For multifamily investors, today’s challenging circumstances may present a significant opportunity. Historically low interest rates, coupled with liquidity provided by Fannie Mae and Freddie Mac, are galvanizing many owners to refinance their properties.
During the second quarter, multifamily originations declined 24 percent year-over-year as total multifamily and commercial originations fell by 48 percent, reported Jamie Woodwell, vice president of commercial real estate research at the Mortgage Bankers Association. “An awful lot of that multifamily, particularly in the second quarter, was driven by refinancing,” he said. It’s also worth noting that government-sponsored enterprise origination volume slipped only 5 percent year-over-year, and Federal Housing Administration starts outpaced the same period in 2019.
These trends result from credit markets that tightened as the economy absorbed the impact of the pandemic. “Fannie Mae and Freddie Mac made adjustments in their underwriting processes to account for an uncertain future, and these have been smart and strategic changes,” said Andy Shires, managing director for Greystone, an active Fannie Mae, Freddie Mac and HUD lender.
Tighter underwriting includes requirements for borrowers to set aside between six and 18 months of principal and interest as evidence of ability to pay, pointed out Dave Borsos, vice president for capital markets at the National Multifamily Housing Council. “I think we’re still in that situation where we all don’t know where things are going,” he said.
Rent roll review
Another key factor in underwriting is the level of rent collections. Lenders are particularly interested in seeing rent rolls to ascertain how many residents are making payments on time. While operators have experienced difficulties in collecting rent in some locations, notably New York City and Los Angeles, NMHC’s Rent Payment Tracker—a weekly aggregation representing 11.5 million of the nation’s 21 million apartment units—indicates that rents are largely being collected across a wide swath of the market.
Payment levels vary by month and sometimes drop off year-over-year, “but in general we’re still averaging over 90 percent collections,” Borsos said. NMHC’s definition of “collections” includes partial payments, made multiple times within a month or on credit cards. The storyline is less about 24/7 markets versus secondary markets or suburbs and more about the fundamentals of individual properties.
Despite the rush to refinance at low rates, not all loans pencil out. “In most cases, as an operator, it really isn’t a decision to refinance whenever we want,” said Jeff Simpson, managing partner for Arch Cos., which owns a 2,500-unit portfolio of garden apartments in the Southeast. “Most of these products are fixed-rate products that have yield maintenance defeasance prepayment penalties that don’t warrant refinancing anytime you want,” he added. The exception remains with properties making the transition from bridge loans to permanent HUD financing.
One of the hardest things to demonstrate for refinancing—a stabilized property that’s demonstrated a trailing cash-flow history—is being required by the agency lenders to protect against the effects of a second wave of coronavirus infections. “As an operator-investor, you’re putting money to the side that’s not earning any return,” Simpson said.
Supply & Demand
Even so, lenders, developers and investors are still betting on the extreme housing supply shortage. A February 2020 estimate by Freddie Mac placed the shortfall at 3.3 million units and growing by 300,000 units a year.
As a DUS lender, Greystone has a sweet spot for multifamily refis that lines up with the agencies’ mandated affordability goals. “We like to see workforce housing being invested in, refinanced, and developed because this is a core housing market for the middle class,” Shires said. “The demand for rental housing is still very strong, so we expect financing to remain available for all types of multifamily going forward.” He added that manufactured housing communities are highly attractive to lenders given their long-term stability and to residents because of their affordability. As such, they offer an alternative to traditional single-family and multifamily rental properties.
In the past few years, Greystone has also created a mezz product to help fill a common gap in the capital stack. The loan serves as a short-term bridge between the acquisition of a property and HUD-insured financing. Refinancing and extracting value from a property may be an attractive option, Shires noted, and the opportunity to lock in a low rate for 10 to 30 years is also helping drive activity.
For their part, borrowers want to know what loan-to-value ratio lenders will offer; whether a financial guarantee or a personal guarantee will be required; how loans are being structured; and where cap rates are. So says Matthew Dzbanek, a capital services executive at Ariel Property Advisors, a boutique lender specializing in arranging complex deals.
Six months ago, lenders were giving credit for vacant units and structuring loans around them. “Now lenders are saying if it’s vacant, we won’t count that income or we won’t close until it’s occupied, which has been a big shift for a lot of value-add operators,” Dzbanek reports.
Refis account for some 80 percent of multifamily deals Ariel has closed during the pandemic. Capital sources have varied from balance-sheet lenders and banks to private lenders. Recently the firm refinanced a fully occupied eight-unit multifamily property in Queens, N.Y., with a balance-sheet lender. The mortgage brokerage has also been arranging inexpensive bridge loans for value-add properties that need time to stabilize.
Even with remarkable liquidity levels and low-interest rates, lenders have grown far more cautious, Dzbanek reports. After assessing the size of the unit, lenders are diving deeper and taking occupancy into consideration—for example, whether the apartment is being shared by multiple residents or a family.
Multifamily refis placed with the GSEs require reserves that borrowers initially grumbled about, reports Michael Pop, managing director & co-head of production at Basis Investment Group, a Freddie Mac small-balance lender. The necessity of tying up cash for six to 12 months, however, is now an accepted tradeoff for locking in low interest rates for a 10-year term. The biggest issue for lenders is the unit count of the property, because smaller communities have less margin for error, Pop reported.
As the industry continues to digest fluid and challenging conditions, one strategy that seems to draw more interest than implementation is cashing out equity in existing portfolios and using the proceeds to buy distressed properties at deep discounts.
According to Real Capital Analytics’ recent report on multifamily capital trends, distressed apartment loans reached $840 million in the second quarter. That represents a year-over-year surge from $254 million for the same period last year. To put that in perspective, however, that $840 million total is a fraction of the $5.8 billion recorded during the second quarter of 2009, when the recession was already well underway.
The longer economic uncertainty lingers, the more likely that opportunities to buy distressed apartment properties could increase, notes Real Capital Analytics Senior Vice President Jim Costello. One critical unknown, he adds, is the scope of further federal action to assist renter households with rent payments. The challenge on that front: The spike in distress activity is “really concentrated in two property types … hotels and retail,” rather than multifamily assets.