Multifamily Financing: Where Is The Market, Where Are The Gaps and How Do We Address Them?
For nearly a decade, multifamily financing has had the benefit of the most stable sources of long-term debt, which has kept the investment market strong and the property type in favor.
Whether it is agency lending, life company permanent debt or commercial mortgage backed securities (CMBS) financing, there has been a consistent market for multifamily loans throughout the economic recovery.
Houston has been the beneficiary of significant capital supporting multifamily investment and development during that time, but there has been some reaction to the slowing growth in the employment market due to the oil and gas commodity price pullback.
Construction – New Development
The moderate energy downturn in Houston, coupled with the significant new supply of units and softness in specific market segments, has begun to impact the market for multifamily construction loans and joint-venture equity capital. Construction lenders, which normally would be able to make construction loans with 25 percent or less equity, are now requiring up to 40 percent or more equity from developers.
Construction loan advance rates have dropped to the 65 percent and below loan-to-cost (LTC) range. Banks have been under pressure to curtail their lending on construction loans and are sensitive to the pressure of significant new supply that is affecting lease rates and market occupancies in Houston.
We address these types of shortfalls by looking at alternative loan products such as Federal House Administration (FHA/HUD) financing, mezzanine loans and construction/perm financing from life companies or other alternatives to traditional bank debt.
FHA/HUD financing has always flourished when traditional lending sources begin to pull back. The program allows a developer access to construction/perm financing that allows for a higher LTC construction loan with up to a 35-plus-year permanent loan. This structure comes with some additional costs, processing time and underwriting requirements unique to this structure.
Life companies and nonbank lenders can offer comparable or higher advance rates than banks, and can include fixed-rate permanent loans or high leverage participating structures. These can be the best option in a development scenario, given the current limitations of the amount of construction debt and institutional equity that is available.
Stabilized – Permanent Loan Market
Agency lenders Fannie Mae and Freddie Mac have made adjustments to underwriting in specific Texas markets with significant new supply and overall market softness, which we see in Houston.
They have dropped their standard maximum loan underwriting from 80 percent loan-to-value (LTV) and debt service coverage ratio (DSCR) of 1.25 to 75 percent LTV and 1.3 DSCR with limited interest-only available in certain markets. The requirement for more equity can make it difficult to hit acquisition returns or reach desired proceeds.
As with most guidelines, there is an opportunity to create an underwriting story around the strength of the property and its specific submarket, strong sponsorship and experienced management to support waivers. This might permit for an adjustment to allow a sponsor to maximize his offer in order to win a competitive bid, or reach sufficient proceeds to achieve a full payoff of the existing loan.
Value Add – Bridge Loan Market
In the past, bridge lenders have been willing to lend up to 90 percent of total acquisition costs on value-add properties, with limited or no recourse. Pricing for those transactions has often been high, in the 7 to 9 percent range. While this is a very attractive structure, currently we see advance rates topping out at anywhere from 70 to 80 percent of total acquisition costs, which can create an equity gap.
We seek to close that gap because there is a great deal of competitive bridge financing available seeking bridge/value-add multifamily opportunities in the market today which is priced even more aggressively — anywhere from 4.75 percent to 6.75 percent. The aggressive pricing can make the cost of raising additional equity have a negligible effect on the overall returns due to the advantageous pricing of the first lien.
Overall, the Houston market has weathered the “storm” of bad publicity, overreaction and trepidation that followed the recent downturn in the energy market. Even through years of low job creation we have seen the city and surrounding area grow, as evidenced by the recent U.S. Census Bureau and U-Haul studies, which show that people continue to move to the Houston area at a pace that leads the nation.
These positive indicators insure that we will see continued availability of multifamily capital and improving terms available in the years to come. Until then, a little creativity, finesse and alternative structuring can close the gaps and help make deals work in any capital environment.
— By Bill Haley, vice president, NorthMarq Capital, Houston. This article first appeared in the July 2017 issue of Texas Real Estate Business magazine.