Multifamily Investors Redline Montgomery County

Institutions are refraining from investing in new apartment projects in Montgomery County, hamstringing developers' ability to get projects funded. This suggests a dramatic slowdown in apartment construction is on the horizon. 

Why this matters: The need for more housing has been broadly accepted, and the County has adopted new housing targets in response. Those targets cannot be achieved without attracting sufficient investment. 

What they’re saying:  The National Multifamily Housing Council (NMHC) held its annual meeting in January, which draws the most influential investment companies in the multifamily industry. Former journalist and real estate economist Jay Parsons summarized key takeaways from the meeting in his newsletter, highlighting the focus on regulatory risk and its growing influence on investment decisions.

This represents a significant development. Regulatory risk has always been a consideration when investors assess potential projects. However, its importance has grown considerably in recent years, to the extent that some areas once considered core markets (i.e.large or growing markets with low risk), like Montgomery and Prince George's County, no longer hold that status. 

Local journalist and former Montgomery County Council staffer Adam Pagnucco shared additional insight from local real estate sources about the combined effects of rent control and state and local BEPS laws on housing development.

Pagnucco received a flurry of responses that reflect what he’s been hearing for months: the county is “radioactive” for development (Emphasis added).

Source 1: So I want to build a 200-unit multi-family project.  It will cost roughly $100m.  ideally, I would get 60% bank financing, which means I need to raise 40% or $40m in equity (cash).  a typical developer only puts up 5-10% of the required equity, so we have to get 90% of the equity or $36m from pension funds, life companies, family offices, high net worth, etc.  That’s the problem.  Equity has choices; they can invest anywhere or as close as across the river and not take on the risks of rent control, vacancy control, and, likely to be suggested in the future, just cause eviction.  it’s equity that is down on MoCo.  They’ve told me we are not investing in MoCo when they can build new in DC, PG, or VA and not be subject to rent control.

[Note from Pagnucco: D.C. and Prince George’s County have rent control laws but, unlike MoCo, they fully exempt new construction.]

Source 2: There is a storm brewing on the cumulative impact of all of this, and we continue to hear about it from colleagues. These two policies that will either run up the cost of doing business (BEPS) or remove the ease or ability to recoup costs (rent control) are running up against skyrocketing assessments, the specter of property tax increases, and the dramatic rise of homeowners and property insurance… If you are a lender or an investor, these policies do not make Montgomery County a safe harbor for your money when neighboring jurisdictions simply don’t include those risks.

Source 3: As to the current issues with financing new development in MoCo, the problems are myriad: high interest rates, high equity requirements from lenders, high construction costs, expensive new energy and environmental standards, stagnant (and higher than preferred) prevailing rents that are depressing tenant demand, and rent control, probably in that order. These problems are not unique to MoCo—except perhaps for rent control and the excessive costs of new energy standards; they exist in most metropolitan areas. 

What is unique to MoCo are the unknown future effects of rent control on new projects, the county’s continuing lukewarm reception to new development (reflected in difficult entitlement standards, a slower entitlement process than most jurisdictions, a long permitting process), and just recently the unknown future effect of the behavior of the president on the local economy (loss of federal jobs and federal grants, evolving world economic conditions, general domestic economic chaos).

Source 4: True story, I spoke with a big fund with properties around the country who had called for advice on a project in MoCo and had one in Virginia at the same time. We reasoned through pros and cons of one political jurisdiction vs another. The conclusion was it dropped MoCo due to specter of rent and vacancy price controls, and now looking for a second site in Virginia. Reasoning was, “Why have a new but certain schedule of wasting asset value in 23 years (with a hostile political regime) vs. a clean asset in Virginia?”

Virginia 2, Mayland 0.

Source 5: Undeniably, in current environment getting construction loans for apartments is hard.  Loans in MoCo are doubly hard.  Investor equity for MoCo apartments is impossible. No Va. is the go-to market.  MoCo will see a dramatic reduction in apartment construction going forward.  I built [number redacted] units in MoCo over the last 10 years. I will never build another.  When do you think someone will build in challenging markets like Silver Spring/ Wheaton.  It will be just like Takoma Park… NEVER.

Source 6: The financial world largely runs in other directions when encountering rent control in a municipality, which justifiably scares the dickens out of them. The recent BEPS regulations add stringent icing onto the now poisoned cake.

The new housing package announced by the county council will do little to mitigate their underlying legislative damage, producing relatively few units on the margins given the existing cumulative layering of multiple, and high, taxes, fees, and regulations enacted by the county this quarter century.

This is a great county. It has much to be proud of. Unfortunately, its political leadership has no idea what they are doing in terms of both short term and long term fiscal and economic impacts. Montgomery’s tax base, and consequent public services, are headed towards a fall

While the sentiments mentioned above were submitted anonymously, other investors are being more public regarding their analysis of the region's hostility to investment.

Swiss investor Ryan Smyth is looking to invest in new multifamily projects in the DMV, but immediately crossed Montgomery and Prince George's Counties off the list of potential markets, citing the widely known sentiment that these counties are not viable for investment moving forward. 

Developer Josh Wooldridge of NRP Group anticipated challenges in attracting investment would emerge following Montgomery County's passage of rent control on the I Hate Politics podcast (4:08-6:25) back in September of last year. 

“When I finance a project, I go to the capital markets to borrow money for those projects, to find investors for those projects. And the thing that I've been most frustrated with is that those investors have a choice. And investing in Montgomery County has not been at the top of their list.

When it comes to the rent stabilization law that we have [in Montgomery County], I think we're really going to need an exemption for new construction. There's a 23-year rolling exemption. The way our projects typically work is I build the project and I'll own the project for, say, five years. I am most often selling our project to an institutional investor or say a state pension fund. They're going to own it for 10 years. They would expect at the end of 10 years to sell that to another institutional investor. It could be another pension fund.

We're talking about what we call Class A multi-family apartments, and they're considered Class A for about 20 years. That means that until about 20 years, they don't need major renovations. They're institutional. They're high quality. The problem is that third owner is not going to buy the property because they're going to be facing the exemption running out at 23 years. Then they're not going to buy it from the second guy. My investors aren't going to believe that we could ever exit the project and sell to one of those pension funds. That's the challenge with the rolling exemption.”