By Mitch Walsh
Featured in Multi-Housing News
Despite lingering volatility, borrowers have ample options in 2025, writes Gantry's Mitch Walsh.
This year’s Mortgage Bankers Association’s Commercial Real Estate Finance conference in San Diego was upbeat overall. This points to a receptive climate for borrowers in the year ahead. Optimism was high for lenders charting their plans for 2025 allocations. Discussions included expectations for spreads to continue coming in, in a small way offsetting the stress of a higher-for-longer rate climate.
The MBA forecast the 10-year Treasury at 4.5 percent as the expected benchmark for this year, and for it to dance around above and below that figure in the months ahead, making timing a critical consideration for applications and closings. We are already seeing yields dip below that level at 4.4 percent as of this moment, a welcome respite after a quick run of volatility spiked yields into the high 4s after the Federal Reserve’s 2024 rate cuts. Regardless, debt options are more manageable today for most if not all investment plans at these levels.
Where is the money?
A key question for borrowers. What source is best to approach for an investment purchase or refinance? Almost all lenders are prioritizing multifamily allocations at the top of their desired asset classes for loans. For borrowers, that means options are extensive, with life companies and agencies often the best choices with the most competitive programs for permanent debt. Bank and CMBS lenders are also offering strong permanent options best suited for specific circumstances. Bridge lenders will also include a growing number of debt funds and private lending sources that will compete alongside banks and some life companies in this space. Preferred and participation equity is available for assets requiring more cash-in to right-side debt service during refinance.
Life companies
Insurance lenders were clear on goals to maintain or even increase their allocations to real estate lending in 2025. They will be focused on core assets, with DSCR requirements consistently at 1.30 or better. They primarily focus on primary and secondary markets around the country, however, will work with correspondents on exceptions to that rule. A clear advantage for the insurance lenders is their willingness to lock a rate at application. Their loans are non-recourse. Also, they have a streamlined underwriting process that flows after application, and an earned reputation for certainty of close. They are more conservative on leverage but will be flexible on interest only requests that meet certain DSCR coverages. They are active in today’s market and have done a great job filling the void as banks retreated from new underwriting as Fed rate increase impacted their balance sheet.
Some life companies have the ability to retire construction debt on new builds by providing permanent financing before full stabilization. If leasing trends and market conditions suggest the project will meet performance targets early in the loan term, these lenders may offer a solution that eliminates the need for costly bridge-to-bridge financing. This can provide relief to quality projects facing delays due to rising costs and supply-chain disruptions.
The agencies
Agencies will be competitive on spread as the year begins and increase their allocation targets from 2024, which they did not meet last year. Agency lenders will remain the leading option for assets in secondary and tertiary markets where life companies are a little less comfortable. They will be a strong resource for B and C class properties, as well as Class A. Their best terms will be reserved for borrowers that can meet their affordability criteria, which can allow them to amortize on a 35-year schedule in select instances. They will dip down to a 1.25 DSCR and will lock the rate before closing, although not at application. That leaves some room for volatility to impact a transaction. Upfront due diligence is a bit more of a heavy lift. Agency lenders are able to grant interest-only terms to maximize proceeds at their lower DSCR thresholds. They are also a nonrecourse lender.
Banks and credit unions
Regional banks and business banks are slowly returning to the market to compete as their balance sheets improve and liquidity returns. They are a particularly competitive source for small -balance deals. Banks are also a great resource in secondary and tertiary markets and compete with agencies in this space. Their underwriting is more sponsor-driven than other lender types. However, they are often pricing their fixed rate debt in a higher range, resulting in loans with rates from 6.75 to 7.25 percent, higher than the agencies and life companies. Bank loans will often be recourse driven and require some form of depositor relationship as well as performance clauses that could reset terms in tough circumstances. However, in many cases, their willingness to go super local while placing their loans makes them an appealing option even at a higher rate threshold.
CMBS
CMBS deals are extremely viable for larger transactions and popular again with investors, due to improved underwriting standards. These loans will be most susceptible to rate volatility as they do not lock the rate until closing. The underwriting process for CMBS loans is a far more complicated process and not as timely and efficient as processing life company or agency loans, however they have the ability to go to higher leverage points, lower DSCR and mostly feature interest only terms. There are also five-year CMBS programs in the marketplace, an evolution that meets borrowers hoping for a better rate climate in the relatively near future and planning for an earlier exit without the longer commitment.
Rate volatility
Before we begin to see core assets trade, most attendees I spoke with believe we will need to see volatility settle down. We saw the most sales activity in 2024 during the Q2 and Q3, when yields were consistently trending or holding in the lower range of the current cycle. The spike that sent the Treasury skyward when Fed rate cuts ensued and put volatility back into the mix at the tail end of an improving year, stalled the market again at the close of 2024. The market is looking for stability, and if the Treasury holds stable at 4.5 percent, or hopefully below, we expect to see the market transacting again in 2025 with manageable permanent loans and bridge acquisition financing readily available.
Pain points in 2025
For borrowers that pursued extensions in the rate climate of 2022, 2023 and 2024, my initial takeaway from lender conversations is that the era of extend-and-pretend is over. Expectations are that rate- challenged assets that kicked the can on maturities but were unable to achieve enhanced performance or secure additional equity will ultimately have to become distressed sales, with the majority these assets being class C properties. The most stress is at the lower-mid to lower-level properties that don’t have the amenity offering and were unable to meet the market with a strategic unit repositioning. Projects that were underwritten for rent growth that didn’t anticipate or plan for a rising interest rate climate are especially vulnerable as short-term debt is resetting and rate buydowns expiring. Bridge-to-bridge options will exist but will require a clear exit strategy to meet the moment.
Debt conditions are improving and lender optimism for a productive year are based on the real fundamentals of a resilient and healing market. As highlighted above, there are an abundance of options to consider when sourcing debt in the months ahead. A temporary softening in multifamily rents in some overbuilt markets is expected to tighten once again toward Q3 and beyond. Overall, most assets with maturing debt can find a permanent solution, many with proceeds available to retire debt. If the 10-year can hold below 4.5 percent, and move closer to 4 percent, we should see a healthy investment market return. Let’s get busy.