A healthy economy and a growing roster of capital providers looking for returns means high-leverage non-recourse financing is not only available, it’s a thriving subsector within the capital markets.
After nearly vanishing during the recession and the early years of the recovery, demand from high-leverage finance providers for multifamily projects that include either ground-up development or transitional, value-added business plans is strong.
Of late, deals we have solicited and closed have seen loan-to-cost ratios regularly hit or exceed 80 percent and have received multiple bids. These deals include both traditional multifamily and non-traditional deals, such as ground-up co-living requests and also single-family build-to-rent requests.
For example, recent closings include an 80 percent loan-to-cost, non-recourse, cash-out bridge financing on a 200-unit multifamily property, and an 80 percent loan-to-cost, non-recourse, ground-up construction loan for a 270-unit student housing development with nearly 900 beds. Notably, both closings were in secondary, non-core markets.
Favored Class Status
Multifamily developers and investors enjoy favored class status from high leverage financiers due to the resiliency the asset class demonstrated throughout the past economic cycle and housing shortages in many markets nationwide.
Typically, the multifamily deals attracting high leverage non-recourse financing are from entrepreneurial sponsors doing institutional-level deals. These are often mid-rise projects with equity partners that are either family offices or syndications, as opposed to institutional limited partners who will usually cap leverage at approximately 65 percent loan to cost.
While high leverage loans carry more risk, they also offer more reward. Less equity is required, and the return on equity can be substantially higher as a result.
The trade-off can also be seen through the prism of loan pricing. For full leverage requests of 80 percent or more, pricing ranges from 400 to 600 basis points over the one-month LIBOR rate, which is significantly cheaper than the cost of equity capital. For bridge loan deals at the same leverage ratio, spreads range from 250 to 350 basis points over the one-month LIBOR rate. While there is still a gap on non-recourse construction spreads vs. traditional recourse bank financing, the spreads on non-recourse bridge loans have compressed considerably and are often competitive with bank financings that could include some level of recourse.
Variables that will affect pricing include leverage level, debt yield, the location and strength of the sponsor and the associated business plan.
As with lower-leveraged loans, high-leveraged financing are secured by the property itself and the standard non-recourse guarantees (completion, carve-out and carry) generally apply. Sponsors should have an expert on their team who can verify there are no surprises in the loan terms. That expert can be a capital market advisor, who can also craft a marketing strategy that is likely to get the attention of multiple high leverage capital providers to ensure a competitive bidding process and also ensure a smooth and successful execution.
Due Diligence Requirements
To best position a loan request, advisors will often recommend and facilitate a market study or appraisal, a clear description of the location and its demand drivers, a high-quality Excel model, a detailed representation of the sales and rent comparables and will need to provide information about the non-recourse guarantors’ track record and experience.
When hiring a capital market advisor, make sure to ask about their experience with all of these details, the depth of their contacts and about their success rate.
With the economy expected to remain strong and interest rates low for the foreseeable future, the outlook for securing high-leverage loans is good for quality sponsors. Assembling the right team to design and present the loan request is still essential, though.
Also, ensure that your team keeps an eye on market threats that could affect consumer confidence and, therefore, capital markets. Currently, those threats could include the Coronavirus as well as trade tariffs and tensions.
Zachary Streit is senior vice president at George Smith Partners’ Davies Group, a capital market services provider.