Multi-Family Housing: US agencies help investors to make it a family affair

Fannie Mae and Freddie Mac back wave of multi-family deals, reports Al Barbarino

In October, one week after news broke that Blackstone had purchased the largest apartment complex in Manhattan for $5.3bn, Starwood PropertyTrust announced the purchase of a multi-family housing portfolio from Equity Residential for nearly $5.4bn.

Starwood’s closing of a deal just a sliver larger than Blackstone’s may have looked like one-upmanship, considering their close rivalry, but it also seemed fitting that more billion-dollar deals would arise during a year that had already charted some of the strongest multi-family housing investment sales numbers on record.

The continued improvement in the economy and the unemployment rate, along with the Fed’s delay on raising interest rates, were among the confluence of factors that elevated the multi-family housing sector in 2015, leading to big increases in lending to the asset class by all lender types.

US Vacancy Rate Falls Q2 2015Vacancy rates fell to 15-year lows in Q2 while 173,000 apartment units were constructed across the country, the second-highest figure since 2000, according to CBRE research. A JLL report showed that investment sales in the first half of the year were the strongest “in both the prior and current cycles”.

In turn, lending to the sector ballooned. The Mortgage Bankers Association (MBA) expected (at the time of going to press, prior to the year’s end) $224bn of originations to multi-family housing by the end of 2015, up 15% from 2014’s $195bn.

“We’re seeing interest rates staying lower for longer than many folks anticipated, strong property prices and great funda- mentals in terms of increasing [net operating incomes] and that has bolstered investment sales and mortgage originations,” says Jamie Woodwell, vice-president of research and economics with the MBA.

Big deals drive volumes

One of the reasons for the strong invest- ment sales and origination figures was the prevalence of not only more deals, but also larger ones.

Agency lenders Fannie Mae and Freddie Mac have led the pack among the lenders to multi-family property. The government-sponsored enterprises, combined with the Federal Housing Authority (FHA), originated $73bn of loans in 2014 and the total was expected to reach $102bn by the end of 2015, according to the MBA.

In one of the largest deals, Lone Star tapped Freddie Mac for the massive multi-family housing deal it completed in June, securing a seven-year, $5.12bn mortgage loan from Berkadia on the $7.6bn acquisition of REIT Home Properties, based in Rochester, NewYork, which included 107 multi-family properties across nine states.

“With long-term financing at higher leverage and on a non-recourse basis, Fannie and Freddie are by far the strongest,” says Russell Dey, a vice-president with Walker & Dunlop’s senior housing group, which originated the year’s largest senior housing loan. “The multi-family acquisition market is still very frothy and that has driven lending volumes, especially given that we are in the midst of a refinancing boom.”

The agency lending boom was thanks in part to the Federal Housing Finance Agency (FHFA) redefining affordable lending targets for Fannie Mae and Freddie Mac. Among the new rules, a portion of affordable and assisted living housing for seniors have been excluded from previous $30bn lending caps placed on the government-sponsored enterprises (GSEs), and income thresholds for affordability have been increased.

Mitchell Kiffe
Mitchell Kiffe

“CBRE and others have worked to identify those opportunities,” says Mitchell Kiffe, a senior managing director with CBRE’s multi-family lending team.

Fellow CBRE senior managing director Peter Donovan adds: “We believe it’s going to be a very liquid, active market for the next 12 to 24 months. We’re feeling very bullish, and we’ve gotten some relief on the caps with the GSEs.”

Experts note that the agency lenders are the strongest option when it comes to long- term, non-recourse loans.They also have what Kiffe calls a “very broad mandate”, willing and able to finance the “ABCs” in terms of asset class.

Banks typically lend for shorter terms on a floating-rate basis, or sometimes with no recourse, but at lower leverage. Life companies tend to finance class A product or perhaps into the B-plusses, but only at “very low leverage” on the latter, Kiffe says.

