All of a sudden, it feels almost like 2006 redux: The financing market is seeing a lot of money and too few deals.
The good news for multifamily borrowers is that as the major lenders return to the sector, owners and developers seeking acquisition, refinancing or rehabilitation financing will be in a stronger position.
The reasons for increased capital inflow are various. Debt sources are confident about the economy. In the low-interest environment, capital is looking aggressively for the higher yields afforded by debt investments. At the same time, apartments are a preferred property type—and the only commercial real estate sector with strongly improving fundamentals. These circumstances have one effect on financing realities: increased competition among capital sources for deals—at least the best ones.
“I would say it is beginning to feel more like a borrower’s market. There is a tremendous amount of capital chasing deals,” says John Brownlee, senior managing director of HFF (Holliday Fenoglio Fowler). “There is more capital chasing deals than there are products to satisfy that capital. If it is the right deal with a great sponsor and the deal underwrites, there is a lot of competition for that deal…I won’t call it a feeding frenzy, but it is becoming very competitive.”
The re-entry of CMBS, life insurance companies and banks will mean more competition for Fannie Mae and Freddie Mac, as well as Federal Housing Administration (FHA)-insured financing, which have dominated and held up the multifamily market through the recession. Indeed, the Mortgage Bankers Association’s (MBA) latest survey indicates that the GSEs’ market share has fallen significantly, from the low-80 percent to the mid-50 percent range by the end of last year, says Jamie Woodwell, MBA vice president, Commercial Real Estate Research.
The drivers of debt capital
Overall numbers show an undeniable ramp up in financing, particularly in the fourth quarter. Multifamily loan originations increased by 81 percent in the last three months of last year compared to the same period in 2009, according to preliminary data from the MBA. MBA reports huge increases in overall commercial real estate financing in the fourth quarter, when total commercial and multifamily loan originations gained 36 percent to reach an annual total of $110 billion from a year ago.
“Looking across the different investor groups, assuming they keep up the pace, we would
expect to see more production in 2011 versus 2010,”
The big drivers behind greater capital availability and a more competitive environment for multi-housing financing are three players who are now back: CMBS, life insurance companies, and, to a limited extent, banks. Some of these entities were practically out of the market not so long ago.
CMBS is the big elephant in the room. The mortgage securitization markets have returned from the dead, and investment banks, commercial banks and other finance players have been busy hiring and putting together CMBS originations shops. The number of CMBS direct-lending outfits has increased from a handful a year ago to about 20 players currently, according to anecdotal estimates.
In 2010, CMBS issuance was $11.6 billion, compared to a high of $730 billion in issuance at the peak of the CMBS market. CMBS issuance is forecasted by Moody’s to total $37 billion in 2011. And, according to preliminary MBA numbers, CMBS originations saw a big increase in the fourth quarter, when it spiked by a whopping 6,000-plus percent, compared to the year before.
These CMBS shops are possibly feeling a pressure to put out money, increasing the level of competition in the financing marketplace among lenders. “What is going on in the CMBS market, with over 20 players created, is going to create a lot of liquidity in multifamily and real estate food groups,” observes Ron Davis, vice president at Johnson Capital.
Life insurance companies are also said to be increasing their allocations for commercial real estate, particularly multifamily, or at least holding steady their levels of investments from last year. Financing by life companies increased by 170 percent in the fourth quarter from a year ago, according to preliminary MBA numbers.
And many banks, meanwhile, are said to be cleaning up their balance sheets and getting into better positions to lend again. Loans originated for commercial bank portfolios fell 25 percent in the fourth quarter, though the originations increased by 102 percent when compared to the third quarter. “The banks are back and active,” confirms Paul Decain, chief investment officer and principal at Bainbridge Companies. “They are open for business for sure.”
That apartment market fundamentals rebounded very strongly in 2010 is not lost on these debt capital sources. At the end of 2009, the national vacancy rate was 8 percent; by the end of 2010, it had dropped markedly to 6.6 percent, according to data from Reis Inc. Over that period, asking rents climbed by 1.6 percent, and effective rents by 2.3 percent. This year will likely see continued strengthening of the apartment market as apartment demand is likely to outstrip supply, says Ryan Severino, senior economist at Reis.
