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Current Season: First Draft Live
Between economic whiplash, shifting policies and market volatility that changes by the hour, you need industry insights that cut through the noise. That's exactly why we're launching First Draft Live, a new weekly series that breaks down what's happening, why it matters and what you need to know to do better business.
Join us live on Bisnow.com every Friday at 12:30 PM ET / 9:30AM PT for conversations with the industry's sharpest minds discussing the week's most critical stories, or catch the replay right afterwards — here on your podcast app of choice.
Alright. Welcome to First Draft Live. It's Friday, October 23. I'm Mark Bonner, Bisnow's editor in chief coming to you live from New York. I wanna thank everyone who is tuning in live today.
Mark Bonner:Hope you're getting prepared for a great weekend. So let's jump on in. In case you haven't noticed, there's a little bit of a split screen in American apartments right now. On one side, we have the buildings. After three years of oversupply, the Sunbelt glut is starting to burn off.
Mark Bonner:Apartment starts in September were down 26% from a year ago. Fewer cranes now means fewer empty units later. On the other side, we have the money. Five year debt cost about what it did at the 2023 peak, and the Fed meets again next week, six weeks after its first rate hike since 2023. But the money, it hasn't disappeared.
Mark Bonner:It's just gotten pickier. On Wednesday, Apollo agreed to put $1,300,000,000 into a two thirds stake in 19 UDR apartment community... Communities. UDR can buy Apollo out starting in year five and an expected fixed return of seven to seven and a half percent. So the question really isn't whether capital still wants apartments.
Mark Bonner:It's what that capital cost and who can afford it. Few companies sit closer to that question in Cortland. The Atlanta based firm built one of the largest apartment portfolios in the country on Sunbelt growth. And over the past year, it bought $1,600,000,000 in a portfolio mostly around Washington DC. To help unpack all of that, I'm joined today by Steven DeFrancis, Founder and CEO of Cortland.
Mark Bonner:And to our audience, before we jump on in, send your questions into the chat. We'll get to as many as we can. Steven, welcome to First Draft Live.
Steven DeFrancis:Thank you, Mark. Great to be with you. So
Mark Bonner:let's start on the ground. For three years, the Sun Belt has been the cautionary tale. Developers built more port... Apartments than renters could fill, and owners have been paying people to move in. But the tide looks like it's turning.
Mark Bonner:New construction has fallen off sharply, and the wave of new units is getting filled. So the question to you is, is the Sun Belt actually turning the corner? And how would you know, Steven? What are you looking at?
Steven DeFrancis:Yeah. So great question. So the short answer is yes. It's The Sun Belt has been struggling, it's been a huge headwind to supply, and I would say that the Sun Belt, it's really all what had become the growth markets of The US prior to COVID. So some Southeast, Southwest, Mountain West, all those markets were seeing very strong population growth and job growth prior to COVID, and during COVID then saw an enormous wave of new supply coming out of COVID.
Steven DeFrancis:Huge headwind over the last several years, but now as you look across the markets in our portfolio, and I think in most of the market, most other market participants would agree, you're finally starting to see that most of the areas have absorbed the majority of that new supply and are finally starting to get their footing operationally, and some traction on the rental side of the rent. This has taken a lot longer than anybody really anticipated. The mantra was stay alive to '25, and it looks like it's going to be a '27, and I think looking back, we as an industry didn't appreciate the sheer volume of new supply that had been kicked off. Part of it was because it was in much broader locations than traditionally where you would have seen new supply in all these markets, much more exurban locations in addition to the in town locations. You had built to rent, so you had a lot of product that wasn't traditional apartments.
