Bank OZK has been one of the boldest and most active multifamily construction lenders of the past few years. From Manhattan condominiums to Miami garden apartments and mixed-use developments in Washington, D.C., and Dallas, the regional bank has been the fuel behind many recent high-profile projects.
MHN checked in with Mike Moran, executive managing director of originations at Bank OZK, to get the bank’s forecast for lending conditions in light of several threats looming on the horizon, including rising inflation and construction costs, and geopolitical issues. Moran expects lending to remain healthy this year but concedes that growing concerns could result in a slowdown.
Here are the key trends that Moran believes will continue to define the multifamily lending landscape this year and beyond.
How confident are lenders now when it comes to financing new multifamily projects?
Moran: Lenders appear to have tremendous confidence financing new, ground-up multifamily projects. Notwithstanding the recent, rapid increase in interest rates and construction costs, we continue to see lenders issuing terms on deals—generally at wider spreads than 2021, while holding LTCs and LTVs. Solid property performance, market dynamics, strong tenant demand, a solid job market, healthy values, and ample liquidity—both in equity and debt markets—bolster lender confidence in the multifamily construction lending business.
How have multifamily lenders adapted to consumers’ evolving preferences?
Moran: Since the pandemic and the work-from-home trend, renters are valuing more space, unit design and property amenities that provide a convenient WFH arrangement such as high-speed internet, soundproofing, dedicated workspace and smart package storage.
For years, population growth has trended toward the country’s southern markets. Additionally, the build-to-rent product has attracted institutional capital and expanded in states with ample land such as Arizona, Florida and Texas. People are increasingly placing value on the experience provided by a stand-alone unit offering a sense of “ownership” and simple life conveniences; and sponsors are often able to charge a premium rent compared to traditional multifamily product. Thus, a brighter light shines on understanding the supply-demand dynamics and income levels of the market.
As these preferences evolve, we educate ourselves on the nuances and peculiarities and focus on how underwriting, structuring, funding, or other aspects of the transaction are affected. Ultimately, we look for ways to bring creative, flexible and analytically driven capital solutions that are congruent with and supportive of the preferences.
As a regional bank, have your lending practices changed since the onset of the pandemic?
Moran: Our core practices have not changed. We bring the same thoughtful, rigorous, creative, and disciplined approach to underwriting, structuring, and servicing our loans that we always have. We still focus on financing best sponsors and product.
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What are the top three trends impacting multifamily construction financing as of now?
Moran: Construction costs and interest rates are rising at a pace that has not been experienced in decades, which is, in part, a result of the Federal Reserve’s policies, supply chain issues that resulted from COVID-19 and, recently, significant geopolitical issues and concerns that have intensified and impacted not only the relations among countries but also the U.S. and world economies.
Today, it appears we have two negotiations with respect to loan sizing: first, term sheet execution and, again, after the sponsor receives the bid and construction budget from the general contractor. The impact these increases will have on construction volume going forward is yet to be seen. Sponsors and developers are grappling with these issues, but nevertheless continue to pursue planning of new projects. Our sponsors are typically very well capitalized and can absorb the additional equity required to cover these cost increases.
While certainly not a new trend, government regulation remains one of the most impactful. As population and employment growth continues disproportionately in the South, Southeast and Southwest in large part due to more favorable regulatory, tax and cost of living factors, the dynamics supporting new construction and institutional investment will continue.
Capital flows into alternative commercial real estate asset classes, such as single-family BTR, life sciences buildings, and cold storage and refrigerated warehousing, is another key trend.
Do you expect borrowing costs to rise significantly this year?
Moran: As interest rates increase, borrower interest costs increase. Rising land costs and construction costs directly affect the overall cost of projects. All of this directly impacts equity investor returns. If costs rise, but rents and other revenues do not keep pace, then the equity investors may not be able to achieve their desired IRRs or multiples, which could affect whether deals move forward or are shelved. While banks may help absorb a portion of increasing costs, often the sponsor will need to raise additional equity or other subordinate financing.
For projects that are under construction, the interest rate allocations and holdbacks will be under pressure. Going forward, lenders will pay special attention to how debt service is going to get paid as the holdbacks and allocations are exhausted more rapidly.
Keep an eye on cap rates! We are hearing antidotal evidence of moderate cap rates increases. As interest rates rise, sales transaction volume could slow as sellers and buyers adjust expectations.
The Federal Housing Finance Agency has increased the 2022 multifamily lending purchase caps for Fannie Mae and Freddie Mac by $8 billion each. What does this mean for Bank OZK?
Moran: As mentioned, we predominantly finance construction projects. As such, an essential part of our diligence in underwriting transactions includes an analysis of various ways in which a borrower may repay the loan. Given Fannie’s and Freddie’s dominant market share of the multifamily permanent loan market, having more liquidity provided by them is an undeniable positive. It certainly helps in keeping up with inflation and the significant increase in multifamily valuations that has occurred over the past years.
You’ve closed several high-profile loans in the past year, including $800 million for a 69-story condominium high-rise in Manhattan’s Upper West Side and $410 million for a mixed-use tower at 520 Fifth Ave. in New York’s Midtown submarket. What is attracting you to the Manhattan multifamily market?
Moran: While multifamily suffered significantly in Manhattan during COVID-19, as in most major cities, rents and occupancy have come back very quickly and are generally exceeding pre-pandemic levels. Given the historic stability of the asset class, it is a highly competitive market, especially for the high-end projects we target.
While we will continue to target multifamily deals in Manhattan, we will stick to our leverage and return targets. Having said that, over the nine years that our New York City office has been open, we have not financed a stand-alone multifamily construction/conversion deal in Manhattan. This was not by design but a result of leverage/pricing not meeting our standards.
We have financed a handful of Manhattan projects, which included multifamily as part of a larger mixed-use asset offering. However, almost all of our multifamily origination in the New York City area has come from the boroughs and Jersey City. We will continue to be active in the boroughs and seek to do more in Manhattan.
How will recent migration patterns affect the multifamily business the remainder of 2022 and beyond?
Moran: The South, Southeast and Southwest will continue to attract people and investment capital at a faster growth rate compared to the rest of the U.S. (But) Dense urban areas hit hard by COVID-19 and mask mandates are showing steady evidence of recovery. Residents that moved away during COVID-19 could be lured back by the amenities and energy that attracted them to the urban setting pre-pandemic. People may want to return to new, amenity-rich buildings that are closer to work as offices continue to open.