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Multifamily vs Treasury/MBS


Gregmal
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So I keep hearing about how obviously 3-4 cap rates on MF units is a bubble or is too frothy or how people dont understand how this can be or any of the usual nonsense. Can someone explain to me how a treasury trades where it does, with zero inflation protection, or a mortgage gets sold to investors with a 30 year fixed coupon at 2.5/3/3.5 and liquid as water....but having what is essentially a diversified income stream tied to the same underlying feature(a place to live, in many places with a better, known, and desirable location) with 12 month mark to market inflation protection not an absolutely superior asset? You can have a mortgage or MBS trade treasury + a couple points, no one bats an eye. Either this makes no sense, or the current 3.5/4 cap in multifamily is arguably a bargain...cant have it both ways. Just trying to wrap my head around how folks think these things should be trading at what? 5 caps? 6? Granted they'll never trade on par with Treasuries bc of obvious reasons, but why shouldn't these be on par with, or superior to mortgage tied investment rates?

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33 minutes ago, Gregmal said:

So I keep hearing about how obviously 3-4 cap rates on MF units is a bubble or is too frothy or how people dont understand how this can be or any of the usual nonsense. Can someone explain to me how a treasury trades where it does, with zero inflation protection, or a mortgage gets sold to investors with a 30 year fixed coupon at 2.5/3/3.5 and liquid as water....but having what is essentially a diversified income stream tied to the same underlying feature(a place to live, in many places with a better, known, and desirable location) with 12 month mark to market inflation protection not an absolutely superior asset? You can have a mortgage or MBS trade treasury + a couple points, no one bats an eye. Either this makes no sense, or the current 3.5/4 cap in multifamily is arguably a bargain...cant have it both ways. Just trying to wrap my head around how folks think these things should be trading at what? 5 caps? 6? Granted they'll never trade on par with Treasuries bc of obvious reasons, but why shouldn't these be on par with, or superior to mortgage tied investment rates?

 

My only guess would be because it's easier to get out of a treasury. 

 

I think 1.5% on a 10-year treasury is a terrible deal. Anyone who buys and holds to maturity is likely looking at a negative return. 

 

But I might be inclined to buy it for the next 6-12 months to collect that 1.5% safely and I can sell whenever I want to if it seems like rates are moving higher. 

 

Seems to me it'd be harder to get out of the multifamily property without fire sale pricing so people recognize that while 3-4% cap rates makes sense today - they don't expect it to make sense in 2-3 years and may not feel confident in their ability to get out before then. 

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1 hour ago, Gregmal said:

So I keep hearing about how obviously 3-4 cap rates on MF units is a bubble or is too frothy or how people dont understand how this can be or any of the usual nonsense. Can someone explain to me how a treasury trades where it does, with zero inflation protection, or a mortgage gets sold to investors with a 30 year fixed coupon at 2.5/3/3.5 and liquid as water....but having what is essentially a diversified income stream tied to the same underlying feature(a place to live, in many places with a better, known, and desirable location) with 12 month mark to market inflation protection not an absolutely superior asset? You can have a mortgage or MBS trade treasury + a couple points, no one bats an eye. Either this makes no sense, or the current 3.5/4 cap in multifamily is arguably a bargain...cant have it both ways. Just trying to wrap my head around how folks think these things should be trading at what? 5 caps? 6? Granted they'll never trade on par with Treasuries bc of obvious reasons, but why shouldn't these be on par with, or superior to mortgage tied investment rates?

 

At what cap rate does a new construction MF work out to in the sunbelt markets?  How does the market price for MF stack up against new construction costs?  It's hard to argue against economics, so what are the economics?

