It was Oct. 15, 2014, and Mike Kavanau was trying to lock up his latest apartment deal. His client was seeking permanent acquisition debt financing for a $120 million, Class A luxury tower in downtown Chicago.
Then, the bottom of the market dropped out.
In the span of just 10 minutes, the yield on 10-year Treasury notes fell dramatically, plunging nearly 35 basis points from the open, the biggest drop in the market in five years. The event would eventually become known as the Treasury Bond “flash crash” of 2014.
Just minutes later, Kavanau, senior managing director at multifamily finance brokerage HFF, went to pull the trigger.
But with the debt markets going berserk, his options were quickly drying up. Some of the 22 primary bond dealers who trade directly with the U.S. Treasury started shutting down their machines. They were trying to avoid being forced into losing trades when their computers automatically generated quotes to customers. That tamped down liquidity in the bond markets, and the tightening quickly rippled to other areas of the debt market, including lenders of multifamily loans.
Suddenly, life insurance companies, which typically win the highest-quality debt deals on Class A assets in primary markets, had disappeared. Same with many of the banks and private lenders with whom the life companies compete. Even conduit lenders, the purveyors of commercial mortgage-backed securities (CMBSs), which typically take deals other lenders may think risky, were gone. On that October morning, it seemed as if almost everyone was quickly retreating to the sidelines, wary of trying to catch a falling knife.
Everyone, that is, except the government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, as well as the Federal Housing Administration (FHA). As Kavanau gazed at his screen, he saw that Freddie Mac was still standing, dealing in the middle of the maelstrom as sub–2 percent Treasury yields blew through the market. On the day when liquidity was slowing to a trickle, the GSEs did what they’re expected to do: They provided liquidity, and Kavanau got his lock.
“We didn’t get it at the bottom, but we got it right after it started on the way back up,” Kavanau says. The result was a 10-year, interest-only loan through Freddie Mac at 100 basis points over Treasury yields, or 3.20 percent. “In my 27-year career here at HFF, if I think about sub–4 percent money, with good leverage and interest-only terms, that’s pretty much lending nirvana.”
And the fact that Kavanau was able to get those terms for his client through a GSE made all the difference. “Freddie Mac was the only lender that would comfortably lock that rate that day,” Kavanau says. “Most of the life companies were on the sidelines. CMBS completely went to the sidelines. And the banks were concerned. But the agencies—that’s one of their jobs. They were in the market, and that allowed us to lock at an exceptional rate.”
Dilettantes of Debt
While the Oct. 15 tale of the tape is an extreme example, Kavanau’s win for his client illustrates an enduring facet of the multifamily debt market; namely, while insurance companies and banks have been gaining market share by offering more flexibility, and conduit lenders have shed the stigma they shouldered coming out of the Great Recession to take on secondary and tertiary deals, when it comes to multifamily lending, the agencies are still the debt kings.
“If we’re talking about multifamily capital for apartments, the agencies are extremely competitive,” says Mike May, senior managing director at financing intermediary Cantor Commercial Real Estate. “Even as new entrants have come into the market, they’ve been pretty quick to defend their market position, whether with their fixed-rate or floating-rate product. Particularly over the last year, they’ve done a great job to enhance their products and respond quickly to market forces.”
Indeed, while the Mortgage Bankers Association (MBA) estimates that 39 percent of all multifamily lending originated from commercial banks, thrifts, and credit unions in 2013 (the latest annual data available), the majority of that activity was fragmented into smaller loans, with an average size of just $1.9 million.
For larger deals, Fannie and Freddie took the lion’s share, generating $47.6 billion in multifamily loans, or 28 percent of the total, with an average deal size of $12.5 million. Life insurance companies won the biggest deals, with an average loan size of $22 million, but had an overall volume of just $18.7 billion, or 11 percent of all multifamily lending. CMBS, for its part, accounted for $6.7 billion, or 4 percent of the total.
Source: Mortgage Bankers Association, October 2014
Multifamily lending hit a record volume of $172.5 billion in 2013, according to the MBA, and that trend only picked up pace last year. Through the third quarter of 2014, year-to-date dollar volume had increased 4 percent for multifamily, with a 41 percent increase, year over year, during the third quarter.
