June 14, 2018
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If you read commercial real estate news – specifically, news dealing with the multifamily sector – you know that a lot of Class A product has been delivered in recent years, with predictable results. More supply has led to slowing rent growth in certain markets, along with an increase in concessions and vacancies. This has meant banks and other lending institutions are more hesitant when it comes to providing funds to develop, or invest in, yet another Class A apartment complex in yet another urban core. Much of the current rental housing targets less than 15% of U.S. renters.
Not all loan applications for apartment builds and buys are automatically stamped “rejected.” However, a better understanding of what lenders might want to see on an application could help prevent frustration and denial when it comes to financing.
Rental Housing that is Affordable
The United States has a serious lack of affordable housing. The Joint Center for Housing Studies of Harvard University (“JCHS”) pointed out in its 2017 State of the Nation’s Housing Report that one-third of U.S. households paid more than 30% of their incomes for housing in 2015, with renters, especially, facing such cost burdens. Much of the new apartment supply delivered is geared toward millennials, who are assumed to have higher incomes. But that assumption isn’t supported by certain facts.
“High housing costs are a special concern for younger and older households, which both have relatively low median incomes,” the JCHS noted.
A recent article in Multifamily Executive, by John Williams of Avanath Capital Management, pointed out that more than 58% of renters earn less than $50,000 a year. The obvious answer to the situation is to build more affordable housing. The difficulty, however, is perception. As construction and labor costs keep increasing, another assumption is that Class A product will generate higher rent growth to pay off the debt.
Williams indicated, however, there are only so many renters with higher income, and “affordable assets can provide risk-adjusted returns that consistently exceed the performance of market-rate product.” Workforce properties are also almost recession-proof, he said, meaning demand tends to increase during economic downturns. Market-rate apartments, on the other hand, have an average turnover rate of 50%.
A property with good risk-adjusted returns and regular demand could be considered more favorably by bank lenders.
A Place for Seniors
Another news topic of interest is people are getting older, and will continue to do so for the foreseeable future. The JCHS study pointed out that one-third of older adults faced cost burdens in 2015 – 54% of whom are renters. Seniors housing encompasses a broad swath of product type, from adult-only, age-restricted communities to memory care, skilled nursing centers. Yet, similar to affordable family housing, there is a need, and demand, for affordable seniors housing, especially for retired baby boomers who no longer want the responsibility of home ownership. According to Sarah Garland, a senior vice president at PNC Real Estate, “Demand shows that there is a growing need for financial institutions to provide lending options for affordable assisted-living communities using Low Income Housing Tax Credits.”
The CCIM institute pointed out that “capital for seniors-housing projects essentially comes from the same lending sources that fund other types of commercial real estate.” These sources include finance companies, Fannie Mae and Freddie Mac, and the local bank. If you can point out that your property will be meeting a seniors community demand, you could have a better chance of obtaining funding for it.
The Green Mindset
Obtaining funding for energy-friendly developments is often easier these days. Government-sponsored enterprises, especially, want to make it less costly to incorporate energy and water improvements into projects that are under construction, as well as those that are already open, and are being retrofitted. As of Q2 2017, Fannie Mae issued 419 loans totaling $10.8 billion to help fund green upgrades to multifamily properties. Thanks to this backing, the bank will likely be friendlier to a multifamily pitch with “green” as a part of it.
Even if you’re applying for a loan for an energy friendly, affordable housing build or buy, understanding the following will help your chances of walking away with the financing you need.
Pro Forma. You might put effort into your pro forma. Your underwriter, however, could be more conservative, and focus on how the property actually performed. This becomes more problematic if the apartment is under construction. In that type of situation, the underwriter will examine similar products in your neighborhood, to determine their performance and net operating income.
Loan-To-Value. Though a typical LTV for a market-rate property might be 75%, it doesn’t mean your project will get that. As such, a greater equity commitment on your part could help ensure the loan.
Debt Service Coverage Ratio. The lender will take the NOI of a property and divide it by the annual debt service application. If the result is below 1.25, the “rejection” stamp may be a likely result. The lender isn’t being difficult; he or she just wants to be sure sufficient funds exist to cover debt payments for the loans.
In summary, it’s true that there might not be as much debt as there once was for apartment investments. However, understanding demand, combined with a realistic market assessment, could go a long way toward giving you a better chance for a loan.
For questions, comments or concerns, please contact Jennifer Duell Popovec