Turmoil in the capital markets continues to hobble conduit lenders, and conventional lenders are returning to more traditional underwriting standards and rates as 2008 begins.


Multifamily developers can be excused for looking back wistfully at the terms and rates they got this time last year.

Many in the lending industry expect 2008 to be a year of market correction as fallout from the subprime mortgage industry’s collapse continues to roil the capital markets.

“These last few months have been tough, and this coming year is going to be tough,” said Larry Melody, chairman of CB Richard Ellis/Melody. “There’s no commercial mortgage-backed securities (CMBS) now, but the agency business has been a savior.”

The biggest trend entering 2008 was the re-emergence of traditional lending sources, such as life insurance companies, banks, and the government-sponsored enterprises (GSEs). Since the market for CMBS declined in mid-year 2007, the traditional lending sources have been processing deals hand over fist.

Freddie Mac kicked off its second half by doubling its production in the span of 30 days. The company processed $1.6 billion in multifamily deals that used its early rate-lock feature in July 2007. One month later, the company processed $3.5 billion in early rate-lock deals for August.

For a typical new construction deal in early January, conduit lenders were quoting a spread of as much as 250 to 300 basis points over the 10-year Treasury rate, compared to Fannie Mae and Freddie Mac pricing, which was at 170 basis points over the Treasury. That spread translated to interest rates on GSE debt as low as 5.6 percent, with the conduits hovering closer to 6.5 percent and higher.

That favorable GSE pricing may not last for long. As demand for GSE debt continues to rise, Fannie Mae and Freddie Mac have begun to grow more selective regarding which deals they want to do.

“Freddie and Fannie have control of their own destiny as to how much they do tighten before there’s resistance by the borrowers,” said Thomas Dennard, CEO of Grandbridge Real Estate Capital. “Right now, on the multifamily side, there’s very little alternative.”

The question on everyone’s mind as 2008 dawned was: How long would it take for the CMBS market to rebound? Most in the lending industry believe that interest in CMBS will continue to be tempered until at least July.

“The capital markets are still pretty unsettled,” said Jeff Day, managing director of Deutsche Bank Berkshire Mortgage, in early January. “But at some point in the middle of the year, demand [for CMBS] is going to exceed supply to a pretty significant level, and that’s going to have some downward pressure on spreads.”

Real-time pricing

The fourth quarter of 2007 was marked by a steep decline in Treasury rates, a key benchmark that helps lenders set pricing. The 10-year Treasury rate reached 4.69 percent on Oct. 12, 2007, but had dipped down to 3.84 percent by Jan. 7.

This proved to be a double-edged sword for the multifamily industry. While such a low Treasury rate helped to keep mortgage rates in check going into 2008, such volatility made it impossible for lenders to quote a price with certainty.

As a result, the debt market was characterized by “real-time pricing” in late 2007 and early 2008. When borrowers request a quote, even from conventional financing sources like life insurance companies and banks, the price they get will rarely stay the same for even a week.

“You don’t really know the cost of your debt until you rate-lock your loan,” said Tom Szydlowski, executive vice president at Wells Fargo Multifamily Capital. “Borrowers are taking a lot more risk on spreads today.”

That lack of certainty is also a direct result of the reduced competition. The GSEs were once forced to extend the benefits of their rate-lock programs to keep pace with aggressive conduit lenders. “Fannie and Freddie used to hold their spreads while you were in the conversation stage,” said Dennard. “But they really don’t have to anymore, because the conduits aren’t making them do it.”

Underwriting redux

The aggressiveness of conduit lenders through the first half of 2007 also forced traditional lenders to make some key changes to their underwriting. The standard 30-year amortization term offered by the GSEs became a 35-year term in 2007, and both Fannie Mae and Freddie Mac also lowered their debt-service coverage ratios (DSCRs).

Some in the industry wonder just how long those new terms will last. “It wasn’t that long ago that a conventional Fannie Mae or Freddie Mac loan had a 1.25x (debt-service) coverage,” said Szydlowski. “They’re not back at that level yet, but I do think that they’re concerned.”

Less bullish assumptions on rent increases have again become commonplace. Loans of up to 80 percent of value can still be had from the GSEs for strong borrowers in strong markets, but most developers should expect 70 percent or 75 percent of value to be the new loan ceiling.

With debt markets continuing to tighten, developers will be forced to back up their deals with more equity in 2008. The rising demand for equity has begun to show, with equity providers beginning to demand better returns on their money as 2008 began, industry watchers reported.

“Equity is going to be extremely important in 2008, and those with significant equity and access to equity are in the driver’s seat for now,” said Guy Johnson, founder and president of Johnson Capital.

The flow of construction financing has been reduced as well, with traditional construction lenders like banks raising underwriting standards and reining in their volumes. Many banks are operating their balance sheets at full capacity in the first quarter of 2008 because they saw such a heavy influx of business since the CMBS market declined.

Even the Federal Housing Administration (FHA) has become an attractive option for market-rate developers again. The FHA’s Sec. 221(d)(4) program features a 90 percent loan-to-cost, a 1.11x DSCR, 40-year amortization, and is non-recourse. What’s more, developers can lock in the interest rate for the construction and permanent loan at closing.

The Top 50

Wachovia, Washington Mutual, and Capmark head APARTMENT FINANCE TODAY’s list of Top 50 Multifamily Lenders, but the rankings may look very different next year.

That’s because these rankings reflect 2006, a booming year for conduit originations. Lenders like Wachovia and Washington Mutual that were heavily invested in the single-family subprime market, as well as the CMBS market, will likely suffer declines. (Note: The Top 50 list reflects numbers provided by the companies, and was supplemented with numbers from the Mortgage Bankers Association.)

For example, while Wachovia tops the list with more than $16 billion in multifamily lending in 2006, the company also reported mid-year 2007 volume of just $1.4 billion, a precipitous drop-off.

The rankings will also likely change next year due to the mortgage lending industry’s continued trend toward consolidation. Three of the top 20 lenders were purchased by larger institutions in 2007, and a fourth was on the block at press time.

This past year saw the acquisition of No. 8 lender LaSalle Bank by Bank of America in a $21 billion sale. The No. 15 lender, Collateral Real Estate Capital, was bought by BB&T, while the No. 16 lender, ARCS Commercial Mortgage, was purchased by PNC. At press time, Bank of America was in talks to buy Countrywide Financial, the No. 18 lender, for $4 billion.

Looking out

Nearly every lender surveyed for this article expects credit conditions to tighten or remain the same through the second quarter of 2008, as underwriting standards continue to be reined in.

Key indicators of the economy’s health are painting a gloomy picture for a swift capital markets recovery in 2008. “Loss of consumer confidence, rising gas prices, and ominous signs of inflation will further spook already fragile capital market conditions,” said Mark Scott, president of lender Commercial Mortgage Capital.

Many in the industry feel that the multifamily industry has been unfairly affected by the current credit crunch. Optimists point to the fact that occupancies are up in many major markets, and that strong immigration trends and weakness in the single-family market will help properties to continue to perform well in 2008.

“We’ve been swept up in the broader fear and paranoia of the credit marketplace,” said Charles Krawitz, a managing director at KeyBank Real Estate Capital. “But reason will return to the market.”