Low interest rates and availability of capital, along with increasing multifamily demand have created favorable conditions for intense capital markets activity. Loan originations for both commercial and multifamily assets rose by 24 percent in the third quarter of 2019 compared to the same period last year and were 9 percent higher than in the second quarter, Mortgage Bankers Association’s most recent quarterly survey of originations shows.
As the industry braces for an economic slowdown, investors are looking at demographic and lifestyle shifts to source new opportunities. In the interview below, Shaunak Tanna, head of structured investments at Basis Investment Group, shares his insights into the challenges of multifamily financing today and forecasts opportunities for the next 12 months.
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What is at the core of successful multifamily financing operations today?
Tanna: The core of successful multifamily financing is really what it has always been: finance experienced borrowers that have significant skin in the game; capitalize the deal appropriately for planned improvements, if any; underwrite sustainable property cash flow based on in-place rents supported by market comps; provide for appropriate vacancy and collection losses; focus on neighborhood demographics and crime issues if any and underwrite appropriate expense levels.
The one risk that we pay more attention to is the risk of increase in property taxes. With local jurisdictions stretching for every dollar, we focus on underwriting appropriate tax increases especially in jurisdictions where a sale can trigger a reassessment.
Name the most challenging aspects in the capital markets today. How do you overcome them?
Tanna: At this point in the cycle, the challenge always is to maintain underwriting discipline and to price deals based on perceived risk as opposed to cost of capital. We have inculcated a culture focused on identifying risks, putting in structural mitigants and not being afraid to walk away from a deal when it does not meet the appropriate risk-return profile. We win transactions through relationships and through an owner-oriented mentality that sees value creation like an equity owner as opposed to a metrics-driven lender.
Availability of capital has been on all lenders’ lips in 2019. Do you expect anything to change when it comes to fundraising in the next 12 months?
Tanna: The search for yield continues unabated, especially considering the Fed rate cuts. Real estate’s relative value in the fixed-income markets has actually improved and, from a spread-to-Treasury-rates perspective, cap rates remain attractive. We don’t expect any material changes to the capital market demand for real estate and related fixed income product.
Tell us about Basis Investment Group’s efforts in the small- and mid-sized assets sectors. What are the company’s plans when it comes to Small Balance lending?
Tanna: The firm’s investments typically range from $2 million to about $50 million, with many of the smaller investments originating into our Small Balance Lending agency platform. We intend to grow this segment of our investment portfolio significantly over the next five years, as we see strong opportunity here, particularly in the multifamily asset type.
Do you expect an economic slowdown or a downturn?
Tanna: Economic data are pointing to a slowdown as reflected in the deceleration in GDP growth—third quarter of 2019 growth rate was 1.9 percent versus 3.1 percent in the first quarter. We also see that macro trend reflect in slowing income growth at the property level.
How is Basis preparing for this next stage?
Tanna: Basis maintains a defensive posture by investing in deals with downside protection through equity subordination, focusing on cash-on-cash returns, diversifying our portfolio by asset type, geography and also property life cycle and by ensuring that our basis in the real estate is at a significant discount to replacement cost.
Where do the next opportunities in the business lie?
Tanna: A significant portion of middle-market commercial real estate assets are owned by Boomers who are looking to move to liquid assets. As these assets change hands, sometimes as a result of situational distress, investors who can move quickly and access and assess these opportunities will benefit from the resulting transaction demand.
Tanna: In 2020, we plan to significantly grow our year-over-year production volume across the platform, while maintaining our prudent investment criteria. We see tremendous opportunity in the intergenerational transfer of real estate ownership that is just starting.