The multifamily lending market has remained the most resilient throughout the pandemic, particularly due to Fannie Mae and Freddie Mac, which have continued to provide liquidity. While alternative lenders, including debt funds, finance companies and mortgage REITs, pulled back dramatically early on, many are back in the market and competing for borrowers in need of construction and bridge loans.
“Probably about a third to a half (of alternative lenders) are actually back in the market,” according to Brad Gries, U.S. head of acquisitions for LaSalle Investment Management. The remainder of these lenders “may say they’re back but they’re sort of pretending. They’re looking at deals, but they’re sort of pricing themselves out of the market.”
Like the government-sponsored enterprises, many regional banks have remained active, providing transition loans that see borrowers through asset stabilization on the way to permanent financing, making it even more difficult for debt funds to compete, Gries explained. So far, LaSalle has not sourced any of its capital needs with debt funds since the onset of the pandemic, with most deals going to life companies or the agencies because of cheaper capital.
Richard Henry, senior director in Cushman & Wakefield’s Equity, Debt & Structured Finance practice said, “We’ve seen a bit of an uneven recovery from (alternative) lenders depending on how they generate their levered of returns.”
Case in point: Dan Palmier, founder & CEO of UC Funds—which is privately financed by family offices and wealthy individuals and has closed 18 to 20 multifamily deals during the health crisis—said his company’s 10th year in business amid a health crisis could have been its worst but instead has been its best.
“We actually look at the COVID-19 world—a downturn—as an easier underwriting exercise than a very bland market because we were staring the enemy in the proverbial face and we know where the downside is and we can see post-COVID-19 where there can be significant upside in transactions, so underwriting really has not changed much,” Palmier said. The only exception may be an analysis of the tenancy and taking into account properties that are dependent on hospitality or airline workers who may be economically challenged.
Of the deals underwritten during COVID-19, Palmier said 65 percent to 75 percent came from opportunities in the multifamily sector where the lender stopped funding construction loans on development projects that were anywhere from 20 percent to 95 percent built. “It was very opportunistic for us that we had capital,” Palmier explained.
Market fundamentals have also been influenced by the pandemic: Henry said that while new leasing has slowed, renewal rates have gone up “substantially” over the same period. “We’ve seen a lot of developers who are looking to still figure out how to sell their assets and meet their exit timing and get off of their construction financing.”
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That situation, in turn, bodes well for lenders who are sitting on the same amount of capital to deploy as they were before the pandemic; only now, there’s a “more focused strike zone,” Henry said. Experts agree that multifamily and industrial will continue to be the favored asset classes and that because of the liquidity in the market, we’re unlikely to see “widespread” defaults in the multifamily arena, especially given the country’s serious affordable housing shortage.
Electra Capital, a bridge lender in the multifamily space that launched in February, a month before the pandemic hit, has so far closed 10 transactions valued at close to $200 million. Entering the market at the onset of the pandemic with no legacy assets to manage and money raised in Israel, the company was positioned to “break through” when many of its competitors were pulling back. The alternative lender offers up to 85 percent on a stretch bridge loan, mezzanine debt, or a preferred equity investment behind a senior loan.
“In all of our deals, we structure in a reserve just in case something unexpected happens,” said Samuel Greenblatt, president & CEO of Electra. For example, in February, Electra invested in a nonstudent housing multifamily deal near the main campus of the University of North Carolina in Chapel Hill, which shut down, posing potential occupancy challenges when people went home.
“The reserve helped augment the cash flow from the property in order to keep the preferred return payments current,” Greenblatt said. The reserves have been “very fortuitous in keeping the investment in decent shape.” Greenblatt said Electra looks at every deal differently and reserves vary on a case-by-case basis, ranging from three months to two years’ worth.
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The company doesn’t do construction financing, though it took out an existing construction loan in October on Four West Las Olas, Elevate Partners’ new luxury apartment tower in downtown Fort Lauderdale, Fla. Electra Capital brought in Benefit Street Partners Realty Trust, a public nontraded mortgage REIT, to provide the senior mortgage of $76 million, while Electra Capital retained a $16 million mezzanine loan.
Though the property was only 58 percent leased, Electra was willing to make the bet because it seeks experienced sponsors with successful track records with whom it can build relationships. The boutique lender’s due diligence also includes lease audits by third-party companies through which it looks at 100 percent of leases, matches them with the rent rolls, and then further reviews the credit file to see if the income can support the tenants.
Joseph Iacono, CEO of commercial real estate alternative lender Crescit Capital Strategies, said his firm offers more flexible structures on transactions and fast response to borrowers with the ability to close in 30 to 45 days, whether on acquisitions or maturities in need of refinancing.
On acquisitions, Crescit can go as high as 85 percent of cost, though typically that debt level is reserved for properties with turnaround situations and discounted payoffs. “So we’re hoping that values are going to be over time much lower than that—that’s the whole play,” Iacono explained. “Once the property is stabilized, that will be closer to 65 percent to 70 percent of value.”
For example, Crescit closed on a $17 million loan for a 333-unit property that was acquired as the result of prior ownership dysfunction during the pandemic. There was $1.5 million in capital expenditures needed to rehab a fair number of units in a property that was just 60 percent to 70 percent occupied, meaning it would not qualify for agency financing. The loan-to-cost was about 80 percent on a three-year loan, with the cost of capital in the low fours.
Iacono agrees with other alternative lenders when it comes to quality sponsors, especially in such a challenging market. “Experience today matters more than it used to,” he said, adding that most of Crescit’s deals are nonrecourse, with the company looking closely at a sponsor’s ability to carry an asset if things go wrong.
With so little acquisition activity and so much dry powder seeking multifamily deals, however, deploying capital may require creativity in the multifamily space, such as the idea of looking at converting hotels. Similarly, though Crescit’s due diligence is more heightened and in the current environment may require additional reserves, it continues to pursue multifamily assets.
The lower cost of capital
Shahin Yazdi, principal & managing director of mortgage broker George Smith Partners, said that the cost of capital has come down dramatically in a matter of a few months. “Pricing was much lower pre-pandemic, but LIBOR was also higher so, in some ways, it’s a little bit of a wash,” he explained. “Pre-pandemic, we would do deals at LIBOR plus 250 (basis points), with a LIBOR floor of 1 percent, and now we’re doing deals—and this is the best quote we’re getting—at LIBOR plus 375 (basis points) with a LIBOR floor of a quarter percent. When the pandemic first hit, that same deal was LIBOR plus 550 or 600, with a floor of 1 percent.”
George Smith Partners has been active in the multifamily construction lending space during the pandemic. Perhaps the most pandemic-related deal took place in mid-October, when the mortgage broker secured a $14.1 million construction loan in Hollywood’s Opportunity Zone for an 86-micro unit co-living project, which Yazdi called the “evolution of the asset class.”