COVER STORY, AUGUST 2007

MULTIFAMILY FINANCING
Our experts weigh in on the state of multifamily financing.
Interviews by Stephanie Mayhew

Cap rates, swap rates, interest rates, the volatile CMBS market — just a few of the myriad of factors that can affect financing on commercial real estate projects and the state of the lending environment in the Northeast. Northeast Real Estate Business sat down this month with several experts in the financial industry to find out how multifamily financing is faring this year so far. Our experts include Steve Wendel, co-head of Deutsche Bank Berkshire Mortgage; David McLain, principal and chief investment officer of Palisades Financial, LLC; Avi Weinstock, executive vice president of Meridian Capital Group, LLC; and John J. Manginelli, the east regional manager for KeyBank Real Estate Capital’s Income Property Group for the Northeast region.

NREB: What multifamily loan products are particularly popular right now?

Wendel: Currently, due to the problems that the CMBS market is experiencing, Fannie Mae, Freddie Mac and to some extent FHA loans  become Deustche Bank’s more prominent products. These agencies have more of a long-term focus on multifamily, so the underwriting pricing criteria has stayed pretty steady as opposed to the CMBS lenders, which were more aggressive earlier in the year and are now experiencing a push from bond investors back to more conservative guidelines; thus, Fannie and Freddie are in the forefront again. In addition, over the last couple of years, a fair amount of our production has shifted to our own conduit and bridge financing programs. 

McLain: As traditional lenders tighten underwriting standards and reduce loan amounts, mezzanine products are in demand to fill the gap between the equity and the first loan position. The overall cost of mezzanine capital can be fixed and is cheaper than obtaining an equity partner where much of the upside profit has to be shared.  

Weinstock: Many people are concerned that we may have already seen the last of the low interest rates. Borrowers are seeking to lock in rates now before their loans mature to take advantage of current rates.

Manginelli: Developers are seeking out loan products such as equity/mezzanine and construction/interim products to build, reposition, and/or develop multifamily product.  On the rental product side, a high level of interest in construction/permanent products is apparent. Developers are focused on locking in rates for the permanent loan during the construction/development phase of a transaction to manage interest rate risk.

NREB:  How does multifamily lending in the Northeast compare to multifamily lending in other markets?

Wendel: The Northeast region is not that different from all other markets. Beginning in March, the 10-year treasury went up more than 50 basis points and swap spreads went up roughly 10 basis points, a 60-basis point increase that is directly impacting loan amounts. If you size a loan based on the same debt coverage you are going to lose approximately 10 percent in proceeds on your loan. Buyers will need maximum leverage to make their acquisitions work, making it more difficult going forward as long as rates stay where they are. If cap rates on acquisitions that sell don’t rise, the return hurdles are going to be tougher to meet because debt has simply become more expensive with a lower loan-to-value. Overall, if cap rates don’t adjust, transactions will start slowing down.

McLain: The high cost of housing in the Northeast has helped to maintain strong occupancy levels in the Northeast versus other markets. In many other markets, cheap housing and loans led to a quick flight to home ownership that quickly depressed occupancies and cash flow. Therefore, cash flow projections tend to be more stable in the Northeast than other parts of the country. Rent control laws, which are unique to the Northeast also impact underwriting and values because these laws restrict pricing.

Manginelli: Loan products and the reasons to utilize them are the same as in most other markets with the differences being the actual locations and resulting economics of transactions. In the urban/city markets of the Northeast, there will be higher density products such as high-rises, in addition to more urban mixed-use product that will most likely include portions of multifamily, retail/entertainment and office use. Construction and land costs have driven many markets, including the Northeast, into more of a for-sale condo type product versus a rental product. As the rental environment escalates in the Northeast there has been a shift back to a rental versus for-sale product.

NREB:  What geographical markets of the Northeast are hot for multifamily right now? Which ones are struggling?

Wendel: In general, the Northeast market is slightly more competitive than your average market because there are more banks, making it a tougher market on average than the rest of the country. As an above average competitive market, it is obvious that the Northeast isn’t really struggling due to the level of job creation and income generation throughout the market. The coastal markets have been exhibiting a high level of activity in the Northeast. From Philadelphia to New York City, the market has been very good, and areas such as Boston have remained steady and burgeoning markets such as Portland, Maine, have shown successful growth and activity. 