Steven DeFrancis:You just, you know, DFW for example built 200,000 new units since COVID. Austin is an example, A third of their apartments in the market were started after COVID, and if you look at a lot of the other markets across the South, you know, the percentage of their stock that was launched after COVID are enormous numbers. You know, Charlotte's 48%, Nashville's in the high 40s, you know, so there's just a lot of product to absorb in a lot of these markets. Now, at the same time, most of those markets have also continued to see really strong demand growth, and that's what's driven the absorption of all the supply, frankly, as quickly as it has been absorbed. The byproduct of high interest rates has been one of the impacts has been it's been very difficult to get home mortgages, which has been a big tailwind to the absorption of the supply in a lot of these markets.
Mark Bonner:So would you say it's a broad recovery, or do you think it's isolated to those markets that you already named, Steven?
Steven DeFrancis:I would say the Sunbelt broadly is seeing, you know, most of the markets we're in, or all the markets that we're in are seeing sequential growth month over month for most of this leasing season, and the majority of the markets we're in are now seeing growth on a year over year basis. It has been a long time since we've seen both rent growth and occupancy growth at the same time. The last several years we've been sort of trading. You get some strength on the rent side, but it's at the expense of occupancy and vice versa. So most, I would say, we're now to a point, unfortunately coming into the slow fall leasing season, but we ended the, you know, we got through the summer and into October continuing to see month over month strength in lease trade outs and occupancy.
Steven DeFrancis:So we're cautiously optimistic that that sets up for a good spring, which we haven't frankly seen in a while.
Mark Bonner:Where are you at on concessions these days? I mean, how much are you giving away to fill a unit today versus a year ago? I mean, that might be a good way to look at this.
Steven DeFrancis:Yeah. So all the... You know, when when I talk about rents, generally I just quote them as effective rents because concessions are a leasing tool, so all the information I've shared is a net of concession perspective on the market. Specific to concessions, we have seen a significant decrease in the use of concessions. Part of that has been driven by we're continuing to see really strong renewals, and so given that we generally are not giving concessions on a renewal, the very strong renewal rates have really helped.
Steven DeFrancis:As we've started to lease up, we've probably picked up four points of occupancy over the last eight months across our portfolio, so now that we've gotten to a stabilized position from an occupancy standpoint, there's a lot less need to give concessions. There's still some concessions being used in certain markets, but for the most part we are weaning ourselves off. We at Cortland, I can't say that's the industry at large, but my guess is it probably is, are starting to wean ourselves off of the concessions on the stabilized portfolio. We'll see if the development community is able to do that as well, but I believe most of those development deals are getting leased up for the most part, and so hopefully, they too will be able to, you know, reduce the amount of concessions they're using.
Mark Bonner:Let's talk about equity because I think that's where the real story is at this moment. The debt is out there. Right? Equity is harder to come by. Last year, as you know, big institutions trimmed how much they plan to put into real estate.
Mark Bonner:The first cut since Hodes Weil and Cornell started tracking it in 2013. Hodes Weil called it a pause, not a retreat, but a lot of big investors are planning to put more into infrastructure instead. Still, this week, as we talked about a second ago, Apollo showed the money is there for the right deal, putting $1,300,000,000 into a stake in 19 UDR apartment community... Communities. Steven, what does scarcer equity do to a deal right now, and why does it matter more now than the cost of debt?
Steven DeFrancis:Well, I would say they're both very important. Debt has been available. You know, we haven't really had a liquidity crisis in multifamily over the last several years. We've just had more expensive debt. There's actually been a very healthy debt market because in a lot of cases over the last several years, as investors were more concerned about potential returns because of interest rates going up and the headwind of supply, a lot of that capital moved into debt.
Steven DeFrancis:And so there was actually some meaningful amount of capital that previously would have been on the equity side that was put into various debt instruments. So, while we all have not liked the cost of debt over the last several years, there has been significant availability of debt. On the equity side, frankly, the equity has also been very available over the last several years. It's just been very hard to make a project pencil. I don't think equity, you know, as interest rates started to move up in '22, you didn't see the same level of expectation for equity returns, but you also didn't see equity returns just agree to come in offsetting the additional cost of the debt capital.
