Multifamily Borrowers Bank on Alternative Lenders
New capital sources come to the rescue and gear up for a revived transaction market.
“Neither a borrower nor a lender be” warned Shakespeare. But a new breed of investor has cast aside the Bard’s instructions in the wake of tighter bank lending conditions, higher interest rates and increased distress among multifamily property owners.
A plethora of debt funds, family offices, and real estate owner/operators continue to invade the domain previously dominated by banks prior to changes in market conditions, reported Thomas Shanabruch, vice president of investments and capital markets for CRG. Along with life companies, REITs and CMBS, these alternative sources are delivering critical liquidity to owners confronting loan maturities and buyers leveraging currently high cap rates.
“The multifamily industry is fortunate to have the agency lenders,” Shanabruch said. “But in many cases, lower-leverage agency loans are not providing enough leverage for borrowers to pay off their existing loans, so private lenders have stepped in to offer preferred equity and mezzanine debt solutions that work well with the agency loans…”
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For CBRE, alternative lending sources accounted for 33 percent of Q2 commercial and non-agency multifamily loan volume, while banks and insurance companies made up 30 percent of the volume each (see chart) and CMBS made up the remaining 7 percent. Year-over-year, alternative lending grew 22 percent. Bank lending contracted 32 percent, insurance companies lent 3 percent more and CMBS-related originations more than doubled.
Twenty years ago, “it was a four-letter word” to use alternative lenders, Eric Brody, principal at ANAX Real Estate Partners, reported. That began to change in the second decade of the century. “When the banks started failing, that opened the flood gates,” he said. “It’s been really happening since Corona hit.”
The need for alternative lenders is particularly acute for those owners with portfolios of loans written three or four years ago, said Joe Iacono, CEO of Crescit Capital Strategies.
“Treasury rates and SOFR are four to five times higher [than] where they were then, so those loans can’t be refinanced right now . . . That’s giving rise to private capital stepping in to fill the void, not just on multifamily but [on] various property types.”
Many banks are still in an “extend and pretend” mode, according to Matthew Dzbanek, senior director of Capital Services at Ariel Property Advisors. “But we’ve seen some properties forced off their balance sheets,” he added. “Lenders understand the situation. Some deals work, and some don’t.”
“Shadow banks are trying to solve problems in their own way, and private capital is trying to convince equity sources to jump onboard and receive returns outside of buying assets. We are also seeing an increased demand for mezzanine debt and preferred equity to help bridge the gap between the new and old loan balances, so the clients don’t need to bring new capital to the table.”
Fueling development
Financing conventional apartment development has been challenging now that bank lenders growing more conservative. Banks that once lent 75 percent loan-to-cost are now lending closer to 55 percent, he said. Life companies and some of the debt funds are filling that gap to some extent.
But the rush of alternative capital has had a significant impact on affordable development. A good example is Amazon Housing Equity Fund, which has already deployed $2 billion of low-interest loans to fund the creation of 20,000 units and recently announced it will add $1.4 billion in additional capital to offer 20-year-loans at below-market. In exchange, developers are required to create a 99-year affordability restriction for people who earn 80 percent of AMI or less.
“Were it not for Amazon loans, our soon-to-be delivered Nashville apartment community Highland East with 238 units would not have been built,” said Nick Ogden, founder & CEO of Clear Blue Co., a private equity firm in the affordable housing space.
Affordable developers are also benefiting from creative solutions in both private and public low-income housing tax credit space. “Nashville has created the Catalyst Housing Fund, an additional financing tool that works both on the preservation and development side with the aim of preserving affordable housing and making additional housing available,” Ogden said, “which is one of the reasons we’ve pivoted to affordable.”
Constrained lending
The number of U.S. commercial banks dropped by 70 percent, from 14,400 in 1984 to 4,375 in 2020, according to the Federal Reserve.
Unregulated “shadow banks” have been slow to develop, but their emergence appears to be a growing trend in the current cycle—like CMBS in the late 1990s and early 2000s and the rise of agency lenders in the teens, he added.
“That said, I recently learned of a proposed new commercial bank, which will be more challenging to open and operate because commercial banks are subject to government approval and oversight,” Dzbanek said. “It’s also contrary to the trend we’ve seen of banks going out of business and merging in recent years, especially in the New York region.”
The future of banks
As for the future, banks are likely to be out of the space in a material way for the next two to three years, predicted Robert Wasmund, founder of Ascent Developer Solutions. “They will come back slowly,” he said. “But I think there will always be a need for private lenders to answer the call. However, that opportunity has been amplified over the last couple of years by the pressures on the regional banks.”
Further, it’s difficult to see the trend of growing regulation for traditional lenders reversing in the coming several years, Iacono said, and that will require an increasing role for private capital.
