Borrower profile: Affordable Middleburg sees active lending market for durable sponsors 

The private equity manager this month made its first acquisition in Orlando.

Middleburg Communities, a Vienna, Virginia-based owner and manager focusing on high-quality mid-market rental housing, is finding there is liquidity available for developments and acquisitions for lower-leverage sponsors with strong balance sheets and solid track records. 


The company’s focus is on the acquisition, development and management of high-quality, attainable rental housing that runs the gamut from traditional apartment communities to single-family build-to-rent units. Over the past year,
Middleburg has been more focused on expanding its pipeline of mid-market multifamily development and acquisition opportunities, said Kory Geans, chief investment officer.
 

Middleburg recently made its first acquisition in the Orlando area, buying a 300-unit, Class A property in the city’s Davenport submarket. The property fits squarely in the firm’s focus area, which Geans describes as Class A middle-market housing that is well-amenitized but not urban, luxury product. 

“As more people are moving into Orlando, they need relative attainable housing and that has allowed [the Davenport submarket] to grow rapidly,” Geans said 

The property also offers rents that are substantially lower than other parts of Orlando, while still allowing for substantial accessibility to Orlando proper. The city has seen its popularity rise steadily over the past 10 years, with a 1.8 percent increase observed so far this year, according to estimates from Macrotrends, citing data from the United Nations World Population Prospects.  


Accessing financing
 

Middleburg is an active developer and investor, typically using leverage in the range of 55 percent to 60 percent on its transactions. That leverage point has allowed the firm to continue to access capital despite broad volatility in the US and global financial markets, with Geans noting Middleburg’s typical lenders – banks and GSEs – have been very supportive of its deals.  


We are not a high-leverage borrower and at our LTV levels, we have found the agencies to be very good lenders for our product,” Geans added. “The agencies can give you a seven- or 10-year term and, after a year, you can pre-pay with a 1 percent penalty if you’re a lower-leverage lender. But if you’re looking for higher leverage, it’s a very challenging market.”
 


It has been an active year for the firm on the construction front, with
Geans estimating that the firm will have six new groundbreakings before year end and additional acquisitions in its core markets. Acquisitions typically make up about 20 percent to 30 percent of the company’s deals in a year, with development making up the balance. 
 


This
diversified focus has allowed Middleburg to observe a bifurcation between the availability of capital for acquisitions versus developments. The market for construction loans is more liquid right now, in part because many debt funds which have traditionally financed acquisitions at higher leverage levels have scaled back their platforms, Geans said.
 


It has been more volatile to obtain financing for existing assets than construction financing. Those lenders are still there, and that part of the market hasn’t been as challenging,” Geans said. “The biggest issue on the construction front is that the lenders are finding their loans are staying outstanding for longer and they’re now saying, ‘We’re developing a significant exposure to multifamily because we are not being repaid as quickly.’” 
 


There are several reasons for this, including a more protracted construction timeline than projected for an asset. “
But for the most part, lenders are still there, they still want to be in the construction business and, for a group like us, we have been very well capitalized on that side, Geans said. 
 


The question of hedging against interest rate risk is a key question for Middl
eburg and its peers right now. With a trio of significant interest rate hikes over the past few months, including yesterday’s 75 basis point increase, managing exposure to rising rates has become time-consuming and expensive.
 


“The question is what kind of cap will you
buy or will you choose to implement an active hedging strategy to manage your exposure over the next two to three years?” Geans said. “It’s gotten very expensive. On an acquisition we’re working on now, what used to be a low six-figure expense for a hedging instrument is now in the area of $1.5 million today. We have become much more focused on actively managing that exposure rather than buying a cap.”
 


Looking ahead
 

Middleburg sees its healthy lending relationships and strong balance sheet as a way to tap into opportunities that may arise with distressed situations, potentially as an operator of properties that have run into difficulties and need a clear path forward, Geans said. 


It’s unclear, however, when these opportunities will arise and what the window of investment will be. 
 

“In March 2020, there was a roughly 90-day window of opportunity and there was a material improvement in a very short period of time,” Geans said. “We think this time the period might be more prolonged. There will be choppy capital markets and for groups without a durable financing strategy which relied on high-leverage loans, there will be the ability to step in.”