COVER STORY, FEBRUARY 2006
Multifamily Finance
Northeast Real Estate Business talks to lenders and mortgage brokers about the year to come in multifamily finance. Interviews by Nicole Thompson
Northeast Real Estate Business recently spoke with four financial institutions active in the multifamily arena to gauge market activity. Mark Bahiri is a vice president with Madison Realty Capital, a New York City-based direct lender that specializes in short-term commercial financing. Thomas Economou is a senior vice president for lending with Park Avenue Bank, a New York City-based direct lender and intermediary that focuses on the East Coast, primarily the New York/ New Jersey/ Connecticut/ Pennsylvania region. Dan Palmier is the president and CEO of Boston-based Potomac Realty Capital LLC, a direct lender that services loans nationally. Gregg Winter is the president of Winter & Company Commercial Real Estate Finance, a commercial mortgage broker, and W Financial Mortgage Fund, a direct private lender, both based in New York City.
NREB: What loan products do you anticipate being popular for multifamily product in 2006?
Bahiri: There always will be clients looking for fast money to aid in the purchase or refinance of multifamily housing projects.
Economou: We expect an increased demand in short-term, interest-only bridge loans as investors identify properties with upside potential, but require capital expenditure and repositioning in their respective markets as well as properties held for condominium conversion. Given the slow rise in long-term interest rates, we also anticipate a greater demand for long-term fixed-rate permanent loans for properties with stabilized cash flows.
Palmier: Given that interest rates are still at a historically low level and capital being very available, I believe that permanent loans, both conduit and agency, will continue to be in high demand. At Potomac, about 50 percent of our volume consists of permanent loan structures. The other half are structured or specialty finance products such as bridge, mezzanine and preferred equity structures. Recently, we have been seeing a growing need for specialty finance products as more owner/operators are valuing the flexibility and added liquidity these structures provide versus the permanent loan alternatives. Our borrowers are looking for a one-stop source of capital that is flexible, creative and entrepreneurial.
Winter: Given the current bizarre yield curve, long-term fixed-rate products should continue to fly off the shelves in 2006.
NREB: What trends are you seeing in multifamily real estate financing?
Bahiri: Well, with the boom in the real estate market many potential borrowers are seeking conversion money or new development loans.
Economou: The inquiries we have received center upon short-term, interest-only loans (3 years) enabling investors to observe where real estate values and interest rates are headed. Depending on the trend, that will determine their strategy on whether to hold the property as a rental for future conversion to condominiums or to convert to condominiums immediately.
Palmier: One key trend that we are experiencing is the need for flexible loan terms versus commoditized loan structures. This trend is particularly acute in recovering markets whose properties exhibit poor historical results. Most borrowers are entrepreneurs who see the ability to create value in their real estate portfolios. These entrepreneurs have a choice to invest their equity in either real estate or some other commoditized fixed income investment. With the over-commoditization of the commercial mortgage industry, I see a growing need for financing products that are aligned and underwritten in a manner that is consistent with a borrower's unique needs.
Winter: Lenders may begin to shy away from offering several years of interest-only financing as concerns mount that cap rates will finally begin to rise in the coming years. In addition, for new development/construction, lenders are clearly trending toward pulling back on leverage by 5 percent or so on their loan-to-cost level of comfort.
NREB: How does multifamily lending in the Northeast compare to multifamily lending in other markets?
Bahiri: Depending on the specific regional market, we are seeing various demand for multifamily. In general, we find the Northeast multifamily market to be very healthy.
Palmier: Potomac is a national lender headquartered in Boston, with additional offices in New York, Baltimore, Atlanta and Miami. The national multifamily market, like a lot of other markets, is clearly one we feel comfortable with and its attributes dovetail with the global niche factors of our lending platform. Potomac makes investments in transactions that may have value-added stories, Class B and C assets and that are located in in-fill locations.
Winter: Unique demand drivers, barriers to entry and tough zoning help to keep supply more in line with demand in the Northeast. This creates natural buffers to better insulate the Northeast from the overbuilding that can more readily occur in markets like the Southeast.
NREB: What geographical markets of the Northeast are hot for multifamily? Will those markets see continued growth in 2006?
Bahiri: We're finding the New York/ New Jersey/ Connecticut tri-state area to be the hottest market in our region. Hopefully we'll continue to see growth but my inclination is that the market may slow down a bit and stabilize itself.
Economou: Many middle-market investors are finding better returns in low- and mid-rise apartment complexes in secondary markets compared to major markets like the New York metropolitan area. These markets should continue to grow, but only if the local and national economies remain stable and/or improve. A single nationally based or regionally based company drives the local economy of a number of these secondary markets. Layoffs or worse — a shut down of a division or the entire operation — could severely impede the areas continued growth.
