What to Expect From Multifamily Underwriting This Year

Multifamily owners can expect easing of the tightest underwriting and reserves seen during the height of the pandemic, but lenders say that they are still carefully scrutinizing rent collection, concessions and rental rates. Market supply and employment trends will also play important roles in underwriting as the industry continues to navigate COVID-19 impacts.

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Class A properties in urban centers, particularly gateway markets like San Francisco and New York City, saw some of the steepest rent declines in 2020, which were often paired with deep concessions. According to CBRE’s Q4 U.S. Multifamily Figures report, the average rent was $1,666 per month in the fourth quarter, down 1.6 percent from the third quarter. CBRE expects further rent decline in early 2021, with rents beginning to increase in the third quarter and reaching pre-COVID levels by the first quarter of 2022. Markets recording significant rent declines included San Francisco (18 percent); New York City (9.7 percent) and San Jose, Calif. (4.6 percent).

Yardi Matrix reported that the use of concessions increased considerably during the first half of last year. In January 2020, 11.2 percent of properties nationally offered concessions; by July, 15.8 percent were doing so. Concessions in gateway markets showed an even bigger jump during the same period, from 8 percent to 15.3 percent.

“We’ve seen a greater utilization of concessions—some greater than others—throughout all multifamily markets. The problem is that concessions exacerbate the difference between the face rents and effective rents and really can impact the bottom line in a substantial way,” said Josh Westerberg, director at Mesa West Capital. “If you’re not underwriting that as a component to the transaction, I think you naturally will make a mistake of overestimating income of the property.”

Operators in Chicago and other major cities have been offering two, three or four months of concessions on 12- to 18- month leases, reported Matt Stearns, senior managing director at Black Bear Capital Partners. “Ultimately the effective rent is dropping considerably,” he said. “It presents a challenging situation when you’re trying to find a value-add multifamily deal to proof out the numbers, because everything is changing.”

Proceed With Caution

While Stearns expects those conditions to improve substantially in the next six months, it highlights the considerable uncertainty about rent issues that is still influencing multifamily underwriting in the lending market. David Levy, executive vice president & chief credit officer at Walker & Dunlop, said the firm is starting to see flattening in some urban areas hit hardest by declining rents, as well as in some suburban locations where rents have returned to or are exceeding pre-COVID levels.

Other experts advise caution in underwriting rent increases into suburban markets where residents moved in search of more breathing room. “Those (markets) are the ones I would be most concerned would come down,” said Jahn Brodwin, senior managing director at FTI Consulting, adding that he expects COVID-related rent decreases in cities like New York to be temporary.

Other high-priced markets, such as Seattle, Boston, Chicago, Washington, D.C., and Nashville, Tenn., are still facing headwinds. “One of the factors we need to weave into the stress on the apartment market due to the pandemic was the amount of supply that delivered last year,” Levy said. “There were really record levels of delivery across the country.” In Boston and Nashville, for example, new supply reached upward of 5 percent of inventory.  

Location and resident base also played important roles in determining leverage and underwriting of rent collections, particularly at the beginning of the pandemic. “If you had a property in Orlando—and a lot of the tenants worked in retail or at Disney World—given that it was closed, we would have been very cautious,” noted Pamela van Os, senior vice president & head of West Coast agency loan production at Greystone.

Factoring in Reserves

In the early days of the pandemic, when much of the nation was locked down and job losses were rising, rent collection was a chief concern. “The biggest issue for underwriting became residential collections, whether tenants were going to be able to make their payments and whether they were going to be on time,” observed Jessica Cherepski, senior vice president & GSE chief underwriter at Merchants Capital.

Freddie Mac and Fannie Mae acted swiftly, requiring debt service reserves ranging from six to 18 months as a hedge against lost or late rental income.  Other lenders, particularly those that work with the two GSEs, followed suit, noted Jeff Erxleben, NorthMarq executive vice president & executive managing director. That decision had far-reaching consequences for multifamily underwriting because the reserves could be substantial.

Levy called the reserve requirement “the most significant change we made to our underwriting in recognition of the uncertainty last year…It would vary by leverage and vary by program, but there were very significant reserves behind the loans.”

At the height of the pandemic, at least six months of reserves were required for all but the very lowest of leverage deals, typically 55 percent loan-to-value. One clear result was more borrowers choosing lower-leverage loans because they required little or no reserves. In 2020, van Os noted, Greystone observed an increase in loans with leverage of 65 percent or lower.

The reserves helped provide an early cushion to cover declining collections, noted Mitchell Kiffe, senior managing director & co-head of national production for CBRE Capital Markets’ debt and structured finance group. There is now pressure on the GSEs to reduce or eliminate the debt service escrow because some lenders are no longer requiring them. It’s unclear whether the agencies have been responding to that pressure, but they have been showing more flexibility in recent months to waive or lower the reserves required.

“Greystone has been able to get waivers on the lower reserves depending on the sponsor, market and if the property is exhibiting strong collections,” van Os reported, adding that the GSEs will “stretch a little bit more” for top agency borrowers.

“Lightening up on those reserves tells you something about our ability to interpret the market much better this year,” Levy said. “It’s a completely different fact pattern in lending today than it was in March or April of last year in that we really have enough data to understand the patterns of collection in these marketplaces.”

Closeup on Collections

Another key metric influencing underwriting is the rate of rent payments. Kiffe noted that Class A properties have been hurt the most by declining occupancies and rents and lower collections. “It’s just so dependent on the situation on the ground and hard to generalize,” he noted. “I think most lenders are making their loans on assets with in-place income, so they’ll look hard at that.”

 While collections will vary by property and by market, lenders report that early concerns about widespread problems with rent payments have largely subsided. Some residents in Class B and Class C properties may be struggling but rent collections in these segments have remained generally stable. Lenders credit the federal government with approving COVID-19-related aid, including stimulus payments and extended unemployment benefits, for helping tenants with rent issues. They also point to the overall strength of the multifamily market.

One closely watched data set is the rent tracker conducted by the National Multifamily Housing Council. The NMHC Rent Tracker found 80.4 percent of apartment households made a full or partial rent payment by March 6, down 4.1 percentage points from March 6, 2020, but an uptick from February when 79.2 percent of rental households made a full or partial rent payment by Feb. 6. That February metric, in turn, represented an increase compared to 76.6 percent recorded as of Jan. 6. All told, 93.5 percent of renters had paid at least partial rent by the end of February, compared to 95.1 percent who had made payments by the end of February 2020.

“We haven’t seen a whole lot of issues with our rent collection and rental rates because we’re in that middle-, lower-middle class sector,” said Vicky Schiff, co-founder of Mosaic Real Estate Credit, the debt platform of Mosaic Real Estate Investors. The firm provides construction lending as well as preferred equity to a partner that owns and operates workforce housing in the Sun Belt. Rent collection at the firm’s properties is consistent with trends reported by NMHC’s national rent tracker, Schiff adds.

Read the April 2021 issue of MHN.