Fannie Mae, Freddie Mac, and the Federal Housing Administration held this industry together in the darkest days of the Great Recession. But as the economy slowly recovers, the private sector is growing more eager to pick up the slack.
Banks have jumped back aggressively, and an increasing number of them are using the balance sheet to go out longer than five years, which is traditionally the bank's sweet spot. A bank perm loan may be a little more expensive and offer a bit less leverage than an agency deal. But banks often feature more underwriting flexibility, such as more flexible prepayment structures.
Life insurance companies seem able to win any deal they really want, though their appetites are limited to low-leverage, high-quality deals located in urban core markets. On the opposite end of the spectrum, CMBS loans are being quoted in the high-5 percent, low-6 percent range and are still available for deals that don’t fit an agency execution—deals in tertiary markets or with challenged borrowers, for instance.
But it’s not just the menu of permanent loans that is expanding. Shorter-term loans, equity, and mezzanine/preferred equity financing from the private sector have also grown more available.
“Life companies, banks, equity, mezz, bridge—all of that capital came back very aggressively over the past 18 months," says Kevin Smith, a director at New York-based Centerline Capital Group, which opened an Alternative Capital Markets division to source non-agency money for its clients. "We’ve always had a strong agency platform, but there were situations where we would lose a deal to one of those capital sources.”
Here's a gauge of these capital sectors, and where rates are falling in each.
1. Bridge Loans
The bridge loan market has returned, with many loans going out as long as three years, some with two one-year extensions. Bridge loans are pricing anywhere from 300 to 500 basis points over the benchmark LIBOR, and usually topping out at 75 percent leverage, though some lenders will go up to 80 percent.
Yet, the way those deals are being underwritten has certainly changed. Today, bridge lenders aren’t as interested in investing in a deal based on the projected strength of a given submarket. “They’re going to do it based on a real tried-and-true business plan, whether it's investing in improving the asset, burning off concessions, or leasing up the balance of the units,” Smith says. “It has to be something where you can show there’s a real exit for the bridge lender.”
And there’s a tremendous demand for bridge financing these days—for acquisitions of assets that just aren’t ready for a prime-time agency execution, or newly constructed deals looking for a permanent takeout of a construction loan. For instance, Centerline’s new group is working on a bridge loan of around $115 million for a core acquisition deal that still has a lot of concessions to burn off, and management inefficiencies to correct.
2. Equity Capital
The equity market continues to be flush with capital, though some institutional investors are starting to pull back a little, waiting to see how the money they put out over the last 18 months will perform. Still, many of them continue to raise new funds.
Return expectations from equity investors are generally ranging from 12 to 14 percent for core assets, and up to the low-20 percent range for more opportunistic transactions, on a levered return basis.
Defensive refinancings will drive a lot of the demand for joint-venture equity and bridge capital over the next few years. The wave of highly levered CMBS deals maturing over the next few years will leave a lot of borrowers with a big financing hole to fill. “There’s going to be a huge gap between where deals are going to be underwritten today and the equity that’s provided,” Smith says. “We’ve seen it starting to happen already.”
3. Mezz Financing
While bridge loans are starting to flow again, the mezzanine financing space has been quiet for some time. Mezz for multifamily deals is generally pricing in the 10 percent to 12 percent range, reaching up to about 85 percent in the capital stack.
CMBS lenders were doing some mezzanine business earlier this year, holding the B-note in a fund, and Fannie Mae and Freddie Mac rolled out their programs last year. But those GSE mezz programs haven’t gained much traction. Freddie’s, in particular, has had a tough time, mainly because the mezz providers involved are operators, and borrowers aren’t necessarily jazzed about opening their books to a fellow competitor.
Preferred equity deals, instead, have become more common inhabitants of the capital stack for an agency deal. The bigger issue is that there just aren’t too many deals that can handle the high cost of mezzanine financing.