With the top of the multifamily market overheating and demand at the bottom growing, TD Bank real estate group has switched focus. Justin Slaughter finds out more.
The number of homeowners in the US has sunk to a 50-year low, meaning more Americans are renting now than ever before. While apartment investments surpassed those in any other asset class last year, there are some signs emerging that the top-quality multifamily market might be flattening.
Responding to changing demographics and market characteristics, the US Commercial Real Estate group at TD Bank has a new strategic emphasis this year on affordable housing loans.
Gregg Gerken, head of TD Bank’s commercial real estate lending operation, says the shift from multifamily lending on Class A properties to lending on properties that house lower-to-moderate income tenants is primarily based on common sense economics.
“There’s an increasingly large proportion of people who can’t afford to purchase homes,” says Gerken, a veteran with 30 years of banking experience and 19 years at TD Bank, having run the real estate team since 2009.
“Looking at supply and demand, affordable housing seemed like a better space to play in.”
Gerken refers to ‘affordable housing’ as loans on properties in the Class B space, that have an affordable housing tax credit or legal component, or are in geographical areas where a large cohort of residents are at low- to moderate-income levels or in rent-controlled properties.
Though for many banks and financial institutions, “affordable housing” loans come in the form of agency loans, TD Bank has no direct Fannie or Freddie loans in the portfolio. The Canadian bank does however, provide warehousing facilities to a select group of Fannie and Freddie multifamily licensed seller/servicers.
Over 35 percent of the bank’s apartment construction loans have an affordable housing component. Last year the bank made $626 million in loans on low-income housing that were eligible for some form of low-income tax credits, most of which were placed on the east coast – the bank’s main focus area.
In one example last month, TD Bank provided a $51 million mid-range construction loan on an affordable-housing complex, the Shore Plaza East apartments on Boston Harbor, to the real estate firm Weston Associates.
The bank’s switch in emphasis on affordable housing loans comes at an opportune time. The US homeownership rate is now at 63.7 percent, a 48-year low that is linked to financial troubles, according to a University of Pennsylvania report released in May.
This trend is at least partially behind the recent spike in multifamily sales volume in the US in general. A Real Capital Analytics annual report shows that multifamily sales volume went up 32 percent year-over-year in 2015 with $150 billion in sales, more capital than any other asset class received that year.
But as the number of people renting instead of owning homes increases, the Class A section of the multifamily market might have reached its peak, says Gerken.
Gerken says clients are finding it harder and harder to find workable projects with current cap rates, particularly as the higher end of the market begins to overheat.
The Real Capital Analytics report shows that cap rates have declined 30 basis points year-over-year on multifamily assets. Another RCA report shows that the asset classes’ cap rates have flattened during the first quarter of this year.
“If you’re bumping up against price appreciation, at a certain point, it’s getting too expensive,” to do deals on high end product, he says.
The bank sees the Class B multifamily market as a more attractive debt investment, particularly in gateway cities where the higher end of the market is understood to be reaching its peak and demand for lower-income housing surges.
“In Class A, we’ve seen a lot of activity in Boston, but we’ve also seen a lot of opportunity for demand in affordable housing,” says Peter Brockelman, SVP and regional director for CRE at TD Bank, who is based in the New England city.
“Given how frothy Class A is, I think affordable housing helps with our plans to grow the platform.”
TD Bank has responded to the late stage of the cycle by concentrating its lending in the middle market, and has worked to ensure that clients have the equity or debt they need in order to make it through wherever the market will lead.
This year, the bank combined its US Commercial Real Estate Group with the Community Capital Group, which includes $2.3 billion in equity tied to the Community Reinvestment Act (CRA). The merger also brought an additional 30 employees to the newly unified platform.
The convergence of the two groups backs the bank’s shift to the affordable housing sector, as the CRA is a federal act that incentivises large financial institutions to lend to lower-income residents in the communities they serve.
The Community Capital Group had invested funds off the bank’s balance sheet, closing and managing Low-Income Housing Tax Credit (LIHTC) investments, New Markets Tax Credit (NMTC) investments and Small Business Investment Company (SBIC) investments.
“We created a lot more synergy by bringing together two groups that were doing different parts of the capital stack,” Gerken says.
This year has been marked by lenders’ concern about the risk retention rules that are coming on board this December, and their potential dampening of the CMBS market specifically or effect on real estate finance in general.
Brockelman, who joined the company in 2001, says that so far this year, he has seen other banks adjusting their strategies following a rough start to the year for the CMBS market.
“Folks are looking at all the maturities coming forward, and what we’re seeing is banks playing a larger role by filling the gap with more mezzanine debt or preferred equity,” he says, adding that he has seen more private lenders on some repositioning deals.
In this market cycle compared to the previous one, Gerken also sees more discipline. Borrowers have been very conservative and intent on finding equity sources to actually reduce the amount of reliance on debt this time around.
“Every cycle the over-leveraged properties are the properties that run into trouble,” he says. “What’s been encouraging about this cycle is that we haven’t been pushing the high leverage debt, and most of our clients are of the opposite mindset. They want to have more equity in the deal.”
Major players expect a cyclical change in the broader CRE market to happen soon.
“Everyone is asking ‘what inning are we in?’” says Gerken. “Well, most real estate cycles last seven to 10 years, and now is year seven.”
Brockelman says that despite strong market fundamentals, it’s difficult to predict how much interest rates will change going forward.
“The market is frothier now than a few years ago, but that’s the nature of the beast,” he adds. “From the debt side, in today’s market, we have to look at not just what developers are willing to pay, but also what the financing will look like at the exit and whether there is enough cushion in place.”
Brockelman says that the bank’s comparative advantage lies in its relationship- versus transaction-based strategy. The bank prides itself on being transparent with its clients and works hard in structuring its risk appetite to deal with any events on the horizon.
“We can’t be everything to everybody, but when we hook up with the right people, we truly want to be a partner through good times and bad,” he says. “We saw that through the last cycle, sticking to our risk appetite, we were willing to lend capital, but also willing to give a quick ‘no.’ And clients appreciate hearing that as well.”
TD Bank : The facts
Headquartered in Toronto, Canada, with more than 80,000 employees in offices around the world, 25,000 in the US, The Toronto-Dominion (TD) Bank had CDN$1.1 trillion in assets as of April 30, 2016.
Last year TD Bank’s commercial real estate group closed more than 300 transactions totaling $5.1 billion in debt commitments in 2015 and more than 240 transactions totaling $6.3 billion in commitments in 2014, including fixed- and floating-rate construction, permanent, and bridge loans on all major asset types.
The bank has $15.5 billion in commercial real estate commitments in the real estate investment fund and private equity fund. The bank’s lending portfolio consists of 160 real estate properties in New York City, Philadelphia, Boston, Miami, Florida, North and South Carolina and Washington D.C., with regional directors managing each market.
The firm’s underwriting tends to be fairly conservative. The bank targets loan-to-value (LTV) of 60 to 70 percent and a debt yield of 8.5 to 10 percent.