Finding capital for a value-add deal has been a tough task this year.

Many lenders are still shell-shocked from the acq/rehab boom seen at the height of the last upturn. Balance sheets continue to be weighted down by ambitious value-add plays that never delivered the expected results. But as fundamentals continue to improve in many markets this year, more lenders are slowly starting to grow comfortable with the idea of underwriting rent growth.

“More people are talking about it now because there is finally some debt available for it,” says Bill Hughes, managing director of Encino, Calif.-based Marcus & Millichap Capital Corp. “Six months ago, no one had enough confidence in the marketplace to take the risk of a property stabilizing over a period of time. Now there are a number of different financial institutions, typically private funds, that will provide that kind of financing.”

While the government-sponsored enterprises (GSEs) dominate the debt market, they’ve shied away from the repositioning market. Fannie Mae and Freddie Mac technically have acquisition/rehab programs, but they are basically on the shelf as the GSEs continue to privilege and furiously process deals for stabilized assets.

Most of the acq/rehab business being discussed now is on a small scale—bringing a B-plus up to an A-minus for instance. The rehabs that change the nature of a property—such as bringing a Class C up to a Class B—have a much more difficult time finding financing.

“We won’t make that loan; we’re not going to speculate on that type of transformation.” says Mike May, senior vice president at McLean, Va.-based Freddie Mac. “In fact, some of our largest problem assets are exactly that.”

Yet, many private sector lenders are growing more confident with the ability to get a pop in rents through rehab. Bridge loans are available and while rates vary wildly from deal to deal, some lenders are offering these short-term loans for as low as 6 percent (though it ranges up into the mid-teens).

Some of the active providers today include Ladder Capital, BB&T Real Estate Funding, Starwood Capital, GE Capital, Canyon Johnson, and A10 Capital. While these sources have been in the market all year, their focus is changing as the economy improves.

“Bridge programs have been around, but what you could use them for six months ago was basically for stabilized properties,”  Hughes says. “Now, we’re seeing bridge product move into the arena of value-add.”

Berkadia will start a bridge program next year, and CWCapital and Walker & Dunlop are also mulling whether to start a bridge debt program, though the focus initially would be low-risk, a feeder to their agency executions.

“One of the things we’re looking at is if there’s sufficient need and opportunities within that space,” says Don King, national production manager of agency lending at Boston-based CWCapital. “We’re seeing at the property level NOIs improve across the country, and any time you have that dynamic, it makes it a lot easier for interim lenders, bridge lenders to look at an asset and be able to underwrite it.”
Indeed, the rehab market is returning, albeit in a cautious way. Holliday Fenoglio Fowler (HFF) is currently working on four acq/rehab deals—three in Texas and one in California, where the owners will spend between $5,000 and $7,500 a unit for kitchen, bathroom, and exterior upgrades.

“It’s pretty soft stuff, but it’s stuff that you can get a pop on,” says Mike Kavanau, a senior managing director for HFF’s Chicago office. “A year ago, you could put in $7,500 a door and your rent wouldn’t move a penny.  But we’re back in a market where people are optimistic about spending rehab money again.”