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Texas Multifamily Owners, Investors Turn To Alternative Capital Sources

Element-at-College-Station

Electra Capital recently provided equity to One Real Estate Investment to complete the firm’s acquisition of The Element at College Station, a 192-unit multifamily asset.

By Sam Greenblatt, CEO, Electra Capital

Today, a growing number of risk-averse financial institutions are pulling back from the multifamily rental market, leaving owners and investors struggling to complete their transactions. Fortunately, however, private firms are stepping into the gap with alternative sources of debt and equity capital.

As the COVID-19 pandemic disrupted the national economy this spring, banks tightened their standards on all types of loans, according to a recent Federal Reserve survey of senior loan officers. Nearly half the surveyed lenders reported that they had tightened standards on multifamily loans in the first quarter.

Sam Greenblatt, Electra Capital

That pullback can have a potentially crippling impact on multifamily transactions. Let’s say an investor seeking to purchase a $50 million multifamily asset has raised $12.5 million (25 percent) in equity with a bank loan due to provide $37.5 million (75 percent).

But before the deal could close, the bank implements a tighter 60 percent loan-to-value (LTV) ratio limiting its senior financing to $30 million. Now, the investor or transaction sponsor needs to come up with an additional $7.5 million on short notice or the deal will fall apart.

This is where alternative private capital firms can provide flexible, short-term financing solutions, including bridge and mezzanine loans and preferred equity and participation in preferred equity investments. By adding the missing piece to a sponsor’s capital stack, these solutions can play a pivotal role in successfully closing the transaction.

For instance, our firm recently helped a sponsor conclude the acquisition of a student-housing complex near Texas A&M University in College Station. After a major investor walked away from the deal, we provided the sponsor with $4.1 million in preferred equity to complete the purchase.

Sponsors can also reach out to alternative capital sources when building a solid financing structure for a multifamily acquisition. For instance, a sponsor might have secured a $6 million bank commitment on a $10 million property, but fallen short on the equity side, raising just $2.5 million. Again, a private firm could provide the additional $1.5 million needed to complete the acquisition.

For owners seeking to refinance their holdings, private firms can contribute subordinated debt or equity capital. For example, an owner might have a maturing loan issued at  75 percent LTV, while a new senior lender will only go up to 65 percent LTV. This is another example of how private firms can hold the keys to completing transactions, and it demonstrates the flexibility and agility they can bring to the table compared with traditional institutional lenders.

Considerations for Sponsors

For sponsors considering alternative sources of capital, there are several items to consider:

  Type of capital — For example, a mezzanine loan with an assignment of ownership interest would not affect the equity side of the structure. On the other hand, a private firm could provide a preferred equity position in the capital stack, allowing the sponsor to meet a bank’s LTV requirements.

  Desired return — This might be a fixed amount or a certain percentage of the transaction.

   Performance — Most sponsors make deposits that will be lost if the deal falls through. Therefore, a firm providing alternative capital should provide certainty of execution though an unblemished track record for performance.

  Flexibility — Sponsors and owners should work with a private firm that has the ability to customize its offerings and create an alternative capital structure designed specifically for each transaction rather than applying a cookie-cutter formula.

Looking Ahead

The steady pace of multifamily transactions is likely to continue through the second half of 2020 and into 2021, regardless of the status of a COVID-19 vaccine or treatment.  After all, the fundamentals of the U.S. market remain favorable for investors, particularly in secondary markets in the Southeast and Sun Belt states with relatively large, affordable apartments.

Demand for rental units remains high among most demographic groups, particularly generation Zers in their 20s and millennials in their 30s seeking a comfortable work-from-home lifestyle in a community with recreational amenities. Aging boomers in their 60s are also choosing apartments when downsizing to eliminate the costs and headaches associated with owning a single-family home.

According to the U.S. Census Bureau, 34.7 percent of all households were renters in the first quarter of 2020. The vacancy rate on multifamily rentals was 6.6 percent, compared with 7 percent the prior year.   

Despite strong demand, banks are unlikely to relax their strict lending standards in the months ahead due to the ongoing slowdown in the U.S. economy, coupled with global geopolitical uncertainties. Banks that have been hit hard by the downturn are unlikely to generate much enthusiasm for potentially risky loans.

Private firms will therefore continue to provide valuable sources of debt and equity capital to the multifamily market, enabling sponsors to move forward and complete their transactions.

Electra Capital LLC is a privately owned, alternative capital provider specializing in multifamily financing solutions, providing short-term capital and advisory services to middle-market real estate firms. This article originally appeared in the June 2020 issue of Texas Real Estate Business magazine. 

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