McLain: With the current sub-prime mortgage crises and rising home loan rates, home ownership has stalled in many areas and has strengthened the demand for multifamily throughout the Northeast.

Weinstock: With so much 1031 money and institutional investment available, every property is a hot property.

Manginelli: New York City and the surrounding markets, in addition to Washington, D.C., remain hot.

NREB:  How does multifamily lending right now compare with multifamily lending in 2006?

Wendel: Since 2004, the multifamily lending market has seen pretty steady growth. For example, in 2004, Deutsche Bank Berkshire probably did about $3 billion in lending and in 2007 we are anticipating that number to be above $5 billion. Furthermore, we anticipate that this year will be bigger because of the shut off of the condo conversion phase, which took some properties out of our servicing portfolio without even the chance of refinancing. This year, there have been more acquisitions of multifamily properties for multifamily; thus, right now and for the next quarter, Freddie Mac, Fannie Mae and FHA loans are going to continue to pick up market share from the conduits.

McLain: Apartments are currently in vogue right now due to the housing crisis; versus a year ago when investors were still seeking condo conversion opportunities. Lenders have to be careful as high prices are being paid for properties that far outstrip the income ability for these units.

Weinstock: Money is not being lent as freely as perhaps it was 1 year ago. During times like these, it makes particular sense for borrowers to rely more heavily on broker relationships with lenders to fine-tune their deals and obtain the financing they need.

Manginelli: There has and will continue to be a focus on structured finance transactions involving all levels of the capital stack — equity/mezzanine and senior debt capital possibly coupled with forward permanent capital placements.

NREB:  How do you think the lending environment will change during the second half of 2007?

Wendel: A month ago, I would have said that it looked like everything would be hitting on all cylinders, but right now I am not sure. Even in the past weeks, rates have gone up about 20 basis points on top of the 30 that they have already gone up.  This hike in rates is putting stress on every deal that is in the house, so it is hard to tell. It may be tougher to make deals work, which might make it tougher to lend on them.

McLain: The sub-prime mortgage crisis is just starting to impact hedge funds and Wall Street financial institutions. The ripple effect of this crisis could likely cause much tighter lending requirements; thus, lowering loan amounts being offered. The heady lending days of the late 90s through the current period are over, and borrowers are likely to encounter a much more difficult lending environment in the near future.

Weinstock: There is no question that a disconnect exists between buyers’ cap rates and interest rates.  It takes a lot more creativity to maximize financing for a purchaser when a building can’t support the debt service for the loan that is needed to make a deal happen.

Manginelli: We will continue to see more structured finance types of financing.

NREB:  How will changing interest rates affect the lending environment?

McLain:  Higher interest rates without a corresponding increase in property income will lower the amount of loans that borrowers can take and increase future equity requirements.  Higher rates will also increase CAP rates; thus, values could flatten or decrease in the future.

Manginelli: Loan sizing, as defined by debt service coverage and loan-to-value ratios, will generally govern the amount of capital financed in a transaction. Financing levels have been limited by debt service coverage ratios in the past several years and loan-to-value ratios have been at acceptable underwriting levels given cap rate compression, etc. As such, with rates having risen recently, loan sizing has become further limited by debt service coverage levels, assuming that no subsequent inflationary increases in rent levels occurs. Changing interest rates will alter loan sizing parameters, particularly debt service coverage ratios.

NREB:  Are there any other predictions you’d like to make regarding lending in the Northeast?

Wendel: The reason the lending market in the Northeast is so competitive is because of the land use restrictions and the difficulty involved in obtaining new construction permits. The land use restrictions mean less projects get built which creates more lending competition for those that do get built. Overall, the Northeast is viewed as an area of low risk propositions, especially in the primary and secondary markets, furthering the competition among lenders in this region.

McLain: Historically, the Northeast has been a more stable multifamily market than other areas; thus, lenders have tended to focus on this market over others that have higher and lower value swings. There should be plenty of loan opportunities in the Northeast as investors are shifting investment portfolios to target multifamily investment opportunities.

Manginelli: The continued trends towards mixed-use, high-density urban projects with multiple transportation options in the major Northeast cities will continue. Institutions will have to have the product set to ensure that they can finance all levels of capital, debt and equity for these projects.


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