The economic impacts of COVID-19 have reverberated throughout the economy and created questions around the related effect on commercial real estate – specifically multifamily – valuations. We are sharing a series of three posts covering common questions we have been asked since the onset of the pandemic covering our current thinking and strategies around: short term risks, long term risks, and capital market changes.
What are the short-term risks to multifamily investments posed by COVID-19?
While occupancy should remain stable, rent and other income collections are at risk due to high unemployment. Furthermore, Washington state’s eviction moratorium prohibits landlords from increasing rents at renewal and charging month-to-month, late, and lease termination fees.
How is CEP Multifamily addressing these short-term risks in their underwriting?
We have incorporated a “Seller Collection Guarantee” into our model that requires a 12-month seller guarantee against bad debt and collection loss. This guarantee is a percentage of effective gross income and will vary from one property to the next. The Seller Collection Guarantee is placed in an escrow holdback account, and a collection true-up between buyer and seller is completed each quarter. At the end of 12 months, any balance remaining in the holdback account will be refunded to the seller.
Additionally, we have eliminated all month-to-month, late, and termination fees for our first 12 months of ownership, while also assuming <0% rent growth over the same period. Our underwritten rents are the lower of “in-place” or “average of the last five leases by unit type,” thereby enabling us to capture any negative trends.
Lastly, we have increased our “up-front reserves” at closing by 25% to further offset near-term volatility in the market.
If you would like to ask us additional questions on our underwriting during this time, please Contact Us.