Is Negative Leverage Losing Steam?

resource-thumb_Negative Leverage

Brian D. Milovich

Managing Principal, Calvera Partners

The apartment market is at a standstill, and the numbers show it. As of Q2 2023, multifamily transaction volume (i.e., sales of apartment buildings) is down 71% compared to a year ago and is on par with activity back in 2009, in the middle of the Great Financial Crisis when there was more fear in the sales market. Back then, buyers didn’t know if they were catching a falling knife or how long it would take for the economy to recover. There were also fewer dollars chasing apartments for investment. Even though today there is more money interested in apartment investments, the universe of real buyers is a fraction of what it was 21months ago. Those of us actively in the market want to know when these deals will be available to purchase, either on- or off-market.


​Compared to 2009, the freeze in transactions is less about buyer fears and all about seller pricing expectations. The bid-ask spread remains as wide as sellers’ memories are narrow. We talk regularly to investment sales specialists around the country, and the story is finally evolving. Buyers in many markets are starting to decide that they don’t want negative leverage anymore, a novel idea that we’ve been employing in acquisitions for stabilized properties since our founding. Negative leverage is where the interest rate or loan constant is greater than the capitalization rate, causing a property to generate an inferior yield.


For example, if your loan is interest-only at 5.5% and the capitalization rate to purchase the property is 4.5%, a deal with 52% leverage will yield 3.4%. You just reduced the yield on that investment from 4.5% to 3.4%…not great in an environment where you can get close to 5.0% to invest in a money market account. Now, negative leverage isn’t always bad and can actually work in your favor by reducing the buyer pool. When evaluating an investment with considerable renovation or operational improvement potential, the more important metric is stabilized cash yield. If your business plan has you improving net operating income from a 4.5% to a 6.5% yield, then you’ll be in a positive position and can now generate higher cash flow, have caused the asset to appreciate, and the investment to outperform.

If enough buyers dig in and say the in-place cap rate needs to be within spitting distance of the interest rate on the loan, sellers will get the message. Sellers haven’t had to accept it yet as many are holding out hope for a precipitous drop in interest rates, which could cause values to increase and/or make a refinance of their existing loan more palatable. Even if the short-term Fed Funds rate dramatically decreases, unless there is significant movement in the 10-year Treasury, nothing is going to materially change regarding value. Once time runs out on a seller’s bridge loan, or the next interest rate cap payment is due, or the investment fund liquidates, sellers will have to capitulate and meet the market.

Positive or neutral leverage doesn’t by itself make a deal acceptable. However, having a higher initial yield is part of the reason we launched the Calvera Income and Growth Fund. In aslower-growth environment, locking in as high of an initial yield as possible combined with operational acumen will help one’s ability to meet investment goals. Positive leverage also allows for a more advantageous leverage amount which provides for the purchase of larger properties with the same or less equity. Today, it’s common to see new acquisitions with 55% debt and 45% equity. That means, with $10 million of equity and a $12.2 million loan, a $22.2 million apartment property can be purchased. If positive leverage allows for 70% debt, that same $10M of equity can now buy a $33.3M property. That could mean 50 to 100 additional apartment units, allowing for greater diversification and scale.

The quest for positive, or even neutral, leverage seems to be happening like a slow burn across the country. Midwestern markets where cap rates have always been a bit higher were likely first to demand higher cap rates since they’re used to slower growth. Markets in the still-hot southeast are slowly catching up, according to our recent calls and deal underwriting. Once rational investing by buyers coincides with urgency from sellers who have run out of time, we’ll be there to find those deals. Negative leverage seems to finally be losing steam.


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