A — August 17 - 30, 2012 — Mid Atlantic Real Estate Journal
www.marejournal.com
M ultifamily F inancing
By Edward D. Brown, NorthMarq Multifamily owners enjoy low rates and an abundance of capital
T
he historic low trea- sury rates that have been in place over the
agencies (provided implied not direct credit enhancement from the US government) who fund apartment loans primarily on terms from 5 to 10 years (can go to 30 years) with amortiza- tions typically between 25 and 30 years. Loan proceeds under these programs can approach 80% for acquisition loans or no cash out refinances and 75% for cash out refinances. Pric- ing is established via spreads over the benchmark 5, 7 and 10 year treasuries and recent 10 year quotes have ranged as low as 3.62% for full leverage structures. Each program typi- cally locks rate near the date of closing but there are options for early rate lock after significant underwriting requirements have been met. Agency loans are originated, underwritten and serviced through correspondent entities (FNMADelegated Underwriter Servicer “DUS” or Freddie Mac Approved Seller Servicer) which may be affiliated with banks, life companies, invest- ment banks or commercial mortgage bankers. These enti- ties execute all facets of the loan process with close adher- ence to program guidelines and obtain final approval of the loan terms from the agency. The agencies also have programs for specialty rental real estate including Student Housing, Affordable Housing, Senior Housing and Manufactured Home Communities (Fannie Mae only). In general they offer supe- rior rates, high leverage levels, supplemental funding options and interest only periods under certain underwriting scenarios. There is significant specula- tion regarding the future of these two agencies tied into the overall political discussions surrounding federal supported financing agencies. However for the present they remain the overwhelming preferred source of apartment financing and that should continue over the near term. The third government agency source providing capital to the multifamily market is the Federal Housing Administra- tion (FHA). Unlike Fannie and Freddie, FHA is a true government agency funded and operated by the US Govern- ment. It provides permanent financing for market rate and affordable housing through a series of different programs and also provides construc-
tion/ permanent loans for the development of apartment communities. FHA also has historic low rate structures and can provide more leverage (83% refinance and up to 90% of construction costs) than Fannie and Freddie but its process is longer and involves significant upfront expenses including market studies and a variety of underwriting exhibits prior to approval. If the Borrower has the time and inclination to follow the process the resulting loans can be extremely attrac- tive in terms of leverage, term and pricing. Life Insurance Companies The Life Insurance Compa- nies have traditionally pro- vided a meaningful portion of the financing for multifamily rental communities and the as- set class is at the top of the list for these investors. Many Life Companies withdrew from the market or significantly lowered funding targets for all com- mercial real estate during the recent economic downturn as they struggled with above aver- age delinquencies and default- ing loans in their portfolios. However they have re-emerged in the last two years to resume funding with a strong appetite. The Life Companies are most competitive on a rate basis for longer term executions (15 to 25 years) and can structure long term fully amortizing, fixed rate loans with competitive rates for conservative Borrow- ers in today’s market. Their rate structures tend to reward lower leverage Borrowers and they capture a significant share of this level of funding. The Life Companies also compete effectively because of the relative surety of execution that their process can deliver. As portfolio Lenders they offer more flexibility in negotiation of key loan terms, no funded reserves for replacements, a variety of prepayment options and strong servicing relation- ships either directly or through their local mortgage banking correspondents. They try and focus their apartment fund- ing in primary markets with proven, experienced sponsor- ship and often develop multiple transaction relationships with those key sponsors. Many Life Companies are represented in local markets by mortgage banking firms who serves as their exclusive correspondents providing origination, under- writing and servicing for their
loans. Some of these investors tend to be most aggressive in the early part of the year as they seek to fill funding quotas through competitive pricing. Most always reserve some of their best pricing for well lo- cated, quality apartment loans because of their history of low loan loss and delinquencies. Commercial Banks Historically commercial banks provided the bulk of the loan dollars necessary to fund construction of new apartment communities and short term “mini permanent” loans after stabilization of the newly con- structed units. However the recent economic downturn left many of the active construc- tion Lenders with significant delinquency and default issues for new construction (primar- ily single family residential and land development) and virtually stopped all construc- tion funding for a period while markets slowly recovered and loans were worked