Changes in the financing landscape such as the wave of maturing CMBS loans, growing interest rates and the continued demand for multifamily properties have maintained high asset prices, while loan-to-value (LTV) and loan-to-cost (LTC) ratios dropped to 50-60 percent. This turned out to be a favorable context for flexible financing providers to fill the gaps in the capital stack.
In this exclusive Q&A, Max Kirschenbaum, head of business development for RSE Capital Partners, Douglas Lyons, managing principal at Pearlmark, Dennis Schuh, chief originations officer at Starwood Property Trust, and David Blatt, CEO at CapStack Partners, gave MHN a behind-the-scenes look at today’s alternative lending market.
MHN: How do you see the multifamily lending market today in terms of trends and challenges?
Max Kirschenbaum: In some cases, senior construction lenders have cut funding to 50-60 percent LTC. In others, lenders have stopped construction lending altogether except to existing customers of the bank. In the acquisitions space, the election contributed to senior loan interest rates increasing. However, continued demand for multifamily acquisitions from investors, both domestic and foreign, has maintained asset-level pricing, which remains near record highs in most major markets. Sizing loan proceeds based on cash flow coverage, both Fannie and Freddie have pulled back on leverage and no longer hit the 80 percent LTV mark consistently, as used to be the expectation. Funding gaps in both acquisition and development deals have owners and developers looking for new partners, and a handful of flexible capital providers have stepped up to fill the void.
Douglas Lyons: For stabilized cash flowing assets there are plenty of options still available to borrowers including agency execution, CMBS, insurance companies and debt funds depending on LTV and DSC advance levels. For value-add strategies, the debt funds appear to be capturing market share with higher LTVs on a non-recourse basis. For construction, the banks have pulled back considerably due to regulatory issues not likely to be off the table in a Trump era (Basel III/IV) and sizable existing inventories of multifamily construction loans weighted heavily to luxury product in urban markets.
MHN: What could be the long-term impact of such a constricted lending market? What do you foresee going forward?
Kirschenbaum: The overheating of the Class A infill multifamily development market and the resulting inability to find traditional financing for these projects have pushed developers to focus on new strategies and capital sources. Some are still finding opportunity for new development on the periphery of major markets, where you can build projects with larger units on cheaper land and undercut the rents of the Class A properties that have come online in the urban core.
Other developers are turning to secondary and even tertiary markets where fewer Class A apartments have been built this cycle. We also see traditional developers complementing their core business with Class B multifamily value-add acquisitions, again playing to the thesis of delivering a more affordable product that has been underbuilt this cycle.
Lyons: We see significant demand for non-recourse financing projects up to 80 or 85 percent LTC where agency or bank options become extremely limited. In these instances, debt funds for stretch whole loans or discreet mezzanine or preferred equity positions in combination with a bank or insurance company at lower last dollar senior loans are providing attractive options to borrowers.
MHN: What are the advantages of choosing a flexible investor/fund as a financing solution?
David Blatt: Many of these groups are either private equity groups or developers themselves and so there is an inherent understanding of developer’s business plan, which provides a level of certainty when it comes time to fund. The other advantage of these funds’ participation in the debt stack is that they enhance the loan’s credit profile for the traditional senior lenders because if the borrower defaults, you now have a qualified subordinate lender that can step in to the deal.
Dennis Schuh: We can also offer prepayment flexibility, flexible structures surrounding future advances, various debt/equity funding sequences and we do not have hard and fast rules on LTV, DSCR, debt yields etc. We are simply looking for good risk/reward opportunities to deploy our capital.
MHN: What is the number one request coming from borrowers seeking more flexible lending conditions? What do they most often look for outside the traditional lending environment?
Kirschenbaum: Aside from gap equity requests to close acquisition or construction loans, we see a number of requests to create capital events for delayed or over-budget multifamily developments that are nearing completion or stabilization, but not ready for a refinance or sale.
Blatt: First and foremost, these borrowers want assurances that the lender will show up to the closing table. They seek a clear upfront explanation of the credit approval process and want a level of comfort that the lender understands what they intend to accomplish with the property. Behind that, there tends to be an emphasis on lengthening the interest-only period because these borrowers are executing development and rehab projects where cash flow is thin to nonexistent, and is generally rolled back in to the reposition of the property itself.
Schuh: Most commonly, it is probably additional loan proceeds versus what traditional lenders are able to offer.
MHN: Do you still see multifamily as being the most attractive asset class for investors in the coming years?
Kirschenbaum: The overbuilding of luxury multifamily product this cycle, largely targeted towards a millennial renter in the urban core, has created relative opportunity for new development and value-add in peripheral locations of major markets. These markets have benefited from significant job growth over the past cycle, but suffer from a shortage of more affordable rental options. Opportunities to deliver new projects to satisfy this tenant base have been largely overlooked. Additionally, we have a favorable outlook over the next few years on the active living/55+ space, which is buoyed by strong macro trends, as well as traditionally higher rents and a stickier tenant base compared to conventional multifamily.
Blatt: Very much so. Currently, overall renter demand far outstrips supply. In comparison to prior real estate cycles, apartment inventory is low, despite some asserting that particular markets may be overbuilt. Further, we are at historic lows for housing starts too. Factor into that increasing homebuilding costs in the form of land prices, steel, labor and now timber, and this means homes will need to sell for a higher price or just won’t be built because it’s not feasible. Add to that higher borrowing costs for prospective home buyers as interest rates climb, which means they can afford less house for their money. This inevitably redirects a good part of that population back into the renter pool. All this translates into strong support for long-term multifamily investing.
Schuh: With homeownership rates at all-time lows, trends toward immigration to urban cores of major metro areas and the rising rate environment we foresee going forward, we think there will be ample demand for apartment rentals.
Images courtesy of Pearlmark, RSE Capital Partners, CapStack Partners