Key Factors Lenders Are Considering Now: Q&A
Michael Pop, managing director at Basis Investment Group, on how lessons learned from 2020 will impact the capital markets going forward.
The capital markets have consistently adjusted to the shifting economic context, but multifamily lending maintained its steam last year and in the first quarter of 2021.
“We have noticed a large uptick in acquisition activity, as expected,” noted Michael Pop, managing director & co-head of production at Basis Investment Group. “We predict this will continue to pick up throughout the year.”
In the interview below, Pop discusses how COVID-19 has altered underwriting standards and the critical elements lenders are keeping a close eye on when evaluating potential deals.
At this point in the economic cycle, what are some of the dynamics impacting multifamily lending activity?
Pop: The main factor at the top of everyone’s mind is interest rates. We are in the midst of a very volatile time with rising interest rates, which have a direct impact on borrowing ability. As interest rates rise, it affects the underwritten debt service coverage ratio and, thus, has the potential to lower the proceed levels that borrowers can obtain. This decrease in borrowing ability usually means that asset prices must come down, which we are monitoring actively. As of today, cap rates are still very tight, so we have not seen the typical reduction in asset prices as interest rates rise.
Another main factor that we are monitoring is the dry powder that has been sitting on the sidelines during the pandemic. In 2020, refinances made up a large majority of business, given the historically low interest rates and lack of acquisition activity.
Now, with the vaccine rollout and the improving economy, we are already seeing increased acquisition activity. Buyers were largely on the sidelines for the past year given the uncertainty in the market, difficulty of viewing assets, etc. We are now seeing increased consumer confidence—buyers can view assets much easier and investment funds also need to put out capital. These factors will likely result in more balanced refinance/acquisition activity in the months to come.
How are lenders approaching new opportunities?
Pop: Lenders have learned a lot during this past year and have incorporated a few key elements in their analysis of new deals. For example, when looking at refinances—specifically cash-out refinances—lenders are typically adding on some form of increased minimum debt service coverage ratio threshold and limiting large cash-outs in situations in which the length of ownership is limited.
For acquisitions, lenders are wanting the sponsorship to meet increased experience standards. This increase in experience standards typically includes a greater number of multifamily properties owned. Lenders are now focusing on sponsors that are local to the subject asset’s market and have learned that experience is critical in times such as these. The ability to find ways to assist tenants who may be experiencing financial trouble from the pandemic and working out payment plans is essential. The ability to deal with the various government orders related to COVID-19 is also key.
Historical operating performance is another key element that lenders are considering when evaluating potential deals. Certain markets have experienced greater softening than others and focusing on historical data is readily apparent in new lease-up deals. Lenders want to see that the property is able to maintain those collection amounts prior to underwriting them.
Can you tell us about the current focus of Basis’ portfolio?
Pop: On the origination side of our business, construction/development mezzanine financing has been popular, particularly in the more affordable housing sectors of non-gateway cities. Timing-wise, these new construction projects will come online after COVID-19, reducing market risk. Throughout the crisis, we have been most focused on workforce housing in non-gateway cities, as well as grocery/drugstore-anchored shopping centers in strong retail markets.
On the asset management side, as mentioned, we have seen a demand for preferred equity to bridge financing gaps and set up additional reserves during the pandemic. At the start of the pandemic, we launched our “BIG Rescue” program to provide rescue equity to certain borrowers within our fund. The program enabled owners to spend their time, energy and capital resources on property operations and allowed them to stay current on their commitments.
Please tell us about Basis Investment Group’s strategy since the onset of the pandemic. What have you focused on more and what have you chosen to hit pause on?
Pop: At Basis, we are a multi-strategy lender that invests across the capital stack, which has allowed us to remain active during the pandemic. At the onset of the pandemic, we became extremely focused and active on our agency offerings. As traditional bank lending sources hit the pause button throughout the spring and summer of 2020, it was largely the agencies that came in to fill the void and maintain liquidity in the market. We were very active in our Freddie Mac Small Balance Program.
How has the company’s small balance loan program performed?
Pop: Our small balance loan program performed very well throughout 2020. This program offers financing solutions for loan amounts between $1 million and $7.5 million, and it was this group of borrowers that were impacted most heavily by the temporary pause of traditional lending institutions. These borrowers didn’t have the big balance sheets and relationships to obtain traditional bank financing during the pandemic. Freddie Mac and Fannie Mae’s mission is to provide affordable housing, and therefore, in times of crisis when traditional lending sources hit the pause button, we can come in and provide the necessary liquidity to borrowers’ that own smaller affordable multifamily properties.
One of the great aspects of our Freddie Mac Small Balance Program is that we are a national platform. Therefore, we have the ability to serve borrowers throughout the country. Moving into 2021, we have experienced a robust first quarter. Specifically, we have noticed a large uptick in acquisition activity, as expected. We predict this will continue to pick up throughout the year.
What are you looking for in a small loan borrower?
Pop: In the current economic climate, we are looking for borrowers to have increased experience and/or length of ownership in their properties. For example, for acquisition deals, we are aiming for borrowers that have multiple multifamily properties already in their portfolios.
However, this is not a hard-set rule, but rather a general parameter. As the market continues to adjust for us, the idea behind the increased experience is that in times such as these, management of the asset is much more intensive—borrowers may run into more issues with tenants than in past years, so that is a precaution that we see fit at the time. At Basis, we have been closing deals all over the country, most recently with multifamily owners in Michigan and Texas.