Edited by ERICOPOLY
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11 hours ago, Gregmal said:

So I keep hearing about how obviously 3-4 cap rates on MF units is a bubble or is too frothy or how people dont understand how this can be or any of the usual nonsense. Can someone explain to me how a treasury trades where it does, with zero inflation protection, or a mortgage gets sold to investors with a 30 year fixed coupon at 2.5/3/3.5 and liquid as water....but having what is essentially a diversified income stream tied to the same underlying feature(a place to live, in many places with a better, known, and desirable location) with 12 month mark to market inflation protection not an absolutely superior asset? You can have a mortgage or MBS trade treasury + a couple points, no one bats an eye. Either this makes no sense, or the current 3.5/4 cap in multifamily is arguably a bargain...cant have it both ways. Just trying to wrap my head around how folks think these things should be trading at what? 5 caps? 6? Granted they'll never trade on par with Treasuries bc of obvious reasons, but why shouldn't these be on par with, or superior to mortgage tied investment rates?


the end buyers are totally different. The holders of treasuries and MBS are sovereigns, the Fed, banks and insurance companies, etc.

 

the nominal cash flows of those are guaranteed by the most powerful country in the world. Inflation protection is not the point. No one is buying agency MBS expecting inflation protection. They are buying MBS to pick up some spread relative to treasuries by bearing prepayment risk and weighted average life variability. 
 

I don’t see them as comparable at all given their vastly different capital treatment and risk characteristics. 
 

 

Edited by thepupil
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@Gregmal You are spot on. My background is in fixed-income and I bought my first multifamily REIT this year!

 

Multifamily rentals produce cashflows very similar to that of inflation protected bonds. The main difference is that if you take the cap rate + inflation expectations it far, far, exceeds the expected return on inflation protected bonds, or pretty much any investment grade bond. As real yields stay low you will see more and more asset managers who previously had large fixed income allocations follow the 'cash is trash' theme and shift into this space. Some recent examples from Canada:

CPP join venture to build multifamily rentals - March 2021

OTPP owned Cadillac Fairview partners to develop/acquire multifamily rentals - June 2019 

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I think the Treasury argument can be made both ways. But if we want to look at an MBS, which is absolutely comparable to a treasury, theres still typically quite the difference, which was largely my point. MBS and even single mortgages are 100% correlated to treasuries and generally the tightest on any asset class in terms of spread. By why is an MBS? Probably liquidity and laziness and nothing else. Risk profile too? One is secured by essentially the same cash flows as the derived logic behind a mortgage, but diversified and marking to market every 12 months. A mortgage or subsequently MBS has fixed coupon typically and prepayment risk. I can see the textbook reasons why one would prefer an MBS, but dont think they make any sense at all in the real world. Same for a treasury. You have nothing but the guarantee the government will give you the money back. Otherwise you have nothing and get nothing for the privilege. 

 

55 minutes ago, thepupil said:

The holders of treasuries and MBS are sovereigns, the Fed, banks and insurance companies, etc.

 

I was reading earlier in the year that part of the massive run in MF assets has been just this though. Its fairly new phenomenon but specifically banks, insurance companies, and foreign capital. I recall even a few years back a big JLL reports on like 50% increase in foreign buyers or something like that. Theres so much of that money out there that a shift in thinking can create a massive wave.

 

11 hours ago, TwoCitiesCapital said:

My only guess would be because it's easier to get out of a treasury. 

 

I think 1.5% on a 10-year treasury is a terrible deal. Anyone who buys and holds to maturity is likely looking at a negative return. 

 

I pretty much agree. Its totally boneheaded and when you evaluate the real world benefit, liquidity is the only one. 

 

10 hours ago, ERICOPOLY said:

 

At what cap rate does a new construction MF work out to in the sunbelt markets?  How does the market price for MF stack up against new construction costs?  It's hard to argue against economics, so what are the economics?

 

I think its far harder to gauge this today because the market dynamics have gotten a bit whacky there past year. That and the costs will obviously change depending on area. Well located Southeastern MF, offhand, pre covid(dont have anything and cant recall anything post covid documenting anything newer) you're probably looking at $80-100k an acre and $75k per unit, plus maybe another 30% for the stuff the developer/contractor handles, loosely speaking. Bringing it to stabilization would also factor in. But its very regionally sensitive. So if the basis of your question presumably relates to the attractiveness/profitability of building these, and the supply/demand effects thereof, this is potentially another argument as to the benefit of the asset class. Inflation gets really hot, and the cost to build soars, making new build much less practical. I have a few friends who do this sort of stuff in FL and even there, Im hearing how these constraints today are holdings folks back. 

