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Feb. 4, 2013

Capital Markets

By Keat Foong, Executive Editor

For a number of years now, multifamily housing has been the one bright spot among all commercial real estate asset types and has enjoyed the most favorable financing conditions. This financing support has helped hold up apartment values, while other real estate sectors have wilted during the crisis. Will we see a change in this favorable state of affairs?

At the start of this year, there are a number of conditions that could potentially derail favorable multifamily financing conditions: GSE reform, financial regulations, government budgetary changes and economic uncertainty in the U.S. and Europe. At this point, however, the most likely conclusion may be that 2013 will be yet another strong year for multifamily financing, with a relatively plentiful supply of capital that may even, remarkably, increase further.

As per the latest available data, multifamily financing is still on the upswing. The Mortgage Bankers Association’s Quarterly Survey of Originations reveals that although originations volume in the overall commercial real estate sector fell by 7 percent in the third quarter of last year compared to the third quarter of 2011, multifamily loans originations actually increased by 30 percent. Through the third quarter of 2012, multifamily loans originations were 30 percent higher than in the first three quarters of 2011. The GSEs further increased their financings by a whopping 39 percent through the third quarter of 2012 compared to the same period in 2011.

Mortgage bankers’ optimism reflects this positive state of affairs. “We are up substantially. 2012 will be absolutely a record year for Centerline with respect to multifamily loans originations,” says Vic Clark, managing director at Centerline. Centerline projects 2012 multifamily financing volume to be about $2 billion; it is targeting $2.5 billion in multifamily financings for 2013.

Business is also up for CBRE Capital Markets, according to Peter Donovan, senior managing director of CBRE Capital Markets’ Multi-Housing Group. “2012 has been a strong year. We are up substantially from 2011,” he says. CBRE Capital Markets completed more than $11 billion in multifamily financings in 2012, says Donovan.

Conditions anticipated to continue to encourage multifamily financing volume in 2013 and generate robust business for mortgage bankers are: continuing strong investment sales activity levels, even if some of it was driven by efforts to get deals done before the end of the year in case capital gains taxes increase in the new year; strong apartment fundamentals; and low interest rates. The higher level of new apartment development is also expected to generate financing volume as construction loans convert to permanent mortgages.

Looking forward to the next 12 months, capital availability is forecasted to stay strong, as capital sources, whether major or minor, either hold their own or even increase the amount of capital allocated for multifamily financing. “We see modestly more capital in multifamily” in the new year, agrees Mitchell Kiffe, senior managing director and co-head of National Production of the Debt & Equity Finance group at CBRE Capital Markets.

Essentially, CMBS, life companies and private debt capital may seek to execute more debt transactions in the multifamily sector. And the two still-dominant sources of multifamily capital, Fannie Mae and Freddie Mac, are not expected to reduce their amounts of financing this year, even if there is a possibility their percentage participation in the marketplace may decline as more financing comes into the market from other sources.

“Almost everyone that left the market has returned. Everyone wants to play on the multifamily side. There is more capital, whether bridge or permanent, from life companies and banks. For the right deals, markets and borrowers, lenders are back. Multifamily is the flavor of the year,” observes Elliot Auerbacher, vice president at NorthMarq Capital.

NorthMarq projects that its multifamily financing volume, $5 billion-plus last year, may increase by about 5 to 10 percent in 2013. “We are approaching many refinancing opportunities for properties that have been in the pipeline. A very active sales market plus a growing market for new construction will add to those numbers for 2013 as well,” says Larry Stephenson, NorthMarq senior executive vice president and regional managing director.

One of the reasons capital supply may increase for borrowers this year is that Fannie Mae and Freddie Mac financing is predicted to at least hold steady. As Auerbacher says, “Everyone is expecting [the Fannie and Freddie financing] momentum to continue.” Fannie and Freddie financing currently represents about 60 to 65 percent of the multifamily financing market, says Centerline’s Clark. The two agencies are projected to close as much as $30 billion each in 2012 for a total of $60 billion in financings in a market that will likely total about $90 billion to $100 billion. In other words, the two GSEs will have a market share of about 60 to 65 percent in 2012, says Clark.

To be sure, Clark maintains that regulators are likely to focus on the GSEs’ relatively large market share and start implementing small limitations in GSE financings both in order to restrain government participation and to avoid crowding out the private sector. Indeed, Clark maintains that the amount of Fannie Mae and Freddie Mac interest-only financings had been “extremely limited” in the last six months of 2012, and he surmises that interest-only may even “go away in 2013.” Kiffe agrees. He says that from what he hears from Fannie and Freddie, regulators continue to be most concerned about two financing features—interest-only and cash-out. The agencies “really disfavor cash-out” based on their experiences on the single-family financing side, whether justified or not, he explains. “What concerns me the most is further tightening on cash-out and interest-only,” adds Kiffe.