Source: Mortgage Bankers Association, October 2014
But within that span, the GSEs absolutely killed it. Fannie and Freddie increased their dollar volume of multifamily and commercial loans by 118 percent in the third quarter, year over year. In other words, in a growing market, the GSEs are winning more and more of the dollars being lent. They were followed by CMBS, up 47 percent in Q3 from a year earlier, and life insurance companies, which gained 1 percent. Commercial banks, meanwhile, saw a 16 percent decrease in dollars lent during the same period.
For debt dealmakers like HFF’s Kavanau, that increase in GSE dominance just makes sense, and will likely continue through 2015. “The significant majority of our business, call it mainstream, permanent, fixed-rate financing on better assets, is going to the agencies,” Kavanau says. “They are still the go-to lender. They’re built to handle those kinds of flows. That’s all they do, so they’re really good at it. I don’t see any reason for them to slow down.”
Other People’s Money
The bottom line here is that if you’re looking for a lender in 2015, you’ll definitely want to at least talk to the agencies. But keep in mind, depending on what type of deal you’re looking for; how much loan to value (LTV) you want; which markets you’re building, buying, or rehabbing in; and whether you’ve still got a few blemishes on your track record from the dark days of 2007 and 2008, your choices abound from the agencies as well as other debt purveyors.
“For borrowers, the current timing and trends could not be better,” says Guy Johnson, vice chairman of capital markets at lender Walker & Dunlop. “With a continuation of low interest rates and increasingly aggressive lending terms, there are a wide variety of options available, including interest-only, leverage, and limiting recourse.”
While the GSEs offer stiff competition, other lenders are carving out victories on a deal-by-deal basis.
“A lot of times, it’s coming down to which lender is hungriest at that moment in time,” says Marc Robinson, co-founder of apartment brokerage Multi Housing Advisors (MHA). “Who’s got a monthly quota to fill, or which producer is going to push the hardest?”
Shahram Siddiqui, a partner on the business, finance, and tax team at law firm Berger Singerman in Miami, has been seeing multiple offers in his market. “For the best deals, it’s not uncommon to have three or four lenders bidding for the loan,” Siddiqui says. “Sponsors will pick their terms—generally, covenant lite—with the lowest rate possible, and lenders will be as accommodating as they think they need to be to win the loan.”
In other words, just like Len in those Lending Tree commercials on TV, today’s multifamily lenders are competing over you. (For best terms, though, we still don’t recommend negotiating in your underwear.) Each area of the market serves varying scenarios differently, which might make them stand out in a given situation.
A Debt Deal for Everyone
Walker & Dunlop’s Johnson breaks it down succinctly.
“Fannie and Freddie have remained competitive by seeking shorter hold periods with maximum leverage and interest-only terms on large structures,” he says. “CMBS has been popular among leverage-driven borrowers, who want higher cash-on-cash returns with interest-only debt. Life companies have generally been confined to conservative refinances and institutional acquisition financing [at lower LTVs]. And banks are seeking recourse guarantees, shorter amortization schedules, and relationship deposits. They tend to focus more on the borrower than the real estate itself.”
CMBS conduit lenders have also been willing to venture into secondary and tertiary markets, not just the shiny cities on the coasts, and are more forgiving if you made a misstep or two during the unwinding in 2007 and 2008. They also offer nonrecourse terms, meaning if your business goes bust, they won’t come after your personal assets. And, as Johnson’s description implies, they stand out in higher-leverage deals.
“CMBS seems to be the most aggressive when it comes to higher LTVs,” says Danny York, president of Franklin Street Capital Advisors. Life insurance companies, on the other hand, will typically get you the best rate on Class A, well-located product, and maybe within 40 basis points of benchmark Treasuries. But their loan-to-value percentages are lower, say 65 percent, so if what you’re really looking for is increased proceeds, you’ll need to look elsewhere and pay more.
“Rates at this point are often a function of LTV—the less leverage you’ve got, the lower the rate,” says York. That’s one of the reasons, for example, that life companies are writing deals on the best Class A properties.
