By Taylor Williams
HOUSTON — Industry professionals say that while the fundamentals that underlie multifamily properties in major Sun Belt markets are quite healthy, the broader conditions of the U.S. capital markets are so choppy and disruptive that lending volumes are depleted across the board.
The dearth of deals isn’t exclusively attributable to the Federal Reserve raising interest rates, which has now happened 11 times in 17 months. The nation’s central bank is now targeting a short-term benchmark range from roughly 5.25 to 5.5 percent, the highest level since 2001.
Underwriting standards are tightening as owners reckon with serious increases in property taxes and insurance, among other items. Major banks are scaling back their originations in favor of keeping more reserves on hand in anticipation of exposure to defaults on office loans that are coming due within the next 12 to 18 months. The wounds of the collapses of regional lenders Silicon Valley Bank and Signature Bank in March are still fresh, and the country is scarcely a year removed from what will assuredly be a heated and divisive presidential election.
For debt providers, the combined effect of those factors is major reluctance to transact. Lenders and investors have largely shifted their stances from offensive to defensive as a decade-long boom of growth fueled by low interest rates moves closer to its inevitable end.
“The other day, a banker told me, ‘I won’t get fired if I don’t make a loan, but there’s a chance I’ll get fired if I do make a loan,’” said Tony Gray, senior vice president and managing director of debt and equity at Northmarq’s Houston office. “Until there are [assurances] of payoffs, or unless a deal or borrower is exceptionally unique, lenders are looking to kill deals. Underwriting needs to be buttoned-down and bulletproof — no surprises.”
Gray spoke as part of a panel of locally based financial intermediaries at France Media’s InterFace Houston Multifamily conference, which took place in late June at the Westin Galleria hotel in Houston. The event drew nearly 300 people in its inaugural showing. Derek Fasulo, senior vice president of debt and structured finance at CBRE Capital Markets, moderated the discussion.
Clamping Down
Relationships have always been central to dealmaking at this level, as multiple panelists pointed out. In some cases, past successes are enough to greenlight present-day deals. But there’s still an elevated level of scrutiny that comes with this very expensive debt.
“The deals that are getting done right now are mostly choice refinances,” said Gray. “The acquisitions market is anemic outside of a few forced sales. Nationally, our investment sales platform is down 70 percent year-over-year, and the other 30 percent that’s still transacting has a fund life maturity or some other unique situation behind it.”
“We are seeing some banks step up on acquisitions, but usually only for existing clients,” added Brandon Brown, senior managing director of capital markets at Marcus & Millichap Capital Corp. “For the most part, it’s money [with interest rates] in the 8s. For some smaller deals, we have had some success with certain banks and credit unions pricing over Treasuries, so we’re getting some rates in the low 6s for those deals. But that’s about it.”
Some panelists gave anecdotal evidence to illustrate just how much the construction lending well has dried up, even for preferred asset classes like multifamily. Fasulo cited a recent Bloomberg article in which David O’Reilly, CEO of metro Houston-based REIT The Howard Hughes Corp., said that he approached nearly 50 different lenders to secure financing for a new project in metro Houston.
Despite the company’s extensive and established track record in the market in question, O’Reilly walked away empty-handed, proving that even the most seasoned and well-capitalized developers can struggle to secure financing in this environment.
Other panelists shared similar struggles, generally involving placing dozens — if not hundreds — of calls to lenders of all types just to get one or two bites.
“Right now, it’s very challenging to get in with a bank as a new borrower,” concluded Anton Mattli, co-founder and CEO at PEAK Financing, an intermediary based in metro Dallas. “For larger deals — maybe $30 million to $50 million — they need other banks to participate. And banks don’t want to participate in each other’s deals right now. Until a year ago, that was a very common way for banks to build their lending portfolios. Today, unless you have a very well-established relationship, it’s very tough to borrow from banks.”
Over the last 18 months, a number of commercial borrowers that were approaching their loan maturities pushed for bridge debt rather than allow themselves to be locked in to a long-term, fixed-rate structure at the high-water mark. Bridge loans tend to carry short terms and high interest rates.
With many of those loans now maturing, there is a marked challenge in getting those borrowers out of bridge debt and into permanent financing structures that are economically feasible. This unusual circumstance further squeezes deal volume.
“Within the bridge market, lenders are having a real issue selling their paper on the street right now,” said panelist J.C. Clemens, managing director and chief production officer at Houston-based Flagship Capital Partners. “They don’t have a back end to dump their trash, and they can’t put any more trash in the dumpster.”
Later in the discussion, Clemens touched on tightening within the construction lending space, noting that even marquee, deep-pocketed developers were getting less desirable loan terms, such as maximum leverage of about 50 percent and full recourse.
Carl Rasmussen, associate director of mortgage banking at Berkadia’s Houston office, echoed these sentiments.
“Leverage is being scaled back 10 to 15 percent, and then you have to bring in deposits,” said Rasmussen. “For deals that used to be nonrecourse, you’re lucky if it’s partial recourse or full recourse. Making a construction deal pencil out today is extremely challenging.”
Demand for Deposits
Some commercial investors and developers have tried to work around the macro-level obstacles by bringing in the aforementioned deposits to shore up their banks’ balance sheets.
“Some bankers have told us that they’re being instructed to bring in deposits, not make loans,” said Fasulo. “Their bonuses this year are going to be based on deposits, not the business they bring in for loans.”
It’s an unusual approach in which borrowers have to sweeten the deal for lenders. Yet just a couple years ago, lenders were frequently competing among themselves to finance deals, generating better terms for borrowers in the process. Further, there is limited upshot to bringing in new deposits, as Gray explained.
“If a banker makes you a loan after bringing in new deposits, all you’re doing is borrowing money from yourself,” he said. “They’re taking 10 to 20 percent of their deposits, taking that money to the Fed window, borrowing from the Fed and loaning your money back to you.”
Gray further stated that even with new deposits coming in, the additional liquidity provided to the market is not sparking more deal volume or velocity.
“There’s not a capital problem out there; there’s a deal problem,” he said. “There’s plenty of capital, but deals just don’t fit into the box right now.”