Steven DeFrancis:Debt got more expensive, equity largely stayed the same, became very difficult to make a deal pencil. I will say now we're in a market, and I think this has shifted a lot in the last eight weeks as the interest rates have really moved up. I think equity has become really concerned about return, and there has been, to your point about the Otis Weil study, has been a pullback in equity commitments to new funds and new vehicles because it just, you know, I think to a large part a lot of them have just grown tired of waiting for the market to improve and not seeing good returns. Know, the large diversified investors, you know, if you've been you know, allocated across all of real estate, you know, going back to the GFC, you know, it's really been a tough market that whole time, you know, going back that far. So
Mark Bonner:I wanna get into that in a second here, but just one more question on equity, because I think we all know where the equity is going. Right? It's going to AI infrastructure and data centers right now and incredible historic, volumes. Right? In your view, is that permanent or is that a cycle?
Mark Bonner:And what do you think brings that back to apartments?
Steven DeFrancis:Well, I think nothing is permanent in our world. So, you know, definitely there's a lot of equity that's moved from within the real assets allocation for a lot of investors. There's a lot of equity that has moved from real estate to infrastructure. And I think behind that is the fact that a lot of investors have been making more better returns in their infrastructure bets than they have in their real estate bets, and there's also a lot more opportunity for things to invest in in the broader infrastructure bucket than there really were historically. So I think it's a combination of muted returns on the real estate side and enhanced returns on the infrastructure side and enhanced opportunities.
Steven DeFrancis:Just the opportunity to put more capital out in infrastructure than investors historically were able to do. Is it permanent? I don't think it's permanent. Things will cycle. I'm not going to try to project what the end of the data center craze looks like or when that might happen.
Steven DeFrancis:But real estate fundamentals have to improve to earn the capital to move back into the, move the equity capital to come back in and invest in real estate, and frankly I think it will happen. We've struggled within real estate we've had a number of cultural changes and cyclical changes, whether it was the move away from the traditional enclosed mall or the change in how businesses utilize office space, there's been some changes, but then there's also been just the impact of the massive amount of capital that flowed after COVID in things like multi family. Multi family, there is not a decrease in demand that's related to the business cycle like there are in other types of commercial real estate, but coming as a result of COVID, we had capital that became essentially free or very low cost. We had an enormous amount of relocation around the country, which temporarily impacted the supply and demand in all of these markets, people were these growth markets across the Sunbelt where people were moving into. And then, you know, you had the eviction moratoria, which I think had a big impact on it that folks really weren't thinking about at the time in a meaningful way.
Steven DeFrancis:You know, that took a lot of units off market for a temporary period of time, which made things, which made those markets look like they were stronger than they probably were, which then led to more development in those markets. Then all of that product started becoming, you know, was completed and able to be leased at around the same time the eviction moratoria went away. So all those units were then turned and put back in the market. You know, so point being, you just had a number of things that came together at the same time that made markets look like they needed a whole lot more product than it turned out they did. And we're developers.
Steven DeFrancis:That's what we do as an industry. If you give us demand and capital, I can promise you what's going to happen. We're going to build, and that's what happened, and then we just overbuilt the market. But the Sunbelt and the Southeast, Southwest, that's still where the majority of the population growth is going, and it's still where the majority of the job growth is going. We are by no means pivoting out of the Sunbelt, or would I characterize our firm looking in other places as a move away from the Sunbelt.
Steven DeFrancis:It's it's been a time to let the Sunbelt absorb the supply. Get back into a better footing.
Mark Bonner:So let's talk about the debt side. Right. So according to JLL, a five year loan cost under 3% at the end of twenty twenty one. In February, it was about 5%. By late September, we're looking at 6.36.7%.
Mark Bonner:Lenders didn't drive that. The spreads barely moved. The treasury market did, and the Fed raised rates in September for the first time since '23, and they meet again next week. So what happens, Steven, to a deal that penciled at 5% in February when the debt now costs 6.5 percent?