“As we go through 2010, fundamentals will continue to get stronger, which should open the pocketbooks of lenders in a lot of markets,” he observes.
Bainbridge’s Decain sees a financing market that is currently in equilibrium with respect to the supply of, and demand for, capital. There is not an “overwhelming amount of capital,” nor is there an inadequate supply,” says Decain. “There is adequate capital available for all these situations—acquisitions, refinancing and rehabilitation.”
Consequences of having more lenders
One implication of the entrance of additional players is that borrowers will receive more bids for their transactions. Barring unforeseen circumstances, it is likely to become more of a borrower’s market in six to eight months’ time, when “you pick up the phone and get five to six quotes,” says Davis. “The situation is changing in that direction. There are too many guys stepping into the market.”
The caveat is the fact that the capital is still available primarily for the best quality deals, and the top consideration of debt capital may still be the reliability of sponsors. “Class A and solid B-plus assets with good sponsorships-—that is typically where the capital sources play,” says Brownlee. Twenty- to 30-year-old, Class B-minus and Class C garden-style apartments in tertiary markets remain difficult to finance as capital sources are still relatively risk-averse this early in the real estate cycle.
Plus, these are properties that may not have seen upticks in occupancies yet, in contrast to their Class A counterparts, and may require significant capital investments, notes Davis.
But the situation may be fast changing. CMBS may be beginning to inject money into some of the assets that were considered less desirable in the past few years. Fannie Mae and Freddie Mac have always been focused on Class A and solid-Class B properties, with the insurance companies focused on institutional quality apartments.
CMBS originators are simply unable to compete with Fannie Mae and Freddie Mac on such high-quality properties on LTV and interest rates. “Class A transactions in A locations with A sponsorships” will go to the GSEs, says Davis. However, conduits can go down the quality scale and up the risk curve a little. “CMBS today can finance the Class B or Class B-minus properties that, for some reason, Fannie and Freddie do not make.”
As a part of the trend of increased capital availability, rehabilitation financing has also begun to return to the market. Federal Housing Administration (FHA)-insured financing has always been available from the government through this recession. Overall FHA financing gained dramatically in volume in the last two years. But now, some banks are becoming active again in making acquisition/rehabilitation dollars available, although at recourse. Decain says banks of various sizes are participating.
Despite the entry of additional capital sources into the market, borrowers may not be able to expect any loosening in underwriting criteria at this stage. For Davis, that is the reason multifamily financing remains a lender’s market. “Borrowers have more options, but lenders are not placing in exaggerated assumptions,” says Davis. Indeed, at a press conference at a recent MBA convention, Fannie Mae Executive Vice President of Multifamily Ken Bacon affirms that the GSE will not be adjusting its LTV in response to the increased competition or improved multifamily fundamentals.
Currently, the maximum LTV made by GSE lenders is 70 percent to 75 percent, on the best properties, says Davis, and interest rates range from 4 percent to 5 percent. In contrast to the agencies’ low interest rates, conduits have a floor in their interest rates of 6 percent, and leverage of up to 60 percent to 70 percent LTV. “Conduits are being very realistic,” says Davis. Life companies offer even lower maximum LTV, of up to 60 percent, and interest rates are 4.5 percent to 5 percent or lower for the right deal.
Banks will provide 60 percent to 70 percent LTV on the capital stack for the acquisition/rehabilitation transaction, says Decain, but the financing is available only for the larger developers and is backed by “very rigorous” underwriting of all related metrics, such as rent rolls and condition of property. Meanwhile, FHA underwriting has also not relaxed and, for market-rate properties, has been tightened by HUD in the last year, with maximum allowable LTV falling from 90 percent to 85 percent.
All the same, multifamily borrowers may be finding that a borrower’s market is materializing very quickly. “That’s what always happens,” says Decain. “As conditions improve, almost assuredly more capital comes to the system.” Lenders are looking to place their capital in order to obtain yields. “Everyone is competing in the same arena, for the same deals, leading to lower yields,” notes Davis. To win transactions, lenders may start offering more favorable terms, and to obtain higher yields, they may start to inch up the risk-reward spectrum.
To comment, email [email protected]