out. This created a shift in focus for the banks to the relative safety of income in place lending and like their fellow Lenders, apart- ment communities became the investment of choice. At first banks tended to be most competitive for shorter term fixed rate transactions (5 years) but as treasury rates continued to plummet we have seen banks now assume a highly competitive position for fixed rate term financing of apartments up to 10 years. They share some of the same competitive advantages as the life companies with flex- ibility of terms and negoti- ated conditions but also add the ability of the Borrower to interact directly with the indi- viduals approving their loan. As treasuries have reached historic lows many of the life companies have enacted rate floors to protect against overly weighting the total return of their loan portfolios at historic low rates. The banks however have not employed floors and simply assign an underwritten credit risk spread over libor plus an interest rate swap for the corresponding fixed rate term. The all in costs for these executions in today’s market can compete effectively below many life company quotes and sometimes fairly close to the Agencies. The Banks have traditionally required some level of personal
recourse to the Borrower but will waive that requirement for strong, moderate leverage (70 to 75% LTV) apartment loans thus removing one of the major competitive advantages of the Agencies and Life Insur- ance Companies. As a result they are winning more of the competitive multifamily loan business than ever and as long as treasury rates stay low this trend should continue. This loan activity is consistent for many large national and re- gional commercial banks all the way down to down to local savings institutions, credit unions and community banks. A level of conservative apart- ment construction financing has also returned as a result of the demand created by years of relative inactivity in virtu- ally all markets and the bank lenders view this product as an opportunity to secure future permanent financing for stabi- lized apartments. Mortgage Loan Conduits In the years from 2000 through early 2007 mortgage loan conduits became a major source of funding for all types of commercial real estate includ- ing multifamily communities. They tended to offer superior leverage and competitive pric- ing for a variety of properties and were more aggressive in evaluating loan and asset risk factors. As a result of this market stance the conduits ex- perienced significantly higher levels of loan delinquencies and defaults than their competing sources during the economic downturn. This effectively shut down the securitized com- mercial mortgage market for an extended period of time and the remnants of that seg- ment of the industry did not re-emerge until 2010. They resumed activity with a much more conservative approach and limited market appetite for the underlying bonds that fuel their funding. As the economy has slowly improved and mar- kets stabilized the conduit community has regained some market viability and has been quoting and closing business for a couple of years. However the shadow of the older over- leveraged product that is being worked out continues to create higher risk spreads in the mar- ket than their competitors. The conduits are also perceived to be subject to significant volatil- ity in spreads and funding from continued on page 9A
last couple of years have t r a n s l a t e d to a parallel contraction of nominal in- terest rates for commer- cial real es- tate mortgag-
Edward D. Brown
es. Nowhere is this low rate environment more evident than in the various segments of the apartment finance market. In addition to the low base trea- sury rates which establish the pricing for these loans (rates are typically established via a risk spread over benchmark term treasuries) there is also a flight by mortgage investors to the perceived safety of apart- ments as an asset class. The current strength of the overall apartment market is a result of the continued erosion of single family housing values since 2007/2008 and an increase in the pool of prospective renters. Negative perceptions of rental vs. homeownership have disap- peared as mobility and afford- ability now drive a larger por- tion of the residential market and that trend points toward healthy increases in apartment rentals in most markets. The Northeast has partici- pated in this rebound in apart- ment occupancy, rents per unit and sales price per unit that has created this overheated market for both investment and financ- ing for quality multifamily rental communities. There are multiple viable capital sources that offer attractive options for apartment owners seeking financing for their properties. Below is an overview of the major capital sources for apart- ments and a brief discussion of the competitive advantages and factors involved in evaluating each potential source: Agency Financing The largest source of mul- tifamily funding in the US is provided by the combination of the multifamily divisions of the Federal National Mortgage Association- FNMA (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation- FHLMC (“Freddie Mac”).In 2011 these two agencies pro- vided $44.7 billion or 64% of all apartment mortgages written in the US and they are ahead of that pace in 2012. Fannie and Freddie are quasi-governmental
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