 

Edited by Gregmal
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6 minutes ago, maplevalue said:

@Gregmal You are spot on. My background is in fixed-income and I bought my first multifamily REIT this year!

 

Multifamily rentals produce cashflows very similar to that of inflation protected bonds. The main difference is that if you take the cap rate + inflation expectations it far, far, exceeds the expected return on inflation protected bonds, or pretty much any investment grade bond. As real yields stay low you will see more and more asset managers who previously had large fixed income allocations follow the 'cash is trash' theme and shift into this space. Some recent examples from Canada:

CPP join venture to build multifamily rentals - March 2021

OTPP owned Cadillac Fairview partners to develop/acquire multifamily rentals - June 2019 

 

Its not farfetched really, you have seen the same sort of thing play out within the industrial warehouse space over the past few years as well. The market had a certain perception of the risk profile that turned out to be totally off base. Your prime stuff in industrial was trading at like 7/8 cap. 10s weren't uncommon. Now you're at 4. 

 

I even laugh because you look at the MF run, and earlier in the year it was like OMG 3s! Then a few months later everyones like "oh fuck, 20% rent bumps! now it makes sense!"....but the force is strong on this, and the larger backdrop I think has to be given consideration. A treasury pays nothing and relies and the full faith in the government. As I said earlier, I won't argue with the "why" behind the boneheads who buy those. But a lot of the reasons even on paper are the same as why you'd buy a MF unit. But then you get to an MBS and MF? There's no comparison. Even safety of asset. In one case? well we've all seen what happens in the "one case" scenario. You've got a piece of paper and a mess and load of legal expenses should you need to enforce the contractual stuff. a MF unit? You have tenant diversification and short term leases and in a good area will always be filled, even during a crisis.

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Treasuries are not an "investment", they are a way to park money. Treasuries are hyper liquid, can be used as a collateral and are "safe". This make them a cash alternative ( with short duration) for a lot of institutions even though they offer very low yields.

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As I said, I get the "why they buy Treasuries" argument, so while its there, the logic sucks, and instead maybe focus on an MBS...why is an MBS looked at so much different than what a MF unit offers? 

 

Side note, re: parking money in Treasuries....why even bother LOL? Like isnt it just a waste a time? Just leave it in cash...whats funny, is theres a bunch of suites out there with corner offices who actually get paid to do this... Imagine that? Just another example of how the financial system is full of waste.

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10 minutes ago, Gregmal said:

As I said, I get the "why they buy Treasuries" argument, so while its there, the logic sucks, and instead maybe focus on an MBS...why is an MBS looked at so much different than what a MF unit offers? a guarantee of principal from the United States of America. A community bank or insurance company can not (for a portion  of its balance sheet) take ANY principal risk. 

 

Side note, re: parking money in Treasuries....why even bother LOL? Like isnt it just a waste a time? Just leave it in cash...whats funny, is theres a bunch of suites out there with corner offices who actually get paid to do this... Imagine that? Just another example of how the financial system is full of waste. What if your cost of funds is 0 of negative. What if you're underwriting at a 95% CR and need a 3-5 year cash flow that will earn "something". A seasoned 15 yr Fannie Mae MBS would be appropriate. A multifamily building would not. On the long duration side, long term fixed income offers deflation protection. A multifamily building would be destroyed by deflation. Duration has upside too. Even (rather especially) at low nominal yields. 

 

Edited by thepupil
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1 hour ago, Gregmal said:

So if the basis of your question presumably relates to the attractiveness/profitability of building these, and the supply/demand effects thereof

 

 

 

I was simply asking what the issue is:  is it a historically high cost of building/operating that is the problem, relative to market rents?  Or are investors paying way higher than the cost of building these things?  Which is it?