Terms have an effect too. For instance, you’ll likely pay a quarter point less for a five-year deal than for one that stretches to seven years. Count on a quarter point more at each step if you extend to 10 or 12 years, says Josh Goldfarb, Robinson’s co-founder at MHA.
Looser, but Not Loopy
With all those options, borrowing has gotten easier, especially compared with the clamp-down days of the Great Recession. “Across the board, lenders have slowly loosened their underwriting requirements, financing deals at greater and greater LTVs,” says Bobby Bakhchi, CEO of capital advisory firm Hybrid Capital. “Even in the last 12 months, credit spreads have narrowed across the board. The same applies to interest-only loans. This is an excellent time for sponsors.”
That means you can pack more perks into your loan today.
“A year and a half ago, nonrecourse borrowers were relegated to the world of the GSEs and CMBS,” says Deme Mekras, a broker at Franklin Street Real Estate. “Today, you have more options. Some balance-sheet lenders [life insurance companies] have re-emerged with nonrecourse options. Same is true for max proceeds or the highest loan to value available.
“Two years ago, your best shot was with CMBS. Today, most lenders are feeling really safe at 75 percent LTV on stabilized deals. Some deals even have bridge options pushing 85 percent on loan to cost.”
Despite those plentiful offerings, debt mavens say the market hasn’t overheated. Few would characterize today’s climate as anywhere near the go-go days of the mid-2000s.
“Debt has once again become quite attractive, which means lenders are becoming more aggressive,” says Mekras. “But I think it’s important to note that lenders have not checked their underwriting thresholds at the door. Aggressive does not equal irresponsible.”
It also means that closing your loan today, while you’ll be courted by a number of debt suitors, isn’t a gimme. You’ve still got to be on your A-game when you go to apply.
“There is substantially more borrower scrutiny now than there was six to seven years ago,” says York. “Lenders want to know that they can make a decent return on the investment if they should need to foreclose. And tertiary markets are receiving much more scrutiny too. If lenders start treating Tifton, Georgia, the same as Atlanta, we should be concerned, but for now, I think there’s still a safety net in place.”
Or, as Guy Johnson sees it, “Today, much of the underwriting is done to near perfection.”
That means you want to paint as complete a picture of your deal as possible when seeking your loan. “Make sure you have realistic goals, and be up front with the lenders on what [those goals] are,” says Tim Petersen, CFO of Altman Cos., a Boca Raton, Fla.–based owner and manager of 4,800 units. “A fast no is better than a slow maybe that leads to no when all the facts come out.”
The Other Shoe
If there’s one cloud of nagging doubt hanging over the current lending party, it’s gauging how long the party can continue. Most expect 2015 to look much like 2014—subject to the unknown of interest rates.
“If there were a steep rise in interest rates with rental rate increases lagging, you could see unhedged floating-rate borrowers unable to cover debt service,” says Petersen. “It’s the kind of scenario that makes me sleep like a baby—up every two hours.”
But observers also worry about other factors important to sustaining the current trend.
“The multifamily market is extremely attractive right now, largely due to the increased market interest in a more mobile lifestyle and decreases in homeownership,” says Johnson. “However, if demand for homeownership begins to increase again, or rent rates continue to rise ahead of employment and income growth, that would impact the market.”
It’s that kind of potential impact that worries Cantor Commercial’s May, especially when he hears the current industry saw that young people don’t want to own homes anymore.
“Anytime I hear the term ‘paradigm shift,’ I want to run away,” May says. “And that’s what you hear at all the conferences when folks say people today would rather rent than own. I’m not sure I necessarily believe that.”
In May’s view, two factors are stopping today’s renters from buying: Mortgages are still hard to get for many, and the down-payment requirements are still high for workers recovering from the Great Recession.
“If those issues were resolved, and anyone with halfway decent credit could put a 3 percent down payment on a mortgage and have a lender make that loan with confidence, there would suddenly be a huge demand for single-family homes,” May says. “And that, I believe, would come at the expense of the apartment market.”
But until that day comes, the agencies and other lenders are happy to provide the alternative: plentiful loans for multifamily borrowers.