Steven DeFrancis:Nothing good. You know, clearly, there's, you know, that's been a huge impact to values and to the success of projects. Know, NOIs frankly continued to grow through 'twenty two and 'twenty three and into 'twenty four in most cases, which helped offset some of the increasing cost of debt. And to your earlier point, spreads are actually as low as they've been in the last ten years right now because there is so much debt capital available, and so that has helped offset some of the underlying rate movement, but there's no question that there are a lot of properties that are stuck, and there's a number of opportunities that may come in the next year or two years as a result of those properties not being able to meet their debt service. I think, you know, kind of over the last several years, a lot of assets that were over leveraged and not performing, there was a belief by many market participants that in '25 we'd see fundamentals start growing again and rates start going down, and unfortunately that fundamental recovery really took two extra years, and rates moved down a little bit, but obviously have given all that back, and then some, and I think we can all, you know, general consensus is that rates are not going to be back anywhere close to where they were, you know, their lows.
Steven DeFrancis:So a lot of folks are going to have to face the music over the next couple years about what to do with their multi family projects, which are just squeezed between you know, low growth and high capital cost.
Mark Bonner:Yeah, I mean, to your point, I mean, the loans are coming due, right? 2021 Blackstone loan went to a special servicer this week. There's a lot more there that still needs to work through the system. But you mentioned the Fed. Right?
Mark Bonner:And that's coming up next week. What are you expecting? Are you high, cold? What's your view on that, Steven?
Steven DeFrancis:Yeah. I'm gonna... You know, I think that they'll probably hold, but I don't know. I mean, we're focused here on the things we can control, and that's certainly not one of them. I can tell you our house view, whether they hike or hold, is that rates are not going to go down materially or anywhere close back to where they were at their low.
Steven DeFrancis:So I think we're in a new normal rate environment, and it's not great if you have a property that was underwritten assuming a 3% interest rate, but based upon historic norms, the cost of capital today is not crazy and is not unreasonable. Right. And if we have a disciplined development industry, or if we have discipline in the development side of our business, we should be able to pencil to a five handle, ten year without any problem. It's really just getting it's just all the projects that were done assuming something in the twos now need to be recast to something. But new projects today, we think this will be a very good vintage going forward, A, because you're coming into a market that's finally getting strength from an operating standpoint, and we, as you mentioned earlier, starch are way down.
Steven DeFrancis:I think starch last quarter were about 50,000 units relative to a peak, which is over 200,000 units in the quarter. Starts are way down, and that will drive a better market over the next couple of years. Know,
Mark Bonner:I'm going to get to that upside in a second here. Right? Okay. So
Steven DeFrancis:my point is we should be able to pencil with these interest rates.
Mark Bonner:Right. Yeah. And believe it or not, now we're talking a lot of doom and gloom here, but there is some upside. But before we get to that, if you're just tuning in, I'm here with Steven DeFrancis, Founder and CEO of Cortland. We're talking Sunbelt Apartments where buildings are getting healthier and then where the money is getting a little pickier.
Mark Bonner:The twenty twenty seven setups that Steven just referenced. So apartment starts in September were down 26 from a year ago. Earlier this year, CoStar said starts hit their lowest level since 2011. That means fewer projects breaking ground today, which means fewer new apartments a couple years from now. So, Steven, if construction stays this low, do you think the Sun Belt is headed for a shortage in '27 and maybe even in '28?
Mark Bonner:And how is Cortland getting ready for that moment?
Steven DeFrancis:I hesitate to say that because there's probably some developers here on the line. But, you know,
Mark Bonner:you We're amongst friends, Steven. Speak your
Steven DeFrancis:you look at each market, and you can see the population change, and you can see the absorption. Most of the markets are still having some positive population change despite the change in immigration and other things. There's still migration coming to these southern metros, which is driving population growth, and most of these markets have now absorbed the majority of the supply. So if we can stay in a reasonable development market, then yes, there should be several years. And know, 'twenty seven, 'twenty eight, 'twenty nine, that's probably already baked, because even if you started those units tomorrow, they wouldn't be it'd be several years before they're impacting the leasing market, but frankly I think it'll be a while before things really start to move, so you see a lot more development.
