How Rate Hikes Have Changed the Lender Landscape

Featured in Multi-Housing News

Despite disruptions, multifamily investors have numerous debt options, writes Gantry's Tom Grzebinski.

Change is a strong constant in the current market cycle. Change in rate conditions. Change in government policy direction. Change in market fundamentals and consumer patterns. The biggest change for all CRE, multifamily included, has been the increased cost of capital since rate volatility hit at the beginning in 2022. Lenders are responding.

These significant changes to market conditions in recent years have impacted multifamily financing and how new debt is being underwritten for maturities, acquisitions and development. The players are still the same, but they have evolved their programs to better meet the market at this moment. Here is a quick overview of how traditional debt sources are changing their approaches to meet borrower needs and their underwriting criteria.

The agencies: The greatest shift on the horizon for the agencies is structural: a proposed IPO, a possible merger of Freddie Mac and Fannie Mae, and a reimagined government role for the GSEs. These changes remain in formative stages, with clarity expected by year-end. Should these initiatives advance, they could reshape the very core of agency lending.

A more immediate and concrete change is the heightened due diligence for first-time borrowers. In response to previous abuses and fraud, the agencies now require direct interaction between underwriters and new borrowers. Financials, property metrics and sponsor credentials must be submitted directly, and borrowers should anticipate requests for detailed documentation such as W-2s for every property currently owned.

Both agencies require a minimum of 1.25 debt service coverage, with optional rate buydowns of 1 to 5 percent to meaningfully reduce the interest rate, to increase debt service bandwidth and increase loan size in the heightened rate climate. Both agencies offer programs in the five-, seven- and 10-year term range as their most common options. They are interest-only with one-, two- or three-year options as a starting point. In select instances, they will offer a waiver for some additional interest only up to half of the loan term. Lower-leverage loan requests (sub-65 percent) will likely benefit from full-term interest- only options, as well.

Banks: A big change for banks is their return to active lending after a period focused on portfolio stabilization and addressing non-performing loans. With balance sheets shored up, the requirement for borrowers to maintain sizable deposits (typically 10 percent of the loan) is less prevalent, though most banks still require the operating account to be held at the bank.

Banks can go up to 75 percent loan-to-value, but their final loan approvals, as with most lenders, are currently debt service constrained. Most of their loans continue to be recourse driven, but there are more and more examples of non-recourse or partial-recourse terms available. Their minimum DSCR is holding at 1.20 for fixed-rate permanent debt. Banks remain a great resource for value-add projects and can help fund renovations with an interest-only element for value-add acquisitions. Pricing can be very competitive, as banks can offer SOFR swap rates in addition to FHLB and Treasury options.

Credit unions: A big change for credit unions is their growing popularity because they don’t charge a prepayment penalty to retire a loan. This is exciting for borrowers in the current rate cycle who are concerned they will miss out on a near-term rate reduction. They have a sizable amount of capital they are seeking to deploy and are a great resource for loans of less than $30 million. They do require a formality of qualifying as a member. Generally, their pricing is attractive similar to the local banks, and their loans typically have five-year terms with a five-year rate reset option thereafter. Their debt service requirement is 1.25, compared to 1.20 for banks.

CMBS: The resurgence of CMBS is due in large part to their willingness to offer five-year fixed-rate loans, making them an attractive non-recourse option for stabilized assets (typically with 90 percent occupancy or higher) struggling to retire maturing, lower-rate debt. These loans provide the benefit of being a fixed-rate product with an interest-only structure based on a 1.25 debt service determined by the interest-only payment. The borrower is able to maximize loan dollars.

The downside to a CMBS financing is that the rate will typically land at 50 to 75 bps higher than an agency loan and 25 to 50 bps higher than a bank. As an option, borrowers can buy down the rate at a cost of 2, 3, 4 or even 5 full points, which will reduce the rate and push the loan size up. CMBS has other drawbacks, including a 75- to 90-day underwriting timeline. They also rate-lock way into the process, making them far more susceptible to a volatile rate climate.

Finally, the greatest challenge to a successful CMBS financing will be the B-piece buyer, who may change loan terms and upend closing. The key to a successful CMBS loan is to know your B-piece buyer or to work with a lender that has the ability to put the B piece on their balance sheet if no B-piece buyer is available at the underwritten terms.

Debt funds: Debt funds are more active than ever in the current rate climate. Their biggest change is a far greater emphasis on an exit strategy, requiring much more due diligence on borrower planning and project relevancy. These sources are best suited for ground-up construction, heavy rehabs and acquisitions needing substantial improvement. Debt fund capital can be sourced from family offices or other private structures, institutional investors or warehouse lines, with the latter being the least flexible on underwriting. They tend to lend in a one- to three-year commitment, with an option for one-, three- or six-month extensions with a fee.

These loans are typically SOFR based, with a variable rate set at 5, 6 or 7 percent above that rate, making their all-in cost generally in the double digits. Debt funds are also fee driven, with a 1 percent in, 1 percent out set-up or charging a 2 percent upfront cost. They can get higher up the debt stack because they are not bank regulated, so they can reach 85 to 90 percent LTC.

Life companies: The biggest change for life companies in the current cycle is their willingness to offer five-year loan terms, new prepayment flexibility on their 10-year products, and the addition of bridge products to their portfolio mix. They serve as a highly desirable option for stabilized permanent assets and are generally a non-recourse structure. Their permanent loans typically fund at up to 65 percent LTV, with a 1.35 DSCR being the key limiting factor, making them a more conservative option. But they offer unique benefits. Their willingness to rate lock at application helps to mitigate rate volatility concerns and is a huge advantage. They move through due diligence in a streamlined process that offers quick approval and an efficient closing process of usually between 45 and 60 days.

What hasn’t changed? It’s equally important to recognize what has not changed in the face of the current cycle’s many disruptions. There is ready access to debt liquidity and a range of options to finance a project. Multifamily remains a top investment target for a wide range of investors—from mom-and-pops to the nation’s largest institutional landlords. Performance remains strong, even in pockets where softening has occurred recently as a wave of new construction comes online in some of the nation’s growth markets. Demand will remain robust for the long term, with underlying housing fundamentals favoring the continued migration of younger generations into a renting vs. ownership model, as high interest rates and increasing costs limit the move to homeownership. Lenders recognize the strength of multifamily markets and stand ready to accommodate most borrower needs.