With so many multifamily investors seeking maximum financial leverage in acquiring properties, it’s no surprise the two big government-sponsored enterprises continue refining customized mezzanine-type loan programs to supplement senior mortgages.
Though program details differ in some regards, both GSEs can allow borrowers to take overall debt levels up to 85% loan-to-cost or loan-to-value.
Following Fannie Mae’s rollout of its DUS Plus program (as in Delegated Underwriting and Servicing), which in many cases provides for shorter-term value-added financing, Freddie Mac is negotiating its first senior-plus-mezzanine transactions under its new High-Leverage Loan program. Freddie Mac has forged an arrangement to acquire senior loans negotiated through its Program Plus originator network, and CWCapital will purchase second-priority mortgages amounting to as much as 10% of capitalization.
The high-leverage program’s core product is largely targeted at borrowers purchasing stabilized properties – in other words, those able to demonstrate 90% occupancy over the latest 90-day period, said Mitchell Kiffe, Freddie’s vice president of multifamily flow-sourcing. Chalk it up to today’s very low capitalization-rate environment, which at traditional leverage levels means mortgage payments absorb higher and higher proportions of rental collections.
“Investors who have to buy at these low cap rates are running out of [debt-service] coverage,” said Kiffe. So in some cases debt-coverage requirements might keep the Program Plus first-mortgage loan-to-value ratio at just 72% or so depending on property and pricing details. In such circumstances, the CWCapital second under the High-Leverage program would allow the buyer to boost overall leverage to 79% or 80%, Kiffe elaborated.
Programs offer flexibility
Kiffe stressed that Freddie and CWCapital also continue building in program features applicable to acquisition/rehabs as well, with borrowers either selling the property on completion or refinancing the secondary slice with a Freddie supplemental loan. “We and CWCapital intend to look at both stabilized and value-added deals, so there will be flexibility when it comes to occupancy,” said Kiffe.
While the High Leverage program generally envisions simultaneous maturity of the senior and junior loans, administrators continue refining prepayment provisions to make it more attractive to acquisition/rehab deals. That might include a shorter yield-maintenance period for the secondary loan than the senior note, or it might allow repayment of the second loan after just three years with a modest exit fee, said Kiffe.
Freddie and CWCapital had not yet announced pricing for the program’s secondary debt by press time, but Kiffe said that rates will be set using a risk-based formula. For example, the rate on a secondary slice amounting to 5% of loan-to-value (LTV) behind an 80% LTV Freddie first, secured by a solid stabilized property, will likely end up in the range of 450 to 500 basis points over the comparable-term Treasury rate, he estimated. In early February that spread amounted to a coupon rate of 9% to 9.5%.
But the second loan’s rate for low-leverage packages could be as low as 275 to 300 basis points over Treasury. “I think the all-in rate we’ll be able to offer will be one of the program’s advantages” relative to DUS Plus or programs teaming Wall Street conduit loans with mezzanine tranches, said Kiffe.
Choose the best option
With Fannie Mae’s DUS Plus program under a typical 80% loan-to-cost (LTC) first ahead of a 5% LTC mezzanine loan, the standard rate on the mezz portion acquired by Fannie’s partner RCG Longview is 12.6%. But RCG Longview Vice President David Valger stressed the company’s willingness to bargain a bit and, where warranted, offer the mezz at lower pricing than the published standard rate.
Valger also noted that RCG Longview officials and DUS Plus originators have the flexibility to hammer out customized “mutually acceptable” prepayment structures. Rather than a yield-maintenance prepayment provision used with Freddie’s standard High Leverage structure and most conduit-plus-mezz plans, the DUS Plus program’s penalty is based on a fixed percentage of the principal balance, starting at 2% after a one-year lockout.
Indeed, for many value-added players especially, a mezz loan’s prepayment provisions can prove more meaningful than the interest rate alone – assuming the leverage levels are comparable between the loan options being considered, said longtime mezzanine specialist Mitch Clarfield, a director with Deutsche Bank Berkshire Mortgage. With cap rates now so low in strong markets such as the Los Angeles vicinity, even experienced pros have a tough time penciling out a reasonable return if there is not a plan for increasing rents, he added.
Along with the ability to refinance the mezz with a Fannie supplemental loan once the value-added program is completed, the declining-balance prepayment fee was a key factor in a Clarfield client’s decision to choose the DUS Plus program in acquiring and improving the 184-unit Emerald Hills Apartments in Monterey Park, Calif. The private investor in fact expects to refinance a $3 million preferred equity tranche (arranged by Clarfield) within about three years, to be followed a year or two later by the mezz loan.
The borrower, whom Clarfield declined to identify, is investing more than $5,000 per unit for interior improvements at the 1960s-vintage property, whose previous owner had already completed extensive exterior and common-area upgrades. The $21 million senior DUS loan factored to roughly 70% LTC, with the $3.1 million mezz component representing another 10%. Clarfield helped secure the preferred equity from LEM Mezzanine.
The prepay schedule also influenced investor Pacific Property Co. to select a DUS Plus deal for the acquisition and renovation of the 136-unit Townsquare community in Millbrae, south of San Francisco. Pacific Property executives appreciate the ability to retire the mezz as soon as the second year at fixed penalties rather than more onerous yield-maintenance formulas, said Mitch Thurston, the GMAC Commercial Mortgage senior vice president who arranged the financing.
“You do the math and you see that’s more attractive” than alternative defeasance and yield-maintenance programs for a borrower expecting to add value and refinance the mezz with a supplemental loan within a relatively short period, Thurston stressed.
The deal had a $16.5 million senior mortgage and a $4 million mezz component, representing nearly 85% of the venture’s expected costs, which included the repositioning budget approaching $13,000 per unit. “It’s the strategy that dictates which program is right,” said Thurston.
Those sentiments were echoed by Tucker Knight, a Holliday Fenoglio Fowler director who arranged nearly $20 million in senior and mezz financing that was secured by Houston’s new 240-unit Club at Copperfield on behalf of the developer, whose name was not disclosed. The client’s strategy involved taking out the construction debt (and some partner equity) with the best blended cost of capital the developer could get at 90% overall leverage, said Knight.
Wall Street’s willingness to offer higher leverage won out in this case. “You’re generally going to get higher [combined senior and mezz] proceeds with a commercial mortgage-backed security execution,” said Knight. “It seems a lot of borrowers are still going after every last dollar today.”
In fact, the deal from senior lender Banc of America Securities (BofA) and mezz lender Tremont Realty Capital proved most attractive, highlighted by an interest-only payment schedule for the first five years and highly competitive rates on both the senior and junior components.
The 10-year senior loan was for about $17.5 million, priced at 87 basis points over the corresponding Treasury yield, according to Knight. The interest rate for Tremont’s $2.3 million mezz slice, also maturing in 10 years, is 12%. Though the deal required Knight to negotiate an intercreditor agreement between BofA and Tremont, those rates proved well worth the effort, he said.
The prepayment fees are higher than with DUS Plus, but Knight and his client still deemed it more attractive than a traditional defeasance or yield-maintenance schedule. The mezz slice is locked out from prepayment for two years, followed by a 4%-of-balance penalty during the third and fourth years, 3% during the fifth and zero thereafter.