How Banks Are Recalibrating Multifamily Lending Strategies

As interest rates continue to rise, multifamily investors have to be more creative to secure financing at palatable terms. To find out how much lenders have changed their approach to commercial real estate and which multifamily deals have the best chance of being financed today, Multi-Housing News reached out to Steven Caligor, executive vice president & head of real estate and health care for commercial bank BHI, the U.S. division of Bank Hapoalim.

How did the latest interest rate increase modify BHI’s lending strategy for the next 12 months?

Caligor: We have always been a common sense lender, focused on moderate leverage, cash flow and quality sponsors. That will always be our core lending profile. However, as rates soared over the year, we enhanced a few elements in our origination and underwriting.

These include: greater “stress testing” of the debt service coverage ratio (DCSR) during the loan term and the exit value to ensure a successful exit at maturity; additional reserves—interest or construction carry costs—incorporating the forward yield curve; requesting more frequent construction budget updates; resizing or decreasing the loan proceeds in cases where increased interest rates have limited debt service capacity; and shortening loan terms to avoid locking in fixed rates for a prolonged period and/or offering sponsors a floating rate pricing option.

The sponsor becomes a primary lending focus in terms of reputation, experience and liquidity. At times, we will request increased guarantees at the loan onset that will reduce as the project progresses and certain conditions are met. In recessionary times, there tends to be a “flight to quality.”

In terms of asset classes, we are focusing on stabilized properties in residential and industrial sectors, construction of residential multifamily, hospitality and mixed-use properties and bridge facilities with light value-add projects.

Federal Reserve Chair Powell predicts an economic slowdown and an increase in unemployment to a level usually associated with a recession. What is your economic forecast?

Caligor: I do foresee recessionary trends forthcoming based on the interest rate situation and increased cost of living. However, I am not sure unemployment will be at past levels of recessionary times. The economy has already begun to ebb slightly yet demand for basic services remains strong which may support employment in many industries. While companies may reduce the workforce, it may not be homogenous across all industries.

Powell has also indicated a housing market correction is in the horizon. How does this impact BHI’s evaluation of multifamily properties and deals it decides to finance?

Caligor: We will stick to primary and proven areas of densely populated residential markets and limit transactions in tertiary submarkets. This strategy allows us to avoid entering transient marketplaces or new population trends in certain states.

We focus on major metropolitan or well-established suburban markets with strong long-term drivers of multifamily, such as proximity to major business markets, ease of transportation, upscale amenities and thriving neighborhoods offering lifestyle amenities—i.e. shopping, outdoor space, restaurants, education and entertainment.

We evaluate the project based on sponsor liquidity, the project’s loan-to-value and loan-to-cost, debt service capacity, and equally assess the feasibility of “the exit.” Specifically, at maturity, will there be a financing gap and what is the probability of a successful exit with full refinancing?  We aggressively sensitize projected market rents or future sales prices in the exit analysis.

We follow the trends that carried over from COVID-19 that increase the project’s long-term marketability, such as home office space, parking, neighborhood amenities, play spaces, recreational rooms, grilling areas, gyms and pools, movie rooms, rooftops, etc.

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What can you tell us about current demand for debt from multifamily investors/owners?

Caligor: We have clearly seen a downturn in deal submittals due to three major factors. First is the rate environment, which impacts the investor cash-on-cash return, increases carry cost, and can reduce loan proceeds to conform with certain industry DCSR. Second is the recent expiration of the 421-a, which impacts the tax incentives that used to accompany this product. Third are increases in basic operating expenses—boilers, new elevator regulations etc.—that can outpace rent increases.

We have also seen non-bank lenders use mezzanine debt or B Notes to enter the multifamily space to fill gaps in the debt stack as many banks have curtailed advance rates or increased personal guaranty levels. While this creates activity in the marketplace, it can also stress the property as combined interest carry costs are increased in this scenario.

How do you expect demand for this type of credit to change in the year ahead?

Caligor: I believe we will see more construction of new higher-end multifamily products in both major cities as well as suburban areas within close proximity to primary markets. As to NYC, we already see robust construction activity in locations such as Westchester, Jersey City and Queens, to mention a few markets.

The prior hyper demand for stabilized properties may decrease as valuations reduce given the expense loads. For sponsors, the goal is to attract residents who may have purchased a house versus rent in prior periods and to attract those long-term renters who have either up-scaled, seek ease of living or to live in close proximity to work, education or transportation.

Name three things borrowers should know about multifamily financing in the last quarter of 2022 and heading into 2023.

Caligor: Be prepared for increased pricing, possibly lower proceeds and higher reserves or personal guarantees. Discuss your long-term plans and exit strategy upfront with your lender. Expect that construction plans and budgets will be reviewed closely.

Some experts say that the best deals happen during slowdowns or market disruptions. Do you agree?

Caligor: In down times, there are opportunities for long-term investments for sponsors with liquidity and who have prior experience in economic downturns. These tend to be the more stable sponsors who have scale of operations and infrastructure already in place. We will see many “generational” transactions with established players seeking to convert older properties into new uses and adding mixed-use components—grocery, medical, light retail, etc.

We are staying close to our existing relationships and also procuring new best-in-class sponsors as other banks begin to reach lending limits resulting from recent consolidations or mergers.

Can you give us some examples of the types of loans BHI is financing these days?

Caligor: Some of our recent transactions have involved financing for multifamily projects in Jersey City, Harlem and Yonkers. We provided a $25 million post-construction bridge loan for a 110-unit project in Jersey City; a $57 million construction loan for a transit-oriented multifamily development with 160 units on 126th Street; and a $62 million construction loan for a development in Yonkers with 180 units. All three are located in high-growth or up-and-coming areas, which is critical for today’s lending landscape. The development in Yonkers, where we have financed multiple phases, is also a high-end project with the kind of amenities and outdoor space which are very desirable in attracting new tenants.

Steven Caligor is executive vice president and head of Real Estate & Healthcare for the commercial bank BHI, the U.S. division of Bank Hapoalim. Bank Hapoalim provides its clients access to a broad array of products and services available through its bank and non-bank affiliates. Not all products and services are provided by all affiliates or are available at all locations. All credit products are subject to credit approval. Nothing contained herein should be construed as a commitment to lend by BHI or any of its affiliates. The matters discussed herein express the personal views of Mr. Caligor and are not necessarily those of BHI or its affiliates.