 

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3 minutes ago, ERICOPOLY said:

 

 

I was simply asking what the issue is:  is it a historically high cost of building/operating that is the problem, relative to market rents?  Or are investors paying way higher than the cost of building these things?  Which is it?

 

Got it. Its definitely the latter on a raw basis. The land value(especially with entitlements and whatnot) does adjust as its the most supply/demand sensitive component. But it definitely doesnt cost anywhere near where the finished product trades to build one. Similar to industrial where everyone sees a shell off a rural-ish corridor and thinks WTF, how does that, plus a lease trade where it does? But there's value in the aggregate despite not being "that hard" to build. 

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12 minutes ago, thepupil said:

 

So basically if you have the ability to access cash at 0 or negative rates but arent allowed to take risk. Makes sense. 

 

The inflation/deflation argument is also interesting. After a 40 year run on the side of lower rates, I know where I sit on this. But thats a good point. 

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3 minutes ago, Gregmal said:

Got it. Its definitely the latter on a raw basis. The land value(especially with entitlements and whatnot) does adjust as its the most supply/demand sensitive component. But it definitely doesnt cost anywhere near where the finished product trades to build one. Similar to industrial where everyone sees a shell off a rural-ish corridor and thinks WTF, how does that, plus a lease trade where it does? But there's value in the aggregate despite not being "that hard" to build. 

 

Take APTS for example.  Over the past 2 or 3 weeks they have announced 3 new MF properties.  They are getting these at closer to the cost of building, no?  

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21 minutes ago, Gregmal said:

Side note, re: parking money in Treasuries....why even bother LOL? Like isnt it just a waste a time? Just leave it in cash...whats funny, is theres a bunch of suites out there with corner offices who actually get paid to do this... Imagine that? Just another example of how the financial system is full of waste.

 

As an example, Bank of America owns $600-$700 billion of "Debt Securities", about 2/3 of which is Agency MBS. In no world, is Bank of America comparing its MBS holdings to the prospect of buying multifamily. They're totally different. As for why they won't hold cash, well they're earning $10-$11 billion of interest on that portfolio which is low, but it's far more than zero. 

 


image.thumb.png.6fda094daf327a86809c0f5d17018f0a.png

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12 minutes ago, Gregmal said:

So basically if you have the ability to access cash at 0 or negative rates but arent allowed to take risk. Makes sense. 

 

The inflation/deflation argument is also interesting. After a 40 year run on the side of lower rates, I know where I sit on this. But thats a good point. 

 

Yes. Now this doesn't invalidate your overall point. There's also a huge pool of capital, think pensions or foundations that may have held 10-70% in nominal bonds, mostly corporate investment grade or treasuries, where bonds have nothing really to offer them. Everyone has to reach for yield now thanks to years of financial repression. Buying Multifamily (but really ALL "alternatives" and equities) is one way to produce yield. this is basically the multidecadal bull case for BAM, BX, KKR, etc.  

 

It's not clear to me there's anything unique to MF or sunbelt MF regarding this. basically, central banks force those who want to make a real return out of fixed income. period. 

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33 minutes ago, thepupil said:

 

As an example, Bank of America owns $600-$700 billion of "Debt Securities", about 2/3 of which is Agency MBS. In no world, is Bank of America comparing its MBS holdings to the prospect of buying multifamily. They're totally different. As for why they won't hold cash, well they're earning $10-$11 billion of interest on that portfolio which is low, but it's far more than zero. 

 

Yes of course BAML which is a leveraged entity is not comparing MBS to multifamily. But for 'real money' investors they would definitely be comparing them. Take for example the RBC Balanced mutual fund (somewhat representative of what the average person/institution would own). 65% equity, 35% FI with 71% of the FI in government bonds...so 71% of the FI allocation is more-or-less guaranteed to lose money in real terms...not sustainable! If rates persist here you will see more entities seek 'fixed-income like' securities like MF rentals instead of government/corporate bonds.