CMBS, meanwhile, “has not been able to compete and is doing mostly modest, low- leveraged loans on well-sponsored multi- family assets”, Kiffe adds. “It’s at a pricing disadvantage and credit spreads are at an even greater disadvantage.”

The $5.12bn Lone Star financing was one of the largest ever Freddie Mac loans, eclipsing the $4.4bn in Freddie Mac loans Berkadia had completed in all of 2014.

The deal could encourage GSE financing on other recent billion-dollar deals. Blackstone and Starwood declined to comment, but the former is seeking a relatively low $2.3bn of leverage on its deal, as first reported in Real Estate Capital.

Jonathan Gray, Blackstone’s global head of real estate, publicly called the leverage being sought “very low,” noting that the firm was seeking lower returns and less risk on the “long-term” hold.

That could suggest a potential agency deal in the works, due to both the properties’ affordable component – the deal included an agreement with the city of NewYork that 5,000 of StuyTown’s 11,232 units would need to be “affordable”, under city guidelines for the next 20 years – and Gray’s long-term outlook.

Starwood has not said how much debt it will seek, but one selling point for the GSEs is that they will entertain up to 80% loan-to-value ratios, higher than most of the alternative lending sources. “Many folks making large acquisitions have used leverage in the past and often times maximum leverage,” Kiffe says.

The string of billion-dollar deals has followed prolonged strength in the sector. US apartment rents have been particularly hot, climbing 20% on average over the past five years by some estimates. Meanwhile, the home ownership rate fell to 63.5% during Q2 2015 – the lowest level since Q4 1985, according to CBRE research.

A market about to turn?

But the strength of the multi-family housing sector and billion-dollar deals have some scratching their heads, wondering when the market may turn.

Sam Zell, head of Equity Residential, is often followed in real estate and Wall Street circles for his premonitions on market turns – and often credited for calling the top of the real estate market in 2007, when he sold Equity Office PropertiesTrust to Blackstone for $23bn, just before the commercial property market crashed.

“I look at people like Sam Zell and others getting out of secondary markets and it makes me wonder what I don’t know,” says one lender, speaking on condition of anonymity. “It’s got me a little confused, because multi-family fundamentals are still strong. Maybe it’s a yield play. But what if defaults are coming? Is this a ring of the bell that something bad is coming?”

Zell is said to be planning to sell another 4,700 suburban apartments, mostly in western Massachusetts and Connecticut. “There [are] an awful lot of apartments under construction… and the majority of them are garden apartments in suburban areas,” he told the Wall Street Journal.

Barry Sternlicht, head of Starwood, countered: “This is the healthiest US apartment market in my lifetime… [and] we don’t see that trend reversing.”

More investors look to join senior subset

In April, Walker & Dunlop originated the year’s largest senior housing financing, with $670m in loans secured by a 52-property portfolio owned by New Senior Investment Group. The loans, which refinanced 35 assets and funded the acquisition of 17 more, were structured as seven-year, adjustable-rate mortgages under the Freddie Mac Seller/Servicer Program.

Then, in August, the company originated 28 loans totalling $464.7m, secured by 28 independent living properties also acquired by New Senior Investment Group. These 10-year, fixed-rate capital markets execution loans are interest-only for five years, followed by a 30-year amortisation schedule, using the Freddie Mac Seller/Servicer Program.

Russell Dey
Russell Dey

“Seniors housing has often been considered a subset of multi-family, given the operational component of senior housing,” says Russell Dey, the Walker & Dunlop vice-president who led the deal with Laura Beaton. “It’s not just lending on the real estate but on the operations within it and that has scared people away.”

But owners of and investors in more traditional assets are starting to consider senior housing as a feasible, attractive way to obtain the best risk-adjusted returns. The gap between senior and multi-family housing yields has also been significant, Dey says, noting that a 7.25% cap rate on the former versus a 5.5% cap rate on the latter makes the choice an easy one.

“However, there are risks associated with that spread,” he says. “Yields may be attractive, but it’s really important to only lend to best-in- class operators, because you depend on them to operate the business successfully.”