By Erinn Cooke Principal, Gantry
As seen in Commercial Property Executive
The steep rate increases of 2023 introduced some uncertainty to the entire CRE industry for the first time in a decade, and for multifamily borrowers disrupted a “steady as she goes” market complacency with stressed maturities, higher costs for capital, expiring rate caps, and cooling rents after a period of sharp post COVID increases and peak valuations. Add the retreat of banks as a ready source for new originations and you have many borrowers uncertain where debt to refinance or transact will come from in 2024.
For conservative borrowers, liquidity remains abundant in the overall system. Where there is distress, there are also options. We are in a higher-rate environment, but that hasn’t stifled access to debt capital. It has just made identifying the right lender and program more relevant. Multifamily enjoys a unique trifecta of reliable capital sources. Life companies, conduit/CMBS, and the agencies are tested resources for permanent debt, with multifamily loans still a primary target for their capital allocations. You can add debt funds into the mix for bridge requirements and assets in transition. It’s also important to note that banks are still selectively originating new loans. They are, however, underwriting to much stricter standards and often requiring significant depositor commitments.
Each of these lenders offer a viable financing resource for those that plan to or have a compelling need to secure debt in 2024. Many of these lenders have crafted specific programs to meet the market and are adjusting their offerings to align with borrower sentiments. This includes term length, prepayment flexibility, interest only, and extended amortization. Here’s a rundown on various lender advantages and borrower strategies for surviving a tumultuous market.
Term length: Borrowers have demonstrated a preference for five-year loans in hopes of refinancing into a lower rate climate. This is where CMBS has seen dramatic change. For what was once almost exclusively a 10-year product, conduit lenders have introduced five-year loan programs for borrowers seeking higher leverage. Five-year options price higher than a 10-year loan but keep options open for a future refinance absent pre-payment flexibility.
Pre-payment flexibility: For much the same reason as CMBS introducing five-year terms, life companies are willing to offer pre-payment flexibility on permanent loans, often with the first two years locked, maybe with interest only, and step downs to follow, up to the last 90 days.
Interest only: Most agency, life company, and CMBS loans can be programmed to include interest-only periods to help improve operative cash flows. These can be frontloaded introductory periods or carried through the full term.
Rate buy down: CMBS loans can increase proceeds with an upfront rate buy down. Caps on variable rate products from multiple lending sources have become more expensive during this period of rate volatility, but we have seen a peak in pricing and should see easing begin later this year if Federal Reserve rate cuts materializes as expected.
Cash out: For borrowers with existing equity in legacy assets, many are refinancing in the current market for proceeds to deploy into challenged assets. This strategy can also provide repositioning funding for assets in transition at a cheaper price than bridge financing.
Extended amortization: Agency lenders are willing, for qualified borrowers, to go up to 35-year amortization to enhance cash flows and facilitate debt service coverage.
Participating: Where expanding an equity position is required, life companies have introduced participation loans as an option to preferred equity or traditional mezzanine debt. These loans allow them to participate in operative cash flows beyond debt service.
Bridge-to-bridge: For projects in transition where an investment plan has been disrupted, refinancing a bridge loan with another bridge loan remains a viable option. Debt funds will be a primary resource for these loans as banks have taken on a distant secondary position. Life companies are also a resource for bridge loans in select cases. Even though rates are higher, the thought is rates will come back down once the Fed’s signaled cuts materialize.
Affordability: Agencies are actively pursuing allocations targeting affordable assets and will reward qualifying projects with their best rates and terms which could include a 35-year amortization. The agencies can offer up to 60 percent LTV on non-cash out acquisitions and refinances on assets with less than 50 percent affordability. They can go up to 70 percent LTV if over 50 percent of the asset units are affordable.
Life companies: Pricing is competitive and life companies remain a preferred source for their straightforward underwriting and non-recourse terms. At a 1.50 DSCR or better, borrowers could be offered a spread as low as 120 bps over the 10-year treasury.
Agencies: Fannie and Freddie have an agency-compliant preferred senior mortgage plan that gets higher in the capital stack and can transition borrowers out of a bridge loan. Agencies will go up to 80 percent LTV with qualifying DSCR in place. At a 1.55 DSCR, pricing for 10-year debt could be as low as a 120 bps spread. At 80 percent LTV and a 1.25 DSCR, they will price higher by roughly 40 percent. Loans at the higher LTV range assume no affordability component.
CMBS: Has become a competitive option in today’s market climate for distressed assets or for those requiring a higher LTV. CMBS will fund at 70 to 75 percent LTV, and sometimes higher. Their terms are more rigid and while pre-payment flexibility is not an option, interest-only is.
Debt Funds: These structured lending platforms, including family offices and other private lenders, sense an opportunity in real estate from the absence of banks. Their money may be more expensive but is a workable option. They are active in funding bridge and construction loans and creative in both underwriting and LTV/LTC with the right sponsorship in place.