 

image.thumb.png.d8b9d521acd0d164eaa31b4323ff3a74.png

RBC Balanced Mutual Fund

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1 hour ago, ERICOPOLY said:

 

Take APTS for example.  Over the past 2 or 3 weeks they have announced 3 new MF properties.  They are getting these at closer to the cost of building, no?  

Probably somewhere in between. While some dont like the loans, this is why I love them...they pay outsized rates and most have purchase options. You'll have to shuffle with it a bit because the developers have buyout options which is were a good chunk of the one off earnings have been coming from....so that question if you want to get real granular is where the trade off is when a developer buys it out, IE theres massive profit bringing it to market, vs when the company takes the property...but no doubt its below market however I wouldnt underwrite the assumption thats its a tick over construction cost either. 

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1 hour ago, thepupil said:

I agree with you, but I don't really see this as a new phenomenon. It's the tailwind of the past decade. Maybe it's strengthening or just continuing? but you could've said the same thing in 2010/2015/today, no?

I think @maplevalue is getting at the bigger picture. To your point above, NO! The trend is already in place, which is what you want to see! I'll elaborate a little.

 

Take your points above. Theres so much money out there, and theres your spectrum of options. You have cash at the top and IDK, crypto or equity derivatives or some shit at the bottom. Fixed income you have munis and then you have junk bonds. And everything in between. We've had a 40 year bull in rates. We're at 1.5 on the 10 year and negative most elsewhere. Its not a matter of if really, but when this market gets disrupted by the forces of nature and those things that are out of the control of central banks, etc. We've already talked on other threads how if rates stay low, theres good money to be made in a bunch of RE based stuff. But what Im getting at here, is essentially, when that rumble starts to get real and the cash/treasury crowd gets forced out the risk curve...where does the money go? I would think MBS is next on the safety ladder but those too share unfavorable dynamics and lets face it, the spreads arent even that much better. 

 

You've got a lot of good evidence out there that the foreign buyer of US MF is just emerging over the past few years. Why? Because MF housing is largely a US thing. Most overseas dont even know what the asset is because they dont have the same type of stuff over there. I have no clue why, but these mini campus type rental complexes just dont exist in lets say, Europe, the same way they do here. But in terms of profile, they are extremely attractive once one does some half assed or better DD. So I think you have a lot of pointers saying that it could be the asset class with the greatest risk/reward over the mid/long duration. I mean look at the MBS...this was a totally fringe product that only started emerging in like the late 70s. Was still off the radar of most till the late 80s. and peaked 20 years after. Today, the trends happen a lot faster, but theres a lot of overlap in terms of the bull case for these assets. 

 

If not this, any suggestions on what type of asset and risk profile becomes the next in line? Thats the trade Im looking for. 

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Greg, what I'm not understanding is why there isn't already today a glut of MF on the market given how the cap rates have been historically low for so long.  I mean, if it's not building costs relative to rent, then what gives?  Why hasn't this stuff been oversupplied on spec by this point in time?

 

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7 minutes ago, ERICOPOLY said:

Greg, what I'm not understanding is why there isn't already today a glut of MF on the market given how the cap rates have been historically low for so long.  I mean, if it's not building costs relative to rent, then what gives?  Why hasn't this stuff been oversupplied on spec by this point in time?

 

haha yea thats a good question. Best guess would be that "glut" is a subjective term, there is limited supply of buildable space in desirable markets, and sandwiched in there somewhere is the fact that people want to live in decent areas. But thats just a guess. Similar things have been said about warehouses. Which are even more glaring and something that by and large Ive missed as an investment opportunity. But why cant you just build that to wazoo? Relative to building an office tower or even a multi family campus, throwing up a warehouse is easy. Of course theres zoning and permits and all that shit, but same question applies. 

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27 minutes ago, ERICOPOLY said:

Greg, what I'm not understanding is why there isn't already today a glut of MF on the market given how the cap rates have been historically low for so long.  I mean, if it's not building costs relative to rent, then what gives?  Why hasn't this stuff been oversupplied on spec by this point in time?

