How investors are responding to the fallout from recent capital markets mishaps.

On the heels of three bank collapses and another interest rate hike, multifamily investors and developers expect it will be ever harder to finance new and existing ventures.

“There are fewer sources of lending, and banks have tightened underwriting standards,”?explained Paul Fiorilla, director of U.S. Research for Yardi Matrix.

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As economic and capital markets events have unfolded this year, banks, in particular, have become increasingly concerned about having enough capital to service current portfolios and avoiding future risk. So, in addition to making fewer loans, they are offering less in proceeds prioritizing the most profitable assets.?

“Banks are being more careful in their stressing of their interest rates,” noted Adam Parker, a principal at mortgage banking company Gantry. “Even if they are offering a 6 percent, they underwrite to a 7 percent to service their debt service coverage ratio. That has impacted how many loan dollars we can get for a client.”

Proceeds are also an issue for those looking to refinance since their loans are coming due in a higher interest rate environment and worse economic times. With some?borrowers qualifying for less than their original?loan amounts, they may have to bring significant cash or some kind of gap or rescue capital to the table.

Construction is especially difficult to finance since the absence of cash flow increases the risk for lenders. “Right now, there are roughly 1 million multifamily properties under construction, so deliveries will remain consistent for this year and next,” Fiorilla added. “But with construction loans now at least 8 percent or higher it is a lot more difficult for projects to pencil.”?

Source: Mortgage Bankers Association

Tighter All-Around

Fannie Mae and Freddie Mac, which are covering a larger share of the market since banks pulled back, are also fine-tuning their underwriting to be more selective, experts report. Agency LTVs are 50-55 percent vs. 70 percent a year ago,

DLP Capital and other private lenders have seen an increase in their debt business since banks have retreated. “Our rates become a lot more attractive,” said the firm’s CEO, Don Wenner. “Where the overall banking sector has increased rates by 4 to 4.5 percent, we’ve increased by 1 to 2 percent. So that gap has closed quite a bit.”

What’s an Investor to Do?

For borrowers, the “biggest hurdle” today is not financing deals but getting deals to pencil when borrowing costs (around 5.5 percent) exceed cap rates (around 4.5 percent) for multifamily, observed Origin Investments Co-CEO Michael Episcope.?

“Any time you have negative leverage, the more you put on an asset, the worse it performs,” the Chicago-based investor said. “Real estate tends to be a leverage game. That makes deals and velocity come to a standstill.”?

Nevertheless, forward-looking borrowers are braving the perfect storm of higher interest rates, lower leverage, and lower cap rates by tightening their own underwriting and hyper-focusing on income and cash flow.?

“We can’t pay as much for the same asset because it is costing us more and more, and the combination limits how much you can pay,” reflected Steve Carlson, senior vice president. “We used to get 65 percent leverage, and now we can only get 55.”

As a result, Waterton looks to create more of a cushion than it did 18 months ago. “We try to build in a significant buffer between where we are getting loan quotes and where we are underwriting for both proceeds and rate in our accounting,” said Carlson.

Noah Kaufman, acquisitions associate at?Universe Holdings, a Los-Angeles-area value-add-focused multifamily investment firm, said his firm is staying agile as Treasury rates fluctuate, and they are?exploiting compressed cap rates where they can.

“It’s making sure that you are conserving with some movement,” Kaufman told?MHN. “If you get into bidding and submitting an offer and see Treasuries go down, it will not affect your price that much.”

Universe has transitioned from 7 to 10-year fixed-rate loans, the firm’s primary focus historically, to more conservative loan periods with more compressed capitalization rates to fit the current environment.

“It’s just about finding the right opportunity,” Kaufman said. Being conservative in the underwriting, relative to the economy, (where) there is assumable financing and where you have positive leverage.”

The added vigilance, he said, has produced better results for the firm. “We have been extremely happy,” he said. “We are still getting offers left and right trying to get stuff done.”

Shifting landscape

Despite the current financing difficulties, multifamily has many advantages that other sectors do not, such as increasing demand and ever-present agency lending, Escope noted. “Multifamily is more insulated because you have (these lenders),” he observed. “They will step in to do a lot of the lending for stabilized projects.”

Besides, higher interest rates in the single-family market helps multifamily, and the employment figures are still relatively healthy.?“It’s an opportunity today,” Episcope continued. “An opportunity happens when you have an asset or investment with good long-term fundamentals that is experiencing a temporary sort of depression in price. But multifamily will recover. It is a need-based asset.”?

Unfortunately, however, many lenders are not differentiating by property type. “When a bank looks at a real estate portfolio, they are not looking at multifamily,” said Episcope. “They’re looking at their exposure to real estate. When a bank hands back the keys to a portfolio, they don’t want to lend anymore because they’ve just gotten hurt.”