Debt funds and other alternative lenders are finding their ability move quickly, retain credit risk and think differently about underwriting is helping them to increase relationships with borrowers which otherwise might have opted for an insurance company or bank execution.
The flexibility that debt funds provide is becoming increasingly important as transaction volume rises and borrowers need certainty of execution, notes Daniel Jacobs, a managing partner at New York-based private equity firm Asia Capital Real Estate.
The firm, which targets the multifamily and single-family sectors via a series of debt and equity funds, has also found the Federal Housing Finance Agency’s (FHFA) pivot toward mission-driven affordable housing has helped to enhance its relationships with existing sponsors and bring new borrowers to its doors.
Additionally, the FHFA in 2021 lowered its individual production targets for Fannie Mae and Freddie Mac, two of the government-sponsored agencies that it oversees, to $70 billion from $80 billion in 2020. While this will rise to $78 billion for each agency, there will still be a gap in financing because of a rise in multifamily transaction volume.
Data from Real Capital Analytics found that in the first three quarters of 2021, US multifamily sales volumes rose by 115 percent to $178.5 billion. Overall transaction volume rose 75 percent to $462.1 billion during the same period.
“We’ve had a really strong fourth quarter in signing up new deals and we’ve been able to do a little over $1.2 billion this year alone,” Jacobs tells Real Estate Capital USA. “I think the biggest theme around our success this year is that Fannie Mae, Freddie Mac and the other GSEs that operate under the FHFA and have supported multifamily for decades have longer turnaround times and are reducing their market share.”
Assessing credit risk
Debt funds and other alternative managers look differently at credit risk than their bank and insurance company counterparts, in part because they are able to dig in more deeply to the story behind a building or a business plan, says James Dunbar, a senior managing director at Minneapolis-based investment manager Värde Partners.
“What we try to do when we make a loan is understand the inherent value of the building, and then the business plan the borrower has to increase its value,” Dunbar tells Real Estate Capital USA. “The occupancy of that building right now might only be 50 percent, which might not work for your traditional commercial mortgage-backed securities lender, or your traditional bank lender, because it doesn’t have enough cashflow. But we understand why it is just at 50 percent and why the borrower is putting money into that building.”
There’s another service that alternative lenders can provide, particularly now, when too much capital is coming into the market, Dunbar says.
“The good thing about the non-bank spaces is that we retain the credit risk. It’s different from some other lending models where loans are originated and sold; here, they’re originated and the lenders making these loans hold that risk for their investors. I think that helps keep those credit decisions in check and helps balance out markets,” Dunbar says. “The risk any lender is always going to be looking at is when too much capital comes into the space, and people start making poor credit decisions.”
Värde, which had originated about $1.7 billion of loans through the end of October, provides fixed- and floating-rate first mortgages in the office, multifamily and hospitality space. It will also selectively originate industrial, self-storage and some selective retail. In some of these sectors, the stories behind a property are more complex and benefit from flexibility around structure, Dunbar says.
“When you look at some of the flexibility that non-bank lenders can have when they’re structuring these loans for certain business plans, I’d say borrowers are always looking for flexibility around what repayment options are available as well,” Dunbar adds.
Speed of execution
The final factor that is drawing borrowers toward alternative lenders is the speed of execution, says Richard Litton, president of Harbour Group International.
“A typical banking group and big bank lenders on lots of different types of commercial property; they’re not necessarily multifamily experts [for example] so it will typically take them longer to go through an underwriting process and understand the asset,” Litton says. “There are also a lot more regulatory restrictions on banks, so it is a very different sort of process. There’s a speed of execution as well as a customer friendliness component of working with a private lender that you might not typically find in a more traditional bank.”
ACRE’s Jacobs concurs. At a time when investment volumes are rising, cap rates are low and rent growth is high, alternative lenders have an edge and the bridge loans his company provides are in high demand.
“Bridge lenders are crucial when cap rates are low and rent growth is high. It is tough for agency lenders, insurance companies and banks to underwrite rent growth and provide accretive leverage when underwriting a loan based on a low cap rate,” Jacobs says. “But the downside is the bridge lending market is very small compared to Freddie Mac and Fannie Mae and we’re finding that with the increase in transaction volume, there is more pressure on the system as the end of the year approaches.”