Palmier: During the past 14 months, Potomac has funded $1 billion in loans within the Mid-Atlantic and Northeast areas. I am confident that we will continue to see growth in those markets throughout 2006. This is largely attributed to the low supply of multifamily units on the market as a result of an increase in condominium conversions and a recovering economy.
NREB: What makes financing in one multifamily market better than another?
Bahiri: Market demand for multifamily housing is the largest factor that determines the viability of the property. Other characteristics such as historical data and borrower credentials are extremely important as well.
Economou: Diversity in business sectors driving the local economy and a diverse population. A major metropolitan area like New York City has a wide array of services driving its economy. In addition, foreign investors are attracted to a market like New York City because of its diverse needs and opportunities.
NREB: What do you predict for multifamily financing in the next year?
Bahiri: I anticipate a continuation of the strong market we have been seeing.
Economou: At least for the markets in which Park Avenue Bank is involved, we expect a reduction in the number of properties acquired for immediate condominium conversion and thereby a reduction in values. Lenders have been and will continue underwriting loans based on a property's value as a rental property and not on a gross condominium sellout basis. Lenders base the loan amount on the property's actual cash flow and not the expected income from the sale of the individual units. On the basis, borrowers are required to infuse more equity.
Palmier: I think the conduit and agency business will continue to be a fiercely competitive environment throughout 2006. I also am seeing a growing demand for structured loan products.
NREB: What types of multifamily products are most attractive for lenders and why?
Economou: Adjustable rate and/or floating rate loans. This way there is little interest rate risk.
Palmier: Structured loan products are more attractive because they possess a wider profit margin, due to the inherent risks and uniqueness of the underlying collateral.
NREB: How will changing interest rates affect the multifamily lending environment?
Bahiri: As the federal funds rate continues to rise, most lenders in turn will raise rates, which will increase the cost of maintenance. In the end, we'll find the consumer paying the ultimate price of such changing interest rates.
Economou: We should have a better indication of this after the first Federal Open Market Committee meeting in 2006. If rates remain unchanged, I would expect floating rates to drive the market with borrowers paying close attention to the effect on long-term rates.
Palmier: Increases in interest rates will have a significant impact on the lending environment. For our platform, we have seen a clamoring of borrowers refinancing with permanent loans and using our subordinate loan products to amplify their needs to leverage their real estate fully. With increased interest rates, I believe the permanent loan market will slow down. This will have a significant positive impact on the need for structured finance products, including mezzanine and preferred equity products.
NREB: What are the biggest factors affecting the real estate financing industry? How so?
Bahiri: The potential housing bubble enticed many to put their homes on the market. This factor, coupled with a surge in new home construction, generated the largest number of residences on the market in recent history for November of 2005. A problem may occur as residential lenders continue to offer enticing loan products with little or no money down and floating interest rates. If fed rates continue to rise, the potential exists for consumers to find themselves slowly unable to afford servicing such large amounts of debt.
Economou: We believe there are three factors that will continue to have the greatest impact on the real estate industry. One big factor affecting the real estate financing industry is concern over higher interest rates, which leads to less buying power. Additionally, the uncertainty of the strength of the euro versus the U.S. dollar is a big factor affecting the real estate financing industry. If the euro continues to remain at current levels, European investors will continue to invest in strong markets like the New York metropolitan area. Their participation may lessen should the U.S. dollar gain ground on the euro. Finally, the U.S. economy as a whole — will individuals who can afford the higher prices for homes and luxury apartments venture to make the high-end purchase or will they wait for prices to decline as uncertainty of Wall Street and the economy weigh on the minds of potential buyers?
Palmier: Key factors that affect real estate finance include downward pressure on cap rates, high volume of condo conversions, number of lenders, overall commoditization of mortgage loan structures and lack of lender creativity and service orientation. As a result, I feel that there is an absolute need in the marketplace to provide maximum creativity and flexibility in loan structures, while fully servicing customers from origination through loan payoff.
NREB: Are there any other predictions you'd like to make regarding multifamily lending in the Northeast?
Palmier: Throughout the third and fourth quarters of 2005, we have seen numerous opportunities to finance value-added real estate transactions including real estate requiring renovation in turnaround markets and multifamily properties undergoing conversions into condominiums.
In 2006, the condominium market will continue to weaken. There have been signs that lenders have become more cautious with a growing number of non-entrepreneurial lenders being more conservative in underwriting. Thus, there will be a significant need for more entrepreneurial capital.
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