Nevertheless, these changes are “refinements at the margins” and do not represent a significant shift in financing approach on the part of the two GSEs, says Donovan. CBRE Capital Markets has met with the senior management of Fannie Mae and Freddie Mac, which provided the assurance that “it is business as usual.” There is no pressure on the part of either Fannie or Freddie to reduce their market share, says Donovan. “They continue to do business that makes sense. I have not seen any indication that Fannie will in any way pull back from the market. I have not had that sense from Freddie either,” says Donovan. “It is true that they are concerned about crowding out private capital,” adds Kiffe. “And there may be some regulatory push to decrease the footprint. But as long as the underwriting is of high quality, is prudent, and generates an acceptable return, there would not be a big push.”

Besides the strong multifamily fundamentals and the fact that multifamily remains the preferred asset class, another reason for a possibly greater level of debt capital availability for multifamily this year is the extremely low interest-rate environment, which makes the returns on multifamily debt seem very attractive relative to many other income-yielding instruments. For example, the spread between corporate bond and commercial mortgage yields is wide, notes Kiffe. “A lot of money needs to find a home,” he says.

And as bond investors acquire a more favorable attitude to buying CMBS, CMBS financing is becoming more competitive “by the day” in the multifamily space, says Clark. Centerline is taking advantage of this market opportunity, re-entering the CMBS space a few months ago. CMBS as of the end of last year was already within 30 basis points of Freddie Mac or Fannie Mae financing, adds Clark. On the higher quality, well-leveraged deals, some CMBS pricing is within 30 basis points of GSE financings, if not even tighter.

So as CMBS pricing becomes more competitive, the more complicated deals—smaller loans of $2 million to $10 million—and secondary and tertiary market multifamily transactions, will head to CMBS financing, says Clark. According to Auerbacher, that will be good news, as Class C properties in secondary markets are still having difficulty being financed by the GSEs.

Meanwhile, life companies, which continued to lower their interest-rate floors last year, are expected to place more capital into the multifamily sector in 2013, says Kiffe. Life company financing will be about $60 billion in 2012, and some companies expect an increase in 2013, driven by the need to invest. Centerline’s Clark agrees that there may be an even greater volume of capital flow to the multifamily sector in 2013. Further, private debt capital participation will be upping its supply of structured financing, such as bridge or mezzanine. “All of us are trying to increase our balance sheet available to provide more bridge financing,” says Clark. “These are financings that will provide one- to three-year transition loans that will allow borrowers to purchase, stabilize and roll over to permanent debt.”

“There is more capital for multifamily than for a lot of the other sectors,” agrees Auerbacher. However, he cautions that it is not necessarily an “easy” task for multifamily deals to get funded. “It depends on how high a leverage you want and when was the last time the deal was financed.” Multifamily loans that were financed just before the financial meltdown may be difficult to refinance without cash infusion. These loans may have been underwritten very permissively, for example, at high leverage with five-year interest only terms, and they may not have amortized sufficiently, notes Auerbacher. Class C and D multifamily properties are still having difficulty obtaining financing, but Class B multifamily properties even in “C” markets are very much in favor.

No doubt, there are also risks that could derail multifamily financing in terms of borrowers’ ability to obtain loans. Auerbacher says one worry is that interest rate increases could turn around the financing picture very quickly. A major “saving grace” for many loans today is the fact that interest rates are now lower than they were when the loans were first financed, says Auerbacher. “If the interest rate increased two points, that could mean a whole lot of additional properties defaulting,” he adds.

Additionally, one might also think that potential regulatory changes and GSE reform constitute foreboding cloud formations on the horizon. But those risks are not projected to be an impediment for the multifamily industry at present. Regarding the Dodd-Frank 5 percent “skin in the game” requirement, “we have not seen that shaking things up,” says Clark. Most B-buyers are already reserving 50 percent skin in the game today. “The industry is self-regulating” in that regard, explains Clark. And with respect to GSE reform down the road, “we feel confident [the GSEs] will be here in one form or other,” Clark says. Even if one of the GSEs is not present today, Wall Street pricing may only be 20 to 30 basis points higher than GSE pricing, based on current spreads.

In similar vein, Kiffe suggests that the multifamily financing world will not likely be disrupted by legislative reform for the next few years. “Single- and multi-family financings are so dependent on federal support that a 100 percent private capital solution may be years and years down the road at best. Whether we will see legislation in 2013, we don’t know,” says Kiffe. Notes Donovan: “It is really about single family and not multifamily. But, whatever the solution, we think it will be a long transition period, especially for single-family.” Donovan adds that there is no indication from “the administration or the powers that be” that there is either the interest or resources to accelerate the multifamily solution ahead of the single-family. So that means, barring any major financial or economic shocks, even more capital may become available this year to support apartment values.

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