Commercial real estate private credit platforms are finding a growing need for short-term capital to develop or redevelop urban or urban-adjacent multifamily properties in hard-to-replicate locations.
The trend is being fueled by two factors: a significant pullback from the bank lenders which occupied this part of the market as well a sustained need for housing, said Jonathan Needell, president and chief investment officer of Kairos Investment Management Company, an Irvine, California-based investment manager.
Kairos has also found it has more opportunity to work with high-quality sponsors on good projects while originating lower-leverage loans.
“In the debt markets today, things are so much in disarray. As a non-bank lender, we are refinancing people out of loans from banks like Wells Fargo into deals without too much leverage,” Needell said. “That is the way it is in the market right now.”
Indicative data tracked by Real Estate Capital USA found that roughly $2.5 billion of the $6.2 billion of new loans originated in August were in the multifamily sector. Alternative lenders originated 10 loans totaling $626 million while bank lenders originated seven loans totaling $679 million. The balance of the activity came from Fannie Mae and Freddie Mac as well as life insurance companies.
Notably, eight of the 10 financings from alternative lenders were short-term financings for a wide swath of apartment projects in urban areas. Kairos has long believed downtown Salt Lake City is one of the urban markets which will outperform other areas. Earlier this year, the firm originated an $8.14 million senior bridge loan for the conversion of a centrally located data center and parking lot into a multifamily and retail property.
The firm has done roughly a dozen deals in the market, which saw positive change in the wake of the 2002 Olympics, Needell added, and noted Salt Lake City has also seen a population shift which has brought employers like Goldman Sachs to the city.
Even with lower-leverage financings like this, risk mitigation remains a concern. However, Needell pointed out that because the property is not simply unimproved land, the firm was able to get more comfortable with the opportunity. The sponsor will maintain the existing structure, while replacing the electrical and plumbing and adding windows. It will also expand the property into the parking lot.
“The way I always look at land is that it is always the most volatile. But once something has something built on it, the income potential goes up and the value is more resilient and less volatile,” Needell said. “But if there is some improvement on the land, you have choices.”
New York-based real estate manager Northwind Group is also seeing that trend. This month the firm originated $105 million in new multifamily-oriented financings. The firm was able to step into situations in which sponsors might have otherwise worked with bank lenders, said founder Ran Eliasaf.
The firm originated a $70 million condo inventory loan on behalf of developer Southern Land Company on The Laurel Rittenhouse Square, a luxury apartment-condominium property in the city’s tony Rittenhouse Square submarket. Northwind also originated a $35 million first mortgage on Carmel Towers, a 25-story, 216-unit multifamily property in Newark, New Jersey.
“The biggest issue we are seeing right now is there is a really serious shortage on the senior part of the capital stack which is developing into a credit crunch,” Eliasaf said. “We are providing these bridge loans to a much higher caliber of sponsors than we would have done three years ago. At that time, those sponsors would have been able to get a bank loan but because of the current situation, they are turning to private lenders.”
There is a similar opportunity set emerging for private credit platforms which originate preferred equity or mezzanine debt, particularly for sponsors coming up against near-term debt maturities, said Ray Cleeman, principal and head of capital markets and lending at Pensam.
“There is this gap that happens in the capital stack and it has to be filled somehow. You can’t get it in equity or debt, so there is literally just one place to get it and that is preferred equity or mezzanine,” he said. “It has always been interesting to a specific group of people historically, those who want to marginalize the amount of equity they have to raise.”
On the ground
One of the paradoxes of the multifamily market is that it largely continues to be supply-constrained, even after record deliveries in the second quarter. Data from Dallas-based advisory CBRE tracked 91,400 new units coming online in Q2, a level which brought total number of units delivered over the last four quarters to a record 351,500 units.
The forward delivery pipeline, however, is significantly lower because of the paucity of financing for developers, CBRE warned.
Multifamily investment specialist CP Capital US is seeing this play out on the ground as it moves ahead with new projects, said Kristi Nootens, co-head at the New York-based firm.
CP Capital, which invests via joint ventures with best-in-class developers, is in a position where it has more projects under construction than it has been leasing up this year.
The firm has six projects under construction in the submarkets of Washington, DC, Philadelphia, Austin, Charleston, Tampa and Phoenix, and will be bringing online about 2,000 new units. It also is in lease-up with similar assets in submarkets of Boston, Los Angeles and Nashville. In addition to the supply-demand fundamentals for multifamily, the firm believes strongly that some locations will outperform.
“All of these properties are in our target markets, which are growth markets and the suburbs of gateway cities,” Nootens said. “We have been lucky enough to be building through a lot of the supply pipeline which has been hitting the market. In the second quarter, the market saw the highest-ever number of deliveries. While we are seeing a little softening on lease-ups, demand is generally keeping pace with supply in many of the submarkets where we are actively leasing.”
The firm will be leasing up the deals they currently have under construction throughout 2024 and into 2025, a time that is expected to be somewhat removed from the peak supply currently coming online.
It is a hard investment landscape for all, making it difficult to get deals done, both from an equity and a debt perspective, Nootens said.
“Some LP equity partners are sitting on the sidelines, and it is harder to get loans from banks if you’re not a well-capitalized developer with a great track record in that market,” Nootens said. “While it is possible to get a loan, it might not be possible to get a loan at the loan-to-cost that you want.”
Nootens noted that the firm works with stable developers that are able to get loans done right now. “But LTC has come down from 65-70 percent to around 50-55 percent,” she said. “We have also seen a deal close fairly recently at 60 percent LTC, so it greatly depends upon the market, how well the deal underwrites and the strength of the developer’s lending relationships.”
Lenders and borrowers who spoke to Real Estate Capital USA highlighted longer-term concerns over multifamily deliveries over the next two to three years as capital remains constrained, citing the more than 500-basis-point increase in the Federal Reserve’s target rate over the past 18 months.
“Increased cost of capital increases the costs of delivering units to market and reduces profitability,” Eliasaf said. “We also have a valuation issue that is looming around, which will affect the cap rate on these buildings. Buyers are pushing for lower valuations and numbers and the market has not yet found a new balance. When there is instability or uncertainty, that causes fewer projects to hit the ground.”