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Development Lending Increasingly Scrutinized as Multifamily Supply Numbers Peak in New York City

Traditional and Nontraditional Lenders More Aggressively Target Repositioning, Refinancing Projects
October 10, 2017
Banks and other commercial lenders are lending less frequently on new construction of New York City multifamily assets. When they do lend on these endeavors, the preservation of strong depository relationships is a significant motivator. For those developers looking to put piles in the ground now, debt funds and other