Navigating the Changing Landscape for Multifamily Financing in 2017

Posted on May 2, 2017

While multifamily remains one of the most desirable asset classes to finance, a number of new factors have emerged that are making it more challenging to secure competitive financing.

The multifamily market has certainly enjoyed a golden era. Vacancy rates are down, rent growth is up and overall fundamentals point to a healthy investment market for multifamily. According to a recent CoStar report, total net absorption of apartment units in 2016 held steady at over 172,000 units, indicating healthy renter demand for multifamily.

While multifamily remains one of the most desirable asset classes to finance, a number of new factors have emerged that are making it more challenging to secure competitive financing now than before.

The question is: will we continue to see strong fundamentals drive lender appetite for multifamily, or will investors and lenders pull back in response to potential over-construction and uncertainty as to whether the market can sustain this growth?

As a mortgage banking firm, we believe there is still plenty of capital available for the right multifamily investment opportunities. Here are several key trends that investors should expect as they navigate multifamily financing in the year ahead.

Lender appetite for multifamily prevails

Steady rent growth, coupled with high occupancy rates and the overall stability of this asset class, will continue to attract strong investor interest and drive lender appetite for multifamily in the year ahead.

While national vacancy rates are projected to increase slightly with new deliveries, these rate predictions are still lower than historic averages and are significantly lower relative to other asset classes.

On a national scale, strong renter demand has fueled a multifamily construction boom in major metropolitan markets throughout the United States. There has been some speculation, however, that the record number of new deliveries will potentially soften rent growth.

That said, the majority of new development has been concentrated in dense urban cores, while the rest of the nation as a whole has not seen a lot of new construction. As such, this potential oversupply is limited to select markets, and will not impact financing for assets in supply-constrained markets with strong demand drivers.

Underwriting continues to be fundamentals-based. Lenders will still apply the location rule when financing a multifamily property, and will typically favor markets with strong employment and population growth. In addition, lenders will also evaluate the market’s development pipeline to monitor for projected vacancies resulting from new construction.

Availability of capital

For assets that meet the aforementioned criteria, there are still ample sources of capital available to finance multifamily investments.

Most lenders feel that the multifamily market is at the correct pricing, and will continue to finance multifamily by evaluating each property on a case-by-case basis.

In light of rising concerns regarding potential oversupply and rent growth moderation, however, some lenders are being more conservative in their underwriting, and are factoring in this uncertainty in their loan originations.

Banks, for example, will still finance quality assets in strong locations, but are scaling back on the high-leverage loans they issue and taking a more cautionary approach in the evaluation process.

That is not to say that there isn’t financing available for multifamily. Borrowers will simply need to work harder to make their case to lenders, and will need to work closely with an experienced financial partner for the most optimal financing solution. Those with a proven track record, strong fundamentals and solid investment strategy are more likely to secure competitive financing for this product type.

For example, we recently financed a portfolio of nine multifamily properties in Los Angeles. The portfolio consisted of rent-stabilized apartments in the West Hollywood and Koreatown sub-markets of Los Angeles. Given the affordability challenges in this market, this portfolio demonstrated strong tenant demand, high occupancies and stable cash flow, allowing us to arrange high-leverage financing on behalf of the client.

Interest rates trend upward

There are a number of political and economic factors that will impact multifamily financing in the year ahead.

First, interest rates will continue to rise. The current interest rate environment has certainly changed lenders’ outlook on the capital markets. Prior to the recent rate increases, lenders wanted to issue as many loans as possible. Now, lenders are hesitant to lock in rates and are slower to pull the trigger.

On the other side of the equation, borrowers are looking to lock-in lower rates over the long term before rates rise even further. In fact, some borrowers are willing to pay more today for that surety of rate than to take the risk with a higher rate in the future.

Second, the Dodd-Frank risk retention rules took effect last December as well, requiring CMBS lenders to hold onto five percent of their loans as opposed to selling them off as bonds. Though many investors had feared the risk retention rules, the reality is that the impact on lending has been relatively minor thus far. These rules actually helped CMBS lenders obtain better pricing.

Third, Trump recently signed an executive order to repeal Dodd-Frank, the laws which were set in place to prevent the risky lending that precipitated the financial crisis of 2007-08. A potential repeal of these laws could serve as a catalyst for financial deregulation, making lending easier for banks and other capital sources. That said, these changes will not happen overnight, and lending, for the near term, will remain the same.

Ultimately, multifamily as a whole will continue to perform well and remain a solid investment target for investors in 2017. That said, it’s important to acknowledge that there are a few more challenges now than there were in the past, including potential oversupply in urban cores, rent growth moderation and higher valuations and rising interest rates.

There is still plenty of capital available for the right investment opportunities, but borrowers will need to work harder to make their case to lenders. Looking ahead, the best mortgage bankers will navigate these challenges on a case by case basis, and will assist sponsors with finding the most competitive financing solutions for their investments.