Fannie Mae and Freddie Mac are the go-to finance sources for many multifamily investors, but despite their preferred status, the government-sponsored enterprises will have the resources to meet only about $160 billion of the projected $400 billion demand for debt capital this year. The removal of the exclusions to lending caps for green or designated affordable and underserved segments, and establishment of a 37.5 percent affordable housing allocation will make generating volume more challenging still for the GSEs.
“There’s certainly no shortage of competition,” said Tom Booher, head of agency finance for PNC Real Estate. “I think what people are trying to do first and foremost is protect their existing customer relationships.” Booher reports that PNC’s loan volume held steady at some $4 billion from 2018 to 2019, even as overall multifamily lending volume for the year jumped 10 percent to $4.4 billion.
That competition includes not only the GSEs but also but life companies and conduit lenders, reports Roy Williams, managing director and FHA chief underwriter at Wells Fargo Multifamily Capital. In his group, which specializes in construction-to-permanent executions under the HUD 221(d)(4) program, loan sizes have been generally larger. Refinance requests typically range from $20 million to $30 million range, and customers seek construction loans that are larger still.
“And those executions are quicker executions than what we can offer through FHA,” he noted. FHA does, however, does have an edge in the extremely low interest rate environment in that it offers a 35-year fully amortizing product that’s “very appealing” to borrowers with a long-term hold strategy, Williams points out.
In this climate, a variety of multifamily finance sources are stepping up to meet the need. Trepp projects approximately $10 billion of private-label CMBS is returning to fill the void this year. A considerable factor is that not all transactions qualify for agency loans, which typically offer lower rates, options for prepayment and other favorable terms.
In order to compete, some innovative lenders are aiming to capture new business by offering a better borrower experience. To that end, Pasadena, Calif.-based Sabal Capital Partners holds the B piece of the CMBS loans it originates and then acts as special servicer through the life of the loan in a program that it calls S-CRE. “The borrowers know who they’re dealing with when the loan’s being originated and they know exactly who they’re going to be dealing with through the life of that loan,” said Sabal CEO Pat Jackson. Sabal, he notes, does about $1 billion a year in agency loans and roughly double that on the CMBS side.
Greystone launched its $1 billion CMBS loan platform seven years ago, when securitization was just beginning to rebound from the depths of the Great Recession. In January 2020, the firm further expanded its CMBS capabilities with the acquisition of Dallas-based C-III Asset Management and its $20.7 billion loan servicing portfolio, newly renamed Greystone Special Servicing. Greystone also competes with Fannie and Freddie’s supplemental loans based on the five-year projection of increased value and cash flow. On some of its multifamily CMBS deals, Greystone will add provisions for mezzanine debt at year 5 that could take a loan from 70 percent to 75 percent loan-to-value.
“In our CMBS platform, one of the things we wanted to try to do is to give our clients the same touch and comfort that they had with us on the agency side with our CMBS platform,” said Rob Russell, Greystone’s head of CMBS. The firm meets the goal by buying the B-piece buyer of the CMBS loans it originates, which gives it control over key decision-making processes and special servicing rights.
Because Greystone acts as its own special servicer of the 10-year loan, it’s able to work with its clients to alleviate common problems reported by CMBS customers. “You have to as a lender see the forest through the trees,” Russell maintained. “The documents will say one thing but there has to be some rationality to lending. And that’s why, when you control the special servicing, you can go through those processes.”
Watch your step
As multifamily CMBS evolves, lenders are also striving to help clients avoid some all too familiar pitfalls. Losing control of cash is by far the biggest issue for CMBS borrowers, especially new borrowers that have recently secured a loan. “A lot of times, there’s these built-in triggers,” noted Ann Hambly, CEO of Dallas-based 1stService Solutions, which helps CMBS borrowers review loan documents and address issues.
As an example, Hambly offers the situation that befell a customer because of a technicality and a lack of relationship with the special servicer. At closing of the CMBS loan, the property was 95 percent leased, though only 84 percent of residents had moved in. The remaining tenants moved in shortly after closing, but the first-quarter operating statement showed only the cash flow from that preliminary 84 percent pool, rather than the full 95 percent. As a result, the servicer decided that the property’s debt-service coverage ratio failed to meet the required level, and the servicer took control of the property’s cash flow for the entire 10-year life of the loan.
Coming up with flexible solutions for the relatively inflexible CMBS structure will become even more important as demand for multifamily loans increases in 2020 and as Fannie and Freddie strive to meet the new mandate of 37.5 percent affordable housing. If the GSEs have only met 22 percent of their mandate at midyear, they are likely to pull back on market-rate deals to catch up.
Though loan default trends do not necessarily directly affect the ability of individual borrowers to obtain financing, the trends do provide some useful insights. At this point in the cycle, the headline defaults that are a legacy of the financial crisis a decade ago have washed through the system with a relatively small number of loans in each property type, said Manus Clancy, senior managing director, Trepp. As of January 2020, the multifamily delinquency rate stood at 1.83 percent.
A notable exception is the student housing segment. Declining college enrollment and the popularity of online classes is creating a seismic shift in for an asset class that was once touted as recession-resistant. Delinquency in student housing “is the highest right now of all major property types surprisingly for deals for loans that had been issued since the financial crisis—higher than even retail, which is kind of a surprise,” said Clancy. As of fall 2019, student housing CMBS delinquencies stood at 1.72 percent, up from 1.27 percent a year earlier.
The trend is being fueled primarily by product that’s a decade old or so, which no longer commands a premium in the market. Ann Hambly of First Service Solutions reports an influx of delinquencies in markets where student enrollment amounts to only a fraction of capacity. Relative stability still characterizes student housing in two parts of the spectrum: lower-quality student housing that dates from the 1960s or earlier, and brand-new student communities offering the latest amenities.
The changing role of CMBS is taking shape in a multifamily market that is likely to remain vibrant for now, absent a black swan event. An imbalance between supply and demand is a key factor. Only 1.4 million rental units and single-family homes are being delivered each year, far short of 1.7 million new households annually, observed PGIM Real Estate Finance managing director Mike McRoberts, who leads the company’s market-rate Fannie Mae and Freddie Mac portfolio and agency production team. Coupled with strong job growth and greater interest in renting as an alternative to owning, the gap is driving demand and occupancy higher.
While there’s been a lot of talk about competition among lenders, McRoberts says the bigger concern might well be a future lack of availability. The restructuring of the GSEs is an ongoing issue. In November, the Federal Housing Finance Agency announced that it plans to re-propose the entire regulation on capital requirements for Fannie Mae and Freddie Mac this year with the goal of taking them out of conservatorship.
“Overall, our expectation is that 2020 is going to continue to be a year of growth for the multifamily lending market and in 2021 we’re more likely to see the market plateau at a still pretty high level,” said Jamie Woodwell, vice president for research and economics at the Mortgage Bankers Association.