Banks’ Revamped Outlook on Multifamily Lending

The COVID-19 pandemic has upended projections for multifamily lending, but banks should continue to favor the asset class over the long term.

As with so much else in the multifamily sector this year, COVID-19 has dramatically changed the landscape for multifamily finance. Before confinement orders shut down most of the U.S. economy in mid-March, historically low interest rates, stable rent growth and demand were expected to fuel robust a robust multifamily debt market this year. The Mortgage Bankers Association projected that multifamily originations would total $395 billion, which would have been an estimated 9 percent year-over-year increase, and a new record. Observers also expected banks to remain an active capital source, with most matching their 2019 lending levels, if not besting them. At the end of 2019, banks and thrifts held $458.7 billion in non-construction multifamily mortgage debt on their balance sheets, according to MBA. That was a year-over-year increase of 6 percent and represented 30 percent of the market, second only to Fannie Mae, Freddie Mac and other agency lenders.

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But stay-at-home mandates and economic disruption have upended lending expectations, just as the multifamily industry enters its traditional peak leasing period. The unemployment rate is expected to top 32 percent—7 percent higher than the Great Depression’s peak rate, according to projections by the St. Louis Fed. As of April 5, some 31 percent of multifamily renters had not yet paid rent, up from 18 percent a year earlier, according the National Multifamily Housing Council.

What’s more, developers will fall well short of the 371,000 new apartment units originally forecast to come online in 2020, which would have been a 50 percent increase over 2019 completions, according to RealPage.

Eviction moratoriums and mortgage forbearance programs are further complicating the picture. “We’re funding loans that we’ve already committed to, or, for a really great customer at very low leverage, we may proceed,” said Alan Wiener, group head of Wells Fargo Multifamily Capital in New York City. “Other than that, it’s pretty bleak. We have to see the full impact of unemployment and rent collections in April, May and June. And people have certainly notified us that they may need forbearance.”

Source: MBA Commercial/Multifamily Quarterly Databook Q4 2019

Volume shortfall

The coronavirus has effectively halted multifamily lending momentum, observed Jamie Woodwell, vice president of commercial and multifamily research at MBA. Even as lenders report that they are still seeing some demand for well-underwritten, well-structured loans from strong sponsors with high-quality assets, lending volume is far from what it would ordinarily be at this point in the year, he said. Meanwhile, like other lenders, banks have become much more selective and are reexamining underwriting of deals that were in the works.

Given that the CMBS market and most leveraged debt funds are providing little liquidity, borrowers that have strong relationships with banks may have better opportunities to secure loans. By mid-April, however, most observers were seeing lenders of all stripes slowing activity and recalibrating risk for at least 60 days.

“I don’t see banks leaving the market, but right now some are pausing,” said Peter Norrie, managing director at Cohen Financial in Portland, Ore. “A deal that appealed to banks two months ago is getting looked at a lot harder now, as they determine whether they really want to go forward.”

Although banks offer some fixed-rate loans, as balance-sheet lenders they have long specialized in providing floating-rate, short-term construction and value-add debt, observers say. Bank financing is competitively priced and typically includes interest-only provisions. But bank debt also features recourse and conservative loan-to-value ratios of 60 percent to 65 percent. By contrast, debt funds typically provide non-recourse leverage of 75 percent or more, though at a higher cost than bank financing.

The good news for borrowers is that banks are in a much stronger financial position today than they were prior to the Great Recession, so they are unlikely to rein in financing to the same degree they did during that period, said Sharon Karaffa, vice chairman and co-head of production for the multifamily capital markets division of Newmark Knight Frank. Yet some regional banks have indicated that they’re following Fannie Mae and Freddie Mac’s guidance to increase escrow and debt service reserves, Karaffa reports.

“Once some stability returns to the market, we would expect banks to come back,” she said. “It’s hard to make predictions, but I think they’ll continue to look for good, repeat borrowers and cash-flowing properties.”

The fact that most development projects financed today will not open for two years may make banks more amenable to construction loans, noted Jeffrey Erxleben, Dallas-based executive vice president & regional managing director at NorthMarq. As of mid-April, developers who were four to six months away from breaking ground were continuing to move forward with their plans, he added.

Source: CBRE Research, CBRE Econometric Advisors, Axiometrics Inc., April 2020. Based on the 66 metro markets tracked by CBRE EA

Guessing game

But gauging future value amid declining rental rates and growing rent concessions is a major challenge right now, said Gary Tenzer, a principal & co-founder of George Smith Partners. How that value calculation will impact the underwriting of permanent financing to take out construction loans is another riddle, he added.

CBRE Econometric Advisors predicts that by the fourth quarter, the average monthly rent will decline to $1,603, 6.7 percent below its peak in the third quarter of 2019. It also projects that the average vacancy rate will climb to 6.3 percent in the third quarter, a 2.7 percent year-over-year increase.

“Appraisers are having trouble determining value—what kind of assumptions are they making in terms of cash flow, occupancy, rent loss and other measures?” Tenzer noted. “My expectation would be that banks are going to be more conservative because their perception of value is constrained. Any new construction loans banks are doing today are probably going to need more equity than they needed in January.”

What’s more, some municipalities and states have shut down nonessential construction—including multifamily projects—and other jurisdictions may soon follow suit. Thus, banks will want strong, liquid borrowers that are able to weather an indefinite suspension of work, Tenzer added.

With interest rates continuing to bounce along at historical lows, some observers predict that banks will favor multifamily refinancing transactions on stabilized properties over construction loans. But completing those transactions has proven difficult, too, in light of uncertainty surrounding rent collections and vacancies. What’s more, some jurisdictions have deemed appraisers and inspectors to be nonessential workers, making it difficult for lenders to perform proper due diligence, noted Mitchell Kiffe, a senior managing director in CBRE’s capital markets division.

“We’re seeing some refinance activity, but it’s pretty modest,” he said. “We have to work through a lot of unknowns—people aren’t sure of what their cash flow will be—and the market is just not very liquid right now.”

Still, apartments were in favor among lenders prior to COVID-19, and experts anticipate the sector will emerge from the downturn in better condition than other categories, particularly hospitality and retail. In a study of some 12,501 loans with an outstanding balance of $77.5 billion held on bank balance sheets, Trepp found that apartment assets were likely to have a cumulative default rate of 3.3 percent over the next five years—the lowest of any property type, except industrial. Trepp also predicted that multifamily mortgage LTVs and debt service coverage ratios—currently 41.9 percent and 1.79, respectively—would hold up better.

“Before this coronavirus issue changed our world, banks were focused on quality opportunities and quality sponsors,” Erxleben said. “I don’t know if their outlook has necessarily changed, but in the next 30 to 60 days, we’ll probably have a lot more data to shape how the rest of the year plays out.”

Read the May 2020 issue of MHN.