 

Or again, I'd focus on the term "glut". Maybe there is and has been a "glut" but there's simply so much cash out there that at a given price you've got renters lined up for the space and buyers lined up for the product? Would that be inconsistent with the overall housing market? In the current market AMC can produce "air" for people at whatever price the market is and can print all day long. Theres buyers. However a MF campus takes 18-24 months or more to build. The "they'll just build til theres an oversupply" theory a lot of people revert to is, IMO, too much of an academic exercise. In the real world, for a stable, safe, hard asset with good cash flow.....if you build it, they will come. 

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Unless people are renting more than 1 housing unit at a time I cannot see how there could be a glut at present with rents increasing as they have been doing. 

 

With covid and working from home, perhaps adult kids moved out and their parents divorced.  That's pressure on rental demand. 

 

Otherwise, I don't get it... we have higher unemployment and rents skyrocket.

 

 

Edited by ERICOPOLY
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36 minutes ago, Gregmal said:

Or again, I'd focus on the term "glut". Maybe there is and has been a "glut" but there's simply so much cash out there that at a given price you've got renters lined up for the space and buyers lined up for the product? Would that be inconsistent with the overall housing market? In the current market AMC can produce "air" for people at whatever price the market is and can print all day long. Theres buyers. However a MF campus takes 18-24 months or more to build. The "they'll just build til theres an oversupply" theory a lot of people revert to is, IMO, too much of an academic exercise. In the real world, for a stable, safe, hard asset with good cash flow.....if you build it, they will come. 

 

I think this actually does occur in some markets, but not to the wild and dramatic degree that people associate with "gluts".


In my DC/MD stomping grounds, my old apartment floorplan is available for $3,400/month. I rented a this from 2016-2019 for $3,100 - $3,300 / month. I locked in the first 2 years at $3,100 with free parking because there was a mini-glut due to a few buildings coming online which caused rents to decline from the mid $3's, so rent hasn't really grown there in 5 or so years. Not exactly "distress" but also maybe not what you expect when buying a 4 cap (or less) asset.

 

Not far away, JBGS recently delivered 8001 Woodmont, which as of June 2021 was 4% occupied according to the supplemental and is currently offering 2 months free, albeit off a high price point (2 BR = $4K). This is how it happens. Nice new buildings come online, they offer incentives to fill em up, the existing supply might go from 95-90% occupied and they then reduce price by 10% or so. basically, developers are doing what they should do, bring on more supply when the market can bear it.  And the supply gets absorbed as more yuppies move here.  The bear case is they stop moving here and the construction continues and the landlords have to decrease rents more (I don't think that occurs). Construction costs, NIMBYism, permitting time, etc all provide a degree of protection from too much coming at once. 

https://www.8001woodmont.com/?gclid=CjwKCAjwndCKBhAkEiwAgSDKQeslUHvHYFm1KM34_wrZVeti9pyBwoY9YABWXRntEixM7_keTQ8KSRoC_skQAvD_BwE

 

In certain submarkets though (like where FRPH's assets are) the densification seems to have almost played out and there aren't too many more building spots, so you probably start to see less supply availability (this is where @BG2008 chimes in about moats and water and stuff), and rent increases once the moratorium ends. 

 

Seehere: the land between the ballpark and 695 had pretty much been conquered by Yuppie amenitized apartment buildings

https://www.capitolriverfront.org/live-here/residential-buildings

but there are still some big things coming:

 https://www.bisnow.com/washington-dc/news/multifamily/wc-smith-plans-another-capitol-riverfront-project-with-520-units-109731

https://dc.urbanturf.com/articles/blog/dc-has-the-most-cranes-in-the-sky-of-any-city-nationwide/18114

 

https://www.bisnow.com/washington-dc/news/multifamily/dc-apartment-demand-hits-record-levels-as-recovery-accelerates-109539

 

Edited by thepupil
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