Steven DeFrancis:A, just equity capital I think has grown weary about the promise of a very near term recovery. Interest rates are higher, which just by nature makes it harder to make something pencil, but then also unlike previous cycles like this where you've had a meaningful decline in apartment starts, typically that would be met by a similar decline in the cost of apartment construction. Construction costs have come down some from their peak, but I would almost argue they haven't come down, they just stopped going up. There was a while there where if you went and priced a new apartment deal, I think that the subs just threw any number at it
Mark Bonner:to see
Steven DeFrancis:how much pain you would accept. So that has obviously stopped, but there's so much demand for other construction, whether it's data centers or all the things from the CHIPS Act, data centers, or just public infrastructure. And frankly, we can't forget, while we're down in the dumps about apartment performance over the last couple of years, the economy is in really great shape and is still seeing a lot of growth, and so you're seeing a lot of construction demand in non traditional real estate places, which is competing for all that infrastructure, all that construction capability. And so you just haven't seen the decline in construction costs that you would normally see with this much of a decline in construction in multi family starts. So, high cost of debt capital, high cost of construction, higher cap rates at exit, lower you know, it it makes it very hard to pencil a a development deal today.
Mark Bonner:Let's talk about your recent bet. Last November, Cortland closed a $1,600,000,000 deal for 19 Elm communities, 16 of which are around Washington DC. Since then, DC has been working through federal job cuts and rents have dipped a little bit, but almost nobody is building there. Right? Construction is at that ten year low.
Mark Bonner:Why DC? Why at that moment, Steven?
Steven DeFrancis:Great question. Well, so we were already in DC, and to clarify the portfolio, three of those were in Atlanta, as you mentioned. There were 16 in DC. One of those was in D. C.
Steven DeFrancis:Proper, was in the district, and 15 were in Northern Virginia. So they were all in Metro D. C. But in Northern Virginia, and they were all in markets. In that portfolio, we had a very attractive entry point.
Steven DeFrancis:Yes, we made that commitment right as we were at sort of peak doge and peak concern about job growth in the district, but the timing led to a very attractive entry point for us. Frankly, we really liked the asset mix. It was a mix of mostly mid and high rise assets. Elm had owned them for a while, and most of them were in really good locations, but had just not had a lot of capital put into them over the years. Elm as a REIT had become subscale, was struggling to raise new capital, and so as a result, they just weren't able to take advantage of some of the upgrade opportunities that these assets had because of their locations and their product type, and we like that market.
Steven DeFrancis:That market very different than the Sunbelt has Suburban DC has probably half of the amount of Class A apartments per dollar of income than you find in places like Atlanta and Dallas, and so in a market where you have declining supply, as you have today, as you mentioned, and again, most of the supply in that market is not garden style, so it takes a long time to build even when you start, and there's just a lot of income, and so yes, there was going to be some job growth. I think the latest they lost about 65,000 jobs across DC and Northern Virginia, so if you assume all of that was Metro DC, they lost roughly one year of job growth in the impact of those job losses. But as you know, DC is always going to be an engine for growth. Every time you have an election, every time you have a change of administration, there's always a new wave of folks who come in, and more and more industries are locating in the D. C.
Steven DeFrancis:Market to be close to government. And so we just felt like we were coming into a great portfolio of assets at a time when we were able to get a really great entry point such in a good portfolio where all of our upside, for the most part, was in our value add execution versus market growth. So, the market didn't really need to grow for us to be successful in the investment. We just needed to be able to execute our value add plan. Historically, we have a very high likelihood of meeting those plans based upon the 300 times we've done it before, and so we felt, yes, this is a time when it seems somewhat counterintuitive, but we just don't need the market to be the tailwind to this opportunity, and so that's why we thought it was a good idea to move forward.
