Multifamily Finance In A Volatile Market

By: Mark Reichter

In an era of extended volatility and disrupted economic norms, multifamily continues to hold its position as the top asset class for commercial real estate investment.

Strong fundamentals are expected to continue to drive robust performance even in these uncertain times, especially as economic conditions slow the flow of the single-family home sector. Rental housing demand continues to outpace supply, and vacancies remain healthy in most if not all national markets. Even where rents have softened, they are holding at or dipping from recent highs. Expect rental housing to maintain these strengths for the foreseeable future.

Fundamentals remain strong, but regardless of how encouraging the fundamentals are, finance and rates are now having an outsized impact on multifamily investments. The initial shock of a higher rate climate put many trades on hold and have challenged refinancing at even performing assets. This is changing as the market has adjusted to the new higher cost of capital, and valuations are aligning to this new rate climate. Still, cap rates remain tight making loan optimization critical to any successful transaction.

With financing being the key to unlocking new investments or retiring pending maturities, looking at the relevant debt providers is a necessary exercise for me with clients every day. Debt liquidity is substantial. Anyone transacting in today’s market should be looking to survey the full competitive marketplace to identify the best source amongst a myriad of providers and programs. Here is an overview of these options.

Permanent Loans

The top sources for permanent multifamily loans in the current cycle continue to be life companies and the agencies. Banks may be a little better on rate, but most continue to require recourse, performance covenants, and depositor relationships that make their loans far less appealing. Life co’s and agencies almost exclusively offer non-recourse programs tied to asset value with little to no performance terms beyond timely payment.

In this volatile rate climate, life company willingness to lock rate at application and hold for up to 180 days in some cases is invaluable for strategic planning on complicated investments or refinances riding out prepayment penalties for approaching maturities. If a rate works now, lock it, move forward, and take volatility out of the equation. They also feature a streamlined underwriting process once they have a loan under contract for certainty of close. Spreads have widened against corporate bonds, but they remain competitive on rates commensurate with their competitors. These lenders tend to be more conservative than other sources which can limit proceeds, and DSCR will play the greatest role in defining an ultimate LTV. Still their stability, consistency and attentive servicing through maturity make them a gold standard in the lending space.

Agencies, especially with repeat borrowers, can rate lock early in the process albeit for a shorter time frame than life co’s, but still have a lag from the initial application period. They are by far the most active in pursuing new originations and highly competitive on rate with lower spreads and clearly defined terms. You most likely will not have a rate locked until at least receiving an approved appraisal. However, with loans being more constrained in this market by DSCR, agencies are also able to provide greater reach on this front. Their underwriting process is pretty straight forward and their spreads have tightened significantly since the start of the year. Servicing is far less flexible if challenges emerge, but straight forward in expectations.

For projects seeking to maximize leverage, CMBS is also a strong consideration but remains most challenged by current rate volatility. Since CMBS loans do not lock rate until the day of closing, pricing and proceeds can remain a moving target throughout the process. However, full-term interest only and their ability to climb higher into the capital stack by stretching DSCR targets can make them a compelling option for projects struggling to retire a pending low-rate maturity in a higher for longer rate climate. CMBS also offers the least flexible servicing structure.

Bridge Options

For value-add acquisitions or projects still in transition, there is an active bridge loan marketplace that includes life companies, banks and debt funds. These sources are all seeking yield. Debt funds are mostly non-recourse, tend to offer greater flexibility, but ultimately will charge higher rates accordingly. Banks are competitive on rate but are almost always a recourse-driven option. Life companies will be more conservative on leverage and terms, but extremely competitive on rate and are mostly a non-recourse execution. Bridge to bridge refinancing is available from all these sources.

Banks and life companies will be as focused on sponsor experience and business plan alongside underlying asset value, where debt funds will be more focused on business plan and exit strategy during their underwriting. Which source is best for a project will be dictated by sponsor equity capacity, debt service bandwidth, and hold or sell exit plans.

Core Plus

A unique offering that has emerged as life companies began seeking higher yields in the era of low interest rates that preceded the current cycle is the pre-stabilized permanent loan. These structures are best suited for retiring maturing construction loans on recently completed projects where leasing has yet to hit stabilization targets but is trending in that direction. These long-term loans are underwritten to future performance expectations, often underwritten with structure as well as an upfront interest only period to maximize early cash flows. Expect a spread premium of 15bps-50bps, depending on the overall deal, with fixed and floating rate options available. These loans can be placed when occupancy is between 60-80% as long as leasing momentum and market fundamentals point to ultimate stabilization at the asset.

Construction Loans

Banks remain active in their traditional role as a highly competitive source for construction financing. Debt funds are also a ready vehicle for construction financing and will probably remain the most flexible source in customizing their programs to exceptions and not just rules. Life companies are well known for their construction-to-permanent loan programs, which are still a viable consideration mainly for large scale, class A projects. However, the real challenge for any project sponsor and any lender underwriting in today’s volatile market is accurately assessing and aligning project loan to cost. In a chaotic policy and economic environment affecting every aspect of new construction, from labor availability to materials costs, arriving at stabilized performance projections and realistic proformas has become a challenge. Expect that while liquidity is abundant, underwriting will be stringent with any lender.

The Consistent Constant

Every asset will tell a different story and require a different lender for a program tailored to provide maximum return on investment. The one constant that has remained consistent throughout this period of volatility is the abundance of liquidity that remains in the capital markets for commercial real estate lending. This means that in an era where most investors have lost their go-to banking relationship to the challenges of the economic cycle, identifying alternative lenders will be a paramount consideration to optimize debt structures. The best plan in the current cycle is to start early, deploy an expert with a wide market awareness to leave no stone unturned, and know your limits.