MHN Asks…About Financing
What are the challenges and opportunities in multifamily financing? Experts weigh in.
What are the biggest challenges and opportunities in multifamily financing at this point?
Stuart Zook, principal, Monument Capital Management
❝The obvious challenge is that interest rates have risen without a corresponding increase in cap rates. The spread between the two has narrowed considerably. However, the thirst for yield is so strong that some investors are willing to accept a lower current yield. If other investments such as the stock market remain volatile, this is not going to change. I think it would be helpful if the number of options for multifamily permanent financing increased, thus creating some competition. Currently so much of this market is dominated by the GSEs so they can pretty much set their terms as they see fit. This has occurred on the Bridge lending side and we have seen more aggressive terms as a result. Some of the newer players have elected to try to “buy” market share creating a mild bidding war for strong borrowers.
On the new construction side, we are seeing a whole new group of lenders including debt funds enter the market. While good for competition, the challenge here is to sort out which of the terms best fits the project. New products seem to be coming out all the time and it can be overwhelming as to which one to choose. In addition, many of these new lenders have a small track record and it can be difficult to gauge how they will administer the loan.❞
Bryan Sullivan, senior vice president, The Habitat Co.
❝Investors and developers see great opportunity as they continue having access to multiple solutions for financing requirements. Traditional senior lenders are competing aggressively while maintaining loan-to-value discipline and structured debt facilities have reduced pricing over the past 12-24 months meeting the market with attractive mezzanine and preferred equity options. Lenders are getting more creative with offerings to meet borrowers’ need for flexibility and structure. Despite watching the Fed raise interest rates twice this year, one challenge is the all-in cost of debt which has only risen nominally, as lenders reined in their spreads over the chosen index.
As the Fed seems poised to whack rates two more times in 2018, lenders will struggle to absorb the increase through continued spread compression. Borrowers will likely see a more material increase in financing costs. Intuitively, investors anticipate relief from the higher debt costs through lower property valuations. Unfortunately, in the recent rising interest rate environments, cap rates have not moved in a linear fashion with interest rates. As a result, buyers have absorbed the higher debt costs with corresponding lower returns. In cases where buyers have resisted sellers’ price expectations (i.e., Core Investments), valuations did not reconcile and countless deals have been taken off the market.❞
Steve Rappin, president, Evergreen Real Estate Group
❝For senior housing, the biggest financing challenges are underwriting construction costs and real estate taxes. Our new developments have seen sharp increases in construction costs on a month-by-month basis, making it difficult to lock in on a final cost. Additionally, in Chicago/Cook County, the assessor recently treated assisted living/memory care senior living facilities similarly to hotels from a tax standpoint, which threatens to double real estate tax. This is currently being challenged, but in the meantime creates uncertainty in financial modeling and loan sizing. Affordable housing has the same construction cost challenges, but also faces a scarcity of “soft” funds (grants/loans) that used to be available via federal and state sources.❞
Bernard Werner, president & COO, Metropica Development
❝We are seeing strong growth in the multifamily sector and some markets are seeing several new ground-up deliveries of competitive projects. This presents underwriting challenges for lenders in that absorption periods are being extended and concessions offered to prospective tenants are higher. Absorption is taking up to twice as long and during the ramp-up, incentives are twice to three times higher than those offered post stabilization. In addition, the availability of countless on-line rental resources, has resulted in higher market efficiencies for renters than ever before. This challenges lenders to evaluate the impact on financial projections of the elasticity of rents for existing and prospective tenants in a way not previously required. In determining what a stabilized operating projection will look like, borrowers and lenders alike have to consider all of the above.❞
Lindsey Senn, vice president, Fifield Cos.
❝Equity providers are giving up yield in pursuit of only the best multifamily new development projects. Record-setting rents in up-and-coming submarkets are more justifiable than concession burn-off in historically strong and well-located, but currently oversupplied, neighborhoods. For developers, equity financing is all but non-existent for the latter, while significant opportunity exists for projects with the best amenities or finishes in a newly established neighborhood on the precipice of major growth. These amenities might include fitness centers with specialty strength-training equipment, wellness programming, co-working spaces, and reservable entertainment spaces with chef’s kitchens and views.❞
Abe Roberts, associate, Marcus & Millichap
❝Banks are experiencing more difficulty achieving the necessary debt service coverage ratio (DSCR) for new multifamily loan acquisitions, resulting in pressure against the customary loan-to-value amount. Typically, banks have required a minimum of 1.20x DSCR, but conventional (non-agency) debt on 7-10 year term rates have risen to a 4 year high of over 5%. This is resulting in considerable higher debt service payments than years past, which were at a historic all-time low. As a result of restrictions on DSCR and rising interest rates, banks are finding it more difficult to lend at 75-80% loan-to-value which borrowers are accustomed to, and instead, are requiring higher down payments from borrowers. This is a relatively new trend which could have significant ramifications moving forward.❞
You’ll find more on this topic in the September 2018 issue of MHN.