Mark Bonner:Okay. I wanna move on here. I know we're running out of time here, but I do wanna get into this. In May, Cortland agreed to pay $18,000,000 to settle its part of the RealPage rent pricing lawsuit. You guys admitted no wrongdoing, and Cortland agreed to stop using competitors' private data to set rents.
Mark Bonner:The issue isn't going away. Last week, a federal judge in Seattle led a similar case against Yardi keep moving. Yardi says its software doesn't use competitors' confidential data. Steven, I don't wanna litigate the past here. I wanna look forward.
Mark Bonner:I mean, just based on everything that's happened, everything that's known about the real the RealPage situation, how is Cortland setting its rents today? And what changed for you guys when you stopped using that data?
Steven DeFrancis:Yeah, so there's some change within our organization, but also more meaningfully, there's more meaningful change, I think, across the industry at large. We frankly were, and I don't say anything about settling that at that number was lucky, but we were lucky from the standpoint that we had started building our own proprietary pricing product prior to any of this happening. So what it allowed us to do was settle the lawsuits and the various actions early in the process, and our pricing product, which is called Revinex, we don't use any publicly, we don't use third party data. We use all of our own portfolio data, and as a result, you know, that's why we were able to get out of the actions, you know, on the RealPage actions. It has been better, you know, for us it's provided a better pricing and better control because we're using our own data.
Steven DeFrancis:Again, just like when we use their product, these are just suggestions of pricing. We still have, you know, there's a lot of human element in setting that pricing on a regular basis. But that's why we had started building our own program even prior to all of this, because we just thought we could build something that gave us better outputs than what we were getting from the prior system we were using. So, again, that was something already in flight. Obviously, we wished we had been done a couple years sooner and avoided the whole thing, but it has been a great help, and frankly, it's been a huge help as we've gotten into this very choppy market over the last few years.
Mark Bonner:The real estate situation is one of those rare stories in real estate that kind of entered the mainstream, right? Got a lot of headlines from a lot of major publications that are read by regular people, who are very concerned about their rent. Steven, like, what should renters understand about how their rent gets set right now just based off of this? Because I know this is pretty complicated stuff, on the software side of things, but what do you think renters need to understand or what are they may be missing about how this this work gets done?
Steven DeFrancis:Well, you know, I can't speak to what everybody else is doing. I can say there was no conspiracy to raise their rents more than we should have been able to do so prior to using our own product, and definitely not now. Every day we're looking at how many people want to live in our building, how many people are planning to move in, how many people are planning to move out, and we adjust the rents accordingly, And so, it's just about having the data of how our own properties are operating and using that to drive our pricing, how we look at pricing going forward. I will say from an industry standpoint, I think it's going to be pricing is one thing, but this entire question about data sharing I think is going to be the I think the impact of the industry is going be more about data sharing than just pricing. It will be a bigger issue, because now unless you're a large operator like Cortland or one of the other large groups, you are really operating blind.
Steven DeFrancis:You no longer know occupancy, leasing, because of the lack of data share, really have to wait for data to get three, six, seven months old before you can go get it from a data source, and by then it's not particularly useful. And so I think change in the industry and data at large has been that it's now more favorable to the larger operators or the groups that just have more of their own internal data.
Mark Bonner:Steven, I wish we had more time, but, you know, we're a little over here. But... And I got a million more questions to ask you. But that's all the time we have today. I just wanna say thank you so much for joining us today.
Steven DeFrancis:Great to be with you. I appreciate you having me.
Mark Bonner:We'll be back soon with another episode of First Draft Live. You can also find today's episode and all of our past conversations on your favorite podcast app. I'm Mark Bonner. This is First Draft Live.