Construction Financing Gets Harder to Come By
Loans for new apartment projects have been a slam dunk for lenders for nearly the past decade, but there is a new sense of caution developers should be aware of, according to Nicholas Minoia of Diversifed Properties LLC.
We’ve come a long way since the Great Recession and the market for multifamily construction financing has been flourishing for the past eight to 10 years. In fact, the lending market exploded in recent years as the demand for multifamily housing in major metro markets across the country opened wide and has continued to expand.
It seems that every lender was hoping to capture its share of the lucrative construction lending sector, and as such wanted to put multifamily construction loans on their balance sheets. Baby boomers and empty nesters fueled the demand for luxury rentals over condos and single-family homes—good news for developers, no question. But as it turns out now, the caution light is on and it’s caused an unforeseen issue for lenders.
As a result of the extraordinary demand for upscale multifamily rental housing, construction lenders now find themselves with balance sheets that are over-weighted with multifamily loans. While this might not be a problem for these institutions philosophically, the regulatory environment is changing. Bank examiners and regulators are now expressing concern about those overbalanced portfolios, which may be a red flag signaling trouble on the horizon.
Regulating the balance sheets
Unlike eight or 10 years ago, regulators are now calling for more diversification of lending portfolios at commercial banks. Although construction lenders in the multifamily market are still very active, this has caused a shift in terms of underwriting new loans. Today, we’re seeing that only those sponsors with the most significant, long-term track records and the best locations are garnering the right attention from construction lenders. As banks work on rebalancing their portfolios, they are looking to increase their C&I lending and limit their multifamily loans to seasoned developers with solid teams and well-positioned properties.
Making the Cut
Developers beware: If you’re working in the multifamily rental space, sharpen your pencils and prepare for a higher level of scrutiny than in years past. Given that the lending market has become more competitive, today’s multifamily developers must have:
- A very strong track record with an excellent team (construction, leasing, marketing, property management)
- The ability to show strong demand and project feasibility
- High-quality design and in-demand amenities
- Rents that are consistent with prevailing market rates and market conditions.Developers will also need the right location. With lenders looking to lower risk and thin out their construction portfolio, this is not the time to be a pioneer out to settle the outer geographic bands of a major metro market (in the case of my company, that’s New York City). The further out you go, the less focus you’ll get from lenders. Stay close to the core and be in a market where the lenders want to be—and where they know they’ll have strong absorption.Access and proximity to public transportation is also key to strong rents and high demand. Tertiary submarkets, like the New Jersey shore towns, that are within close proximity to metro New York and Philadelphia are seeing unprecedented multifamily growth as strong demand continues for both primary and secondary rental residences.
That said, be aware that certain markets are overheated while others are still hot . . . and others are simply the wrong location. They’re too far out from the major metro core, without strong public transportation or quality dining and shopping. A word of advice to new players in the multifamily game: remember that having the site and getting the zoning doesn’t mean you’ll get the financing.
Although the recent drop in interest rates has stimulated increased demand for rentals, lenders are still concerned about diversifying their loan portfolios with the right mix of projects, sponsors and asset classes. A multifamily project in the right location, from the right sponsor who’s worked the numbers and understands what it takes to make the cut, will reach the top of that narrowing lending pyramid.
Nicholas Minoia is the principal and founder of Diversified Properties LLC and its affiliate, DP Property Management LLC, based in Montville, N.J.