Multifamily Financing’s Endurance Test
- Dec 19, 2018
The last 12 months have comprised significant economic changes that are transforming multifamily lending. We are seeing more alternative lenders, more competition for strong sponsors and quality projects and a revival of the CMBS market. It might look promising, but with the effects of the Great Recession still haunting the business, there is still a lot of caution, particularly for financing construction projects.
Tower Capital, a Phoenix-based independent structured finance firm, has been around for roughly three years and is aiming to reach $200 million in loan volume by the end of 2018. In a conversation with MHN, Co-founder Adam Finkel said he believes the company will surpass that volume in 2019 and have a greater percentage of total loan volume come from financing construction projects. Finkel also shared his outlook for the thriving Phoenix multifamily market
How did the multifamily financing landscape change in the past year?
Finkel: The multifamily landscape continues to be very robust, with a lot of capital seeking to be placed. An abundance of new alternative lenders consisting mostly of debt funds have made the bridge lending space especially competitive. Looking for additional yield, some life companies are now offering light bridge programs. The CMBS market seemed to regain its footing as a feasible source of financing. DUS lenders and Seller/Servicers have been expanding their market presence with additional offices and competition among the agency lenders is especially high. The agency lenders have become much more aggressive to win deals, often quoting terms based upon underwriting off of annualized T1 revenues. This creates greater risk that borrowers will be “retraded” on their loan proceeds by the time the loan is approved if the property does not perform as expected.
How did the current changes in the economy impact borrowers’ preference for a certain financing product? What will be the long-term consequences of these preferences?
Finkel: In general, borrowers are preferring to lock in fixed rates than be exposed to continued rising rates. Interest rate cap purchases are in more demand by borrowers and lenders to help mitigate interest rate risk. The new, recently enacted Opportunity Zones will breathe oxygen into the market, encouraging increased investment in under-served areas and much needed development of affordable workforce housing. Many folks are wondering if the idea of the privatization of Fannie Mae and Freddie Mac will start to gain traction. That will have a major impact on the availability of non-recourse financing for multifamily properties. I don’t expect any significant legislation passing in the immediate future, but it is in the back of people’s minds.
What would you say are the main challenges multifamily borrowers currently face? What about lenders?
Finkel: Rising interest rates are acting as a blessing and a curse, encouraging continued rental demand while also causing more loans to be DSCR (debt service coverage ratio) constrained. Both borrowers and lenders must remain cognizant when it comes to where we are in the cycle and make sure they have realistic proforma projections. In most markets, supply and demand are maintaining a healthy balance, but political and economic uncertainty could provide headwinds.
Tell us how you think the capital stack will look in 2019. How do you see lending evolving?
Finkel: The wounds of the Great Recession still have not completely healed. Coupled with the increased volatility in the stock market this year, and the fact that most believe we are in the late innings of the cycle, lenders remain fairly prudent. They are very focused on the strength of the sponsorship—looking for borrowers with experience in the particular asset class being financed, as well as a strong balance sheet with plenty of net worth and liquidity. Given how low cap rates are, many stabilized properties can no longer support full leverage, especially in multifamily. Fannie Mae and Freddie Mac will both offer as high as 80 percent LTV.
However, most properties these days are DSCR constrained, pushing the LTV below 75 percent in most cases. As senior lenders remain conservative and interest rates rise, there is more demand for mezzanine and preferred equity financing to pick up the slack in leverage and we can expect more active players in that space. Rates typically in the low- to mid-teens for mezzanine debt. Preferred equity lenders may want a back-end kicker in addition to the preferred return.
Lenders will be getting especially aggressive to win deals with strong sponsors and quality projects. More “stretch senior” loans, where the lender keeps an internal A and B note to push leverage up to 85 percent LTV/LTC on construction and rehab loans, are being offered. Lenders remaining cautious on bridge and construction projects supporting the take-out financing. Most lenders are underwriting to an agency takeout, which can limit upfront loan commitment.
How did tech affect the financing business?
Finkel: I didn’t see tech having a significant effect on financing. There are some new cloud-based underwriting and packaging software companies, such as Red IQ and Clik.ai, that are trying to streamline the process for smaller independent local and regional debt and equity shops that are gaining some traction. These have also been utilized by asset managers, developers and acquisition firms.
What are your predictions for the industry in 2019?
Finkel: Certain primary coastal markets are topping out and will see downward pressure on rents due to new supply. Secondary and tertiary markets will see continued activity from out-of-state investors chasing yield. The new single-family for rent—new build—asset class will see continued momentum, along with many new funds being set up to take advantage of the Opportunity Zones.
Tell us about Tower Capital’s goals for the coming year.
Finkel: Tower Capital is targeting $300-plus million in loan originations with a continued focus on multifamily and a greater percentage of loan volume coming from construction.
How do you see the Phoenix multifamily market from a lender’s perspective?
Finkel: The Phoenix multifamily market remains robust with strong demand for both single-family and multifamily housing as population growth remains strong due to continued influx of new residents from markets through California, Vancouver, Toronto and the Midwest, chasing either affordability or better weather/fewer natural disasters. Supply has been kept in check by conservative lender underwriting, increased construction costs and lack of skilled labor. Increasing interest rates will continue to encourage renting as home values and mortgage payments rise.
Image courtesy of Tower Capital