of the most basic human needs is shelter.[/b] Even the little old lady was willing to set up shop in a used shoe to ensure she had a roof over her head during the hard times. The absolute necessity of housing is perhaps the most fundamental principle behind current multifamily lending trends. Lack of consumer confidence during this economic crisis has greatly hurt the retail market, which, in turn, has affected the industrial market. Office and hospitality have also been battered, but multifamily lending has not suffered quite as much, and multifamily financing is still available if the borrower knows what to expect and where to look. There was a common misconception in the market that the dramatic fall in single-family housing prices would allow many renters to move up from renting to homeownership, but this trend has not occurred. The home-lending arena is more conservative than ever, making it extremely difficult for potential home buyers to qualify for loans. In some areas, only 50% of applicants are being approved for home loans. These homeownership challenges should have a positive effect on multifamily occupancy rates. However, vacancy rates are increasing in the current market. More and more renters are doubling up with roommates or moving in with relatives as the recession continues to take its toll on employment. For general underwriting of multifamily loans, rents are not being trended at all, as lenders are beginning to assume that these figures could stay flat. In addition, appraisers are having difficulty finding good realistic comps and are occasionally using cap rates higher than the most recent sales. Expenses are also staying flat – with no major increases expected. Multifamily properties that have undergone a reassessment resulting in lower property taxes may make lenders somewhat more willing to underwrite a loan to the new, reduced amount. At the same time, however, many banks are not lending at all or are lending only to clients with whom they have strong existing relationships. Generally speaking, most lenders that are still active will see multifamily as the preferred product in the market, and some banks are currently willing to lend very selectively to new customers. All of these financiers will want full recourse and are underwriting conservatively, at a 65% to 70% loan-to-value ratio (LTV) and with a 1.25 debt-coverage ratio. In addition, life insurance companies and credit unions are still willing to lend on multifamily projects, but both will usually seek only relatively small deals. Life insurance companies are willing to underwrite $5 million to $10 million transactions at 65% LTV. They will use higher-than-market cap rates – at least 7.5% to 8% – and a 1.25 debt-coverage ratio. Most equity lenders and mezzanine lenders, meanwhile, have temporarily redirected most of their efforts to buying or financing distressed notes or real estate owned properties and are not interested in financing conventional acquisitions or developments. However, some mezzanine lenders are still lending on cashflowing assets – down to a 1.10 debt-coverage ratio and at perhaps 80% LTV, with mid-teen rates. There are also still a few select nonrecourse bridge lenders that have just reentered the market or are considering entering the market with a preference for apartments. Their rates are generally 8% to 9% for two to three years, with a 60% to 70% LTV, along with significant origination fees and exit fees. [i][b]Other choices[/b][/i] Government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac have provided the only moderately aggressive programs for multifamily projects in the past six months. The complication with both options is that Fannie Mae's and Freddie Mac's programs and underwriting standards change constantly, and neither will establish its final criteria to determine rates or the loan amount until the property underwriting is complete. One fear in the multifamily sector is that Congress could place rate caps or limit the amount of money available from Fannie and Freddie. Congress may break these entities apart, nationalize them or even privatize them. If Fannie Mae or Freddie Mac were nationalized, there would be great concern that they might direct more of their available capital to affordable housing, taking money away from conventional multifamily financing – which is where Fannie and Freddie have had their biggest impacts. Moreover, if these key GSE programs were to leave the market or reduce their access, cap rates for multifamily lending would spike overnight. Their current availability is what is keeping returns high and cap rates down for apartment projects. The origination of multifamily loans in the current market has experienced several significant new developments. More equity is required on all projects, along with full recourse. The required rate of return for institutional equity investors has also increased. Large loans are very difficult to secure in today's market, because banks will no longer take any syndication risk. This limitation has had a major impact on new construction for multifamily projects. Only a very limited amount of construction financing is occurring. With cap rates on the rise and lenders discounting distressed properties, it is often possible to purchase existing projects below replacement cost, making it uneconomical to begin construction on a new development. The only new construction financing still available in the market is generally being granted for urban infill and some mixed-use projects that seem especially likely to succeed. These types of projects are being financed with conventional construction loans with substantial equity from relationship banks. Some Department of Housing and Urban Development (HUD) loans are also available for new construction, but these loans take more than 12 months to process. Tax-exempt financing and other affordable construction loan programs are also difficult to use right now. The purchase prices offered for tax credits are very low, and the rates for tax-exempt bonds are very high, as the credit of most local governments has declined recently. All of these challenges point to an uphill battle in the multifamily sector, as lenders continue to be conservative, waiting to see how deep the recession will go. At the same time, it is important to remember that while the market is under stress, multifamily lending is still occurring. An experienced borrower in a non-declining market is the most appealing to lenders in this conservative climate. A strong management company, good records with at least 12 months of stable history and a limited amount of cash-out will aid borrowers in successfully navigating the current multifamily lending environment. The remainder of this year promises to bring a great deal of watching, waiting and struggling for multifamily projects. Things will likely get worse before they get better. Still, multifamily remains the favorite product to lend on, providing opportunity for experienced borrowers knowledgeable about the challenges they will face. [i]Steve Bram is president and co-founder of George Smith Partners Inc. He has arranged over $2.5 billion of financing in over 150 transactions during his 25 years with the company, including all types of construction, bridge and permanent financing on commercial and residential properties, along with joint venture and equity placements. He can be contacted at (310) 557-8336 or sbram@gspartners.com
