing micro-units, and co-living is on the horizon for those Agencies. As the Agencies become more informed on new products types, it will open the doors a little bit and make it easier to finance. The cost of capital may differ from the traditional apartment cost of capital. Another thing, for a complex that is essentially adult dorms, you have to think about who is living there and for how long. It may make sense for someone new to the city or fresh out of college, but once they get a boyfriend/girlfriend/husband/wife/kid they are not going to be able to live there. The biggest impact on bottom line for those projects will be vacancy and turnover. It is attractive from a nominal price-point in any city where a one bedroom is over $3,500 monthly, such as Oakland and San Francisco.

Are lenders more willing to lend only to certain property types (i.e., industrial, office, etc.)?

The most risk adverse lenders are still focused on multifamily primarily, however, some even feel multifamily is a bit frothy and have started pulling back slightly. Other popular property types include industrial, as it is benefited by continued growth of online commerce/Amazon, as well as self-storage. Even quality manufactured housing is a sought after product type. It is more difficult to finance ground up construction across the board, just in terms of getting the deals to pencil—specifically, condominium development in secondary markets. With the rising construction costs, even getting the deal to pencil in downtown San Francisco and Oakland is difficult.

What are the top biggest challenges facing the industry this coming year?

Where we are in the market cycle is going to increasingly dictate the actions of both lenders and investors as they become more focused on the potential downside. They are not going to be as aggressive with their proformas. Where we are in the cycle, in general, will be a big issue. Obviously, if we do see interest rates creep up, that will have a slowdown effect as well. What keeps me up at night is some kind of black swan event, like a massive earthquake or geo-political threat, which could have unknown effects and shock the markets. It’s nothing new, but when the market is this frothy, it could have a more drastic effect.

Overall, are you optimistic or pessimistic for real estate in the next 1-2 years?

What goes up must come down. I’m optimistic for the next 12 months, after that I am on the fence. There's still some runway. Not to sound too negative, but I tend to think that whatever correction happens will happen quicker than most would think. Any correction will be steeper in secondary markets, with more of a plateau in gateway markets.

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