Pandemic-fueled uneasiness has forced lenders to realign underwriting strategies. Anthony Delfre, managing director of the Real Estate Advisors Group at Brown Gibbons Lang & Co., spoke to Multi-Housing News about the multifamily debt market amid the lingering global health crisis. What deals are lenders focusing on and who is still active in the mortgage industry?
What can you tell us about liquidity in the multifamily debt market amid the current health crisis?
Delfre: There is a sentiment of a slight pause for new deals until the shelter-in-place orders are lifted. We’ve started having calls this past week as lenders are beginning to look at new deals after being flooded with Payroll Protection Program loan requests as a result of the CARES Act. Lenders are focused on existing borrowers and deals that were in their credit committee approval process.
Lenders have been flexible for financial restructurings involving SWAPs and interest rate floors. Certain lenders are requesting borrowers to enter into Pre-Negotiation Agreements, or “PNA’s,” in order to replenish reserves, and are limiting the amount of construction dollars on in-process deals. In return, some lenders are considering waiving prepayment penalties/fees to exit.
What is your take on agency lending today, considering the measures announced by Freddie Mac and Fannie Mae?
Delfre: Freddie and Fannie are both requesting that borrowers increase escrow and debt service reserves. We have guided borrowers to hold off on requesting any modifications until they see an actual impact on their rent collections. There is quite a bit of uneasiness from borrowers, given restrictions and guidance regarding non-payment of rent. It is business as usual, but right now, a large portion of multifamily lending is only through Freddie, Fannie and HUD, given the conventional lenders’ general reaction to the COVID-19 pandemic.
Can you tell us about multifamily loan defaults prior to the COVID-19 crisis compared to default volumes in recent weeks?
Delfre: As of April 30, requests for forbearance from borrowers within the agency lending world was in excess of $2 billion. Prior to the COVID-19 pandemic, the multifamily market was on solid ground and the credit quality of those forborne loans was relatively low. Over 86 percent of the loans requesting forbearance have a current debt service coverage ratio above 1.25. Over the next two years, approximately 13,000 loans totaling $148 billion held in commercial mortgage-backed securities may be at risk of default.
Construction lending has certainly been affected by the outbreak. How do you expect this to impact multifamily development?
Delfre: As of now, the hospitality and retail industries have been the hardest hit and multifamily has been less affected. However, lenders are focused on deals that are from existing borrowers. Deals that are in the closing process and have been approved by credit are moving forward. We recently closed on a luxury condo development deal at the end of March, and have several apartment transactions proceeding toward closing in the upcoming months.
Over the long term, multifamily development should fare well as young professionals and empty nesters flock to urban centers in search of opportunity and a downtown lifestyle and less maintenance compared to traditional homeownership. In the near term, developments in progress are moving forward but only to an extent. Lenders are being cautious and monitoring reserves to make sure loans are not out of balance.
How can multifamily lenders better prepare for economic uncertainty?
Delfre: We’ve seen lenders closely monitor collections for April and May. Fortunately, we’ve seen collections come in strong, which has been helping the lender behavior in this sector. In contrast to what we experienced during the financial crisis in 2008, most lenders have been working with borrowers to weather the current environment. In addition to monitoring collections, lenders are closely monitoring reserves.
Lenders have been open to financing alternatives during the current economic uncertainty and have allowed sponsors to bring in additional sources of capital—e.g., PACE, ground leases, etc.,—to provide additional reserves until the impacts of the current environment return to pre-pandemic levels.
Multifamily has long been at the top of investors’ list. How do you expect this trend to be shaped by current events?
Delfre: Multifamily continues to be a very attractive sector for equity investment. The biggest change over the past 45 days has been a desire for distressed pricing and stretching multiples to earn the largest yield. Multifamily will continue to be an attractive investment and we have seen certain portfolios experience limited issues with collections over the past several months. Multifamily will be a safer bet as it’s viewed as being more defensive in nature compared to other asset classes such as retail and hospitality, where consumers will be overly cautious with how they spend their discretionary dollars.
What approach has your company taken in light of current events?
Delfre: At BGL, we’ve been looking at alternative means of financial solutions. One creative new type of capital that we’ve been securing term sheets for is the ground lease. We have been working with senior lenders to reduce their exposure by paying down their loans and replenishing interest reserves that have been exhausted. Some of these ground lease products can be taken out and redeemed at par through swap-rate hedging. We have seen more conservative underwriting, including absorption rates, loan-to-value/loan-to-cost and exit cap rate spreads.