Value Vanguards: How Multifamily Bridge Lenders Are Uncovering Upside
- Nov 01, 2018
Thanks to the lengthy economic expansion, record-low interest rates and solid fundamentals, multifamily has gained wider acceptance on the debt side, and a host of newcomers have flooded the space. Despite a lack of track records in some cases, these non-bank lenders have stepped in to fill the gap left by banks, which have tightened their credit standards in line with stricter regulation. In this milieu, multifamily bridge lenders have seen a surge in demand for their non-recourse, short-term loan products—an ideal fit for borrowers looking to execute unique investment plans faster, using financing with more innovative structures and less stringent terms. While agency lenders still capture the majority of multifamily debt, bridge loan originators have proven adept at providing quick and flexible solutions throughout the capital stack.
Multifamily originations have had a strong year so far, with no signs of slowing. As the Mortgage Bankers Association reported, first-half 2018 originations were 17 percent higher than in 2017 and 110 percent higher than their pre-recession total in 2007. This elevated demand, coupled with a robust rental housing market, has boosted bridge lenders’ market share in recent years. Although long-term capital remains a mainstay, banks and insurance companies are originating more bridge loans, too, drawn to their attractive risk-adjusted returns, while still maintaining a focus on stabilized assets.
“People go to non-banks like us for flexibility, ease, higher proceeds and non-recourse—things that banks generally don’t offer, especially to middle-market investors and developers,” said Jonathan Daniel, principal of Greenwich, Conn.-based Knighthead Funding.
Advantageously to those customers, bridge lenders don’t require the cash flow and occupancy thresholds that permanent lenders do. Additionally, the non-recourse component of a typical bridge loan makes it easier for the borrower to carry the unstabilized asset through the capital improvement process. These capabilities also enable bridge lenders to act quickly in closing loans or adjusting terms as needed.
While bridge lenders, by and large, accept more risk than permanent lenders, the downside risk in multifamily is relatively limited, contends Billy Meyer, managing director Columbia Pacific Advisors, a Seattle-based alternative investment specialist. “The reality is, if one or two tenants move out, it impacts vacancy by a nominal amount,” he added. “In an office or retail building, that could be a hit to your vacancy for a long period of time, plus the time and cost of tenant improvements.”
Multifamily bridge lenders are finding innovative ways to stay competitive with banks. “For the right sponsor, with a strong track record, some bridge lenders are allowing borrowers to come in with a portion of the equity required for a renovation after the loan closes,” explained Felix Gutnikov, principal & head of origination for Thorofare Capital.
Despite their differences, bridge lenders and banks are more allies than adversaries. “In (many cases), a bridge lender will originate a whole loan, and the bank will take the safest, most senior tranche of the loan, while the bridge lender retains the first-loss piece,” Gutnikov added.
In July, Gutnikov’s Los Angeles-headquartered loan origination and servicing firm provided $13 million in short-term bridge funding to refinance and refurbish Park Terrace, a 44,816-square-foot, garden-style senior housing community in Phoenix, comprising 184 independent living and 93 assisted living units. The two-year, floating-rate, interest-only financing repays the community’s construction loan with a $10 million deposit. The remaining $3 million funds the reserves needed while the vacant units are being leased, along with an incentive for the sponsor—a performance-based earn-out. To its advantage, the asset’s garden-style construction distinguishes it from the resort-style senior housing communities that populate the area.
What’s the story?
Today’s landscape of escalating valuations, compressed yields and rising but still-low interest rates has given bridge lenders plenty of room to grow. With fewer reasonably priced investment opportunities in core markets, middle-market borrowers are finding more creative ways to generate value, leading them to approach bridge lenders with complex business plans. “Even for the banks doing multifamily financing, there’s got to be a story, a catalyst behind why they need bridge financing,” Daniel explained. “Then it’s up to us to research and analyze to make sure that we agree with the plan. It’s the ones that have merit that we’re excited to work on.”
According to Daniel, “It’s all about how you buy an asset in this inning in the cycle and create value, and it usually involves repositioning, adaptive reuse or capital infusion.” In July, Daniel’s firm provided $20 million in construction financing for Edge LoHi, a 44-unit luxury condominium in Denver’s fast-growing LoHi submarket and the first such development by Alpine Investment Partners.
Throughout this cycle, most multifamily deliveries in LoHi have been rental housing, Daniel explained. That, in turn, is contributing to pent-up demand for condominiums and necessitated that Alpine secure the parcel quickly. “From a risk perspective, all the boxes were checked,” Daniel explained. “These were guys that had track records with larger companies, and they were able to lock up an unbelievable site.” Furthermore, when Knighthead arranged the financing, the property was already 35 percent pre-sold.
Another boost to the feasibility of the deal is the property’s proximity to Denver’s central business district, which has seen an uptick in job growth, especially in the technology sector. Attracted by this trend, BP recently relocated its U.S. headquarters to Denver. In September, the oil and gas giant moved into a new, 160,000-square-foot campus in LoHi, making around 100 local hires in the process.
Over the past few years, loan requests involving a significant value-add component—usually on neglected garden apartments built between the 1960s and 1990s—have been pouring in, Meyer observed. The asset type remains a hot target for redevelopment and repositioning: As of September, garden apartments were trading at lower cap rates than mid- and high-rise apartments, office, retail or warehouse properties, according to Real Capital Analytics data. The lion’s share of these value-add deals has been in secondary and tertiary markets, a trend that Meyer believes is all but unique to his company. “There’s so much competition for those deals that it’s hard for people to believe they’re out there,” he said.
Earlier this year, Columbia Pacific Advisors took on a bridge lending opportunity that Meyer believes most banks would have refused: an $8.5 million cash-out bridge loan on a 219-unit community in San Antonio. About a decade ago, the property’s owners had purchased the asset, called Sonoma Canyon, with the intention of doing value-add renovations, but due to San Antonio’s low-vacancy market, they were able to keep the community occupied without making improvements. Over time, however, the property’s condition began to suffer.
In search of short-term capital, the borrowers approached Meyer’s firm to secure a bridge loan, with the aim of using the loan proceeds to expedite the purchase of another multifamily asset as part of a 1031 exchange. Since the subject property had very little leverage on it, the borrowers were able to funnel the cash proceeds from the bridge loan to execute the acquisition. “For us, it was a no-brainer, at 60 percent loan-to-value,” said Meyer.
As the cycle wears on and competition for well-qualified borrowers intensifies, underwriting standards will become even more important for bridge lenders to ensure credit quality and facilitate favorable exit strategies. Daniel cautioned: “Over the next 12 to 18 months, if interest rates go up by 50 basis points and concessions continue to rise—(compressing) cash flows—then that’s not a very good outcome for getting refinanced out of a bridge loan.”
Still, the outlook for multifamily bridge finance appears to be wholly positive. Downsizing Baby Boomers and Millennials postponing homeownership will continue to benefit the niche. And as construction and land costs keep rising and the nationwide labor shortage worsens, filling financing gaps will remain a challenge for investors and developers, feeding the demand for bridge loans.
You’ll find more on this topic in the November 2018 issue of MHN.