Every year brings a few question marks in terms of what’s ahead. Some years have more unknowns than others; many agree 2019 is one of those years.
From politics to the stock market to trade tensions, this year has its share of variables on top of traditional uncertainties, such as natural disasters. Add lots of capital chasing fewer deals, an affordability imbalance, and a disconnect between buyers and sellers, and those question marks continue to multiply.
Lenders have generally remained disciplined and diligent in the current market, estimating their level of risk and confidence as best they can. While they don’t have a crystal ball any more than the rest of us do, many finance professionals believe flexibility may be the key to thriving in 2019.
“Most lenders, particularly Fannie Mae and Freddie Mac, have adapted to a more fluid financial climate,” states Marcus & Millichap’s 2019 Multifamily North American Investment Forecast. “Lenders remain cautious, adopting tighter underwriting standards but aggressively competing to place capital into apartment assets.”
As with many temporary blips on the horizon, the report recommends seeing the forest as a whole, rather than getting distracted by a few worrisome-looking trees.
“Strong demand drivers supporting long-term yield models will counterbalance much of today’s market volatility,” the report continues. “[This is] encouraging investors to look beyond any short-term turbulence.”
Sustained Longevity
We may be long in this real estate cycle, but that doesn’t mean renting will fall out of favor anytime soon — far from it, in fact. Rising interest rates and home prices have led to a 4 percent decline in home sales in 2018, the report notes. These increases also tacked on an additional $175 per month on mortgage payments last year, with the average monthly U.S. mortgage now costing $1,700 per month. This has created an even greater disparity between the cost to own and the cost to rent.
On the flip side, Freddie Mac believes rent growth will increase by 4 percent into 2020.
“Even with continued growth in supply, we expect vacancy rates to remain below historical averages in 2019, and we see rent growth reaching 4 percent,” says Steve Guggenmos, vice president of multifamily research and modeling at Freddie Mac. “Along with demographic trends and the shift in consumer preferences toward urban areas, we examine the comparatively high cost of homeownership by market and that is another important factor that will continue to drive healthy performance in the multifamily market.”
Still, this market and the uncertainty surrounding it comes with constraints. Loan-to-value (LTV) ratios have tightened, with leverage ranging from 55 percent to 75 percent. Construction lending has also tightened as a record number of new multifamily units enter the market. Higher borrowing costs and questions about the durability of the growth cycle have further impacted the widened bid-ask spreads.
Rising capital costs and increased down payments are eroding buyer yields, while sellers continue to seek premium pricing based on ongoing robust property performance. Marcus & Millichap also notes there has been some reluctance around lending on future revenue growth through value-add efforts.
This is where flexibility has been key. Investors and developers are increasingly relying on short-term mezzanine debt and bridge loans to cover the span until improvements deliver the planned returns.
“Multifamily portfolio transactions require flexibility,” says Nikhil Kanodia, head of FHA lending at Greystone. “[We want to] offer clients a diverse range of options for purchase and refinance with our bridge-to-permanent financing platforms. We will always go the extra mile to ensure that our clients get the best terms possible, no matter how complex the deal.”
Flexing the Lending Muscles
This strategy was put to the test in 2015 when Greystone provided bridge loans to Amesbury Cos. for three multifamily communities in East Texas. This included the 124-unit Glen Hollow Apartments in Kilgore, as well as the 208-unit Sunridge Apartments and the 120-unit Stone Creek Apartments in Nacogdoches.
The lender was able to provide a total of $19 million in loans to refinance the three assets in January. Financing included a 35-year, permanent, FHA-insured loan; a 35-year, fixed-rate, FHA-insured loan; and a Fannie Mae loan with a 10-year term, fixed rate and 30-year amortization.
The permanent loans allow Amesbury to refinance out of the bridge loans and to continue making capital improvements to each property.
Complex transactions require both flexibility and patience. Benefit Street Partners Realty Trust (BSPRT) was able to flex this muscle late last year when the publicly registered, non-traded REIT provided a $115.5 million loan to the owner of an apartment building in Queens, N.Y., that contained more than 400 units. The three-year, interest-only, floating-rate loan features senior mortgage and mezzanine components, as well as an interest rate floating over LIBOR. BSPRT closed the loan in about three weeks during the holiday season.
“BSPRT was able to move incredibly quickly to close a very complicated transaction, utilizing our middle-market, industry-leading flexible balance sheet,” says Michael Comparato, the REIT’s head of commercial real estate. “We provided the senior mortgage, senior mezzanine and junior mezzanine all under one roof, which provided the borrower excellent execution.”
The loan was used to pay off existing debt and fund certain carrying costs. It will allow the borrower to execute its business plan by funding property upgrades. These include high-end unit renovations, new amenity space, and upgrades to the lobby and fitness center.
Redwood Trust is pivoting as well. The specialty finance company that focuses on credit-sensitive investments has a couple new multifamily ventures up its sleeve. It is participating in a multifamily whole loan investment fund that expands the company’s access to rental housing credit opportunities.
Redwood Trust has also invested in a limited partnership to acquire up to $1 billion of floating-rate, light-renovation multifamily loans from Freddie Mac. The company committed to fund an aggregate of $78 million to the partnership. So far, it has funded about $20 million. Freddie Mac is providing a debt facility to finance loans purchased by the partnership.
After the partnership’s acquisitions have reached a specific threshold, the partnership and Freddie Mac may agree to include the related loans in a Freddie Mac-sponsored securitization. The limited partners may acquire the subordinate securities issued in any such securitization.
“Expanding Redwood’s reach into the multifamily whole loan space is another example of our ability to identify and execute on innovative ways to scale our business for profitable growth,” says Christopher J. Abate, Redwood’s CEO. “This investment strengthens our relationship with Freddie Mac and furthers our efforts to invest our shareholder’s capital in areas of the housing market where it is most valued. We look forward to deploying the remainder of the capital we have committed to the fund.”
While value-add opportunities may not be as rampant as they were in the past, the potential “value” of these propositions isn’t lost on investors – or lenders, despite the current tightening. These deals are particularly attractive in Dallas/Fort Worth, Kansas City, Mo., Las Vegas, Cincinnati, Cleveland, Milwaukee, Oakland, Calif., Philadelphia and Pittsburgh.
— Nellie Day