CARROLL, an Atlanta-based investment management company that focuses on the multifamily sector, last month rolled out its first credit strategy.
The firm is responding to the current dislocation in the capital markets, which has created a unique opportunity set to provide preferred equity in multifamily transactions of $40 million or above, says Patrick Carroll, founder and CEO.
“We are in a situation in which lending and the majority of equity investing has ground to a halt,” Carroll says. “The market does not know where interest rates are going and this has caused a lot of issues with valuations, which means any deals getting done are being completed at lower loan-to-value ratios.”
There is a further opportunity set in the multifamily sector, which has seen substantial transaction activity – much of it financed via floating-rate debt – over the past five years. These loans generally carried two-year interest rate caps, and borrowers, who are going to renew caps, are finding rates are dramatically higher.
“Historically, interest rate caps were very cheap, but now they’re excessively expensive,” Carroll says. “We are seeing investors with maturing interest rates caps who no longer have the capital to buy a cap, and we see that as an opportunity to come into a deal in a preferred equity position to help a borrower purchase a new cap or pay down debt.”
Carroll has also identified several other areas in which the firm can invest, including developers embarking on new development projects and seeing lenders offer much lower proceeds than in the past.
“Borrowers are used to getting 60-70 percent leverage on development deals and that is now down to around 40-50 percent,” Carroll says. “We will be looking at getting into these deals in a preferred position, just to bridge that gap in proceeds.”
Additionally, developers nearing completion on projects need to be able to lock in long-term capital to retire construction debt but have not been able to do so effectively. “These developers are also not able to get the proceeds they need and [that’s] where we can fill the gap,” Carroll says.
The firm is looking for high-quality deals in its target markets and anticipates taking positions of $5 million to $15 million. “These would be the type of properties we traditionally would have been buyers of, apartment complexes in good suburbs, but that also have some kind of problem in their capital stack,” he says.
Carroll has set an initial capitalization of $250 million for Carroll Credit and believes there is both a short- and longer-term opportunity to make preferred equity investments. The initiative comes after the firm has raised and deployed seven multifamily-focused equity funds since its inception in 2004.
“I think it will be part of the business plan going forward because there are great opportunities in lending to earn yield in a less risky position,” he says. “The underwriting is very similar to the investing side and when there are challenges in the market like this, these types of opportunities are very attractive, and you can get better risk-adjusted returns than on the equity side.”
Despite its current volatility, Carroll believes the market’s biggest challenge is from the capital markets rather than the fundamentals of the multifamily sector.
“While the market isn’t seeing rampant rent growth like we had in the past, we are still seeing healthy rent growth and, if the capital markets were not in disarray, there really would be no upset in the market. We are seeing viable assets which are performing well,” Carroll says. “It is 100 percent capital markets driven and that is why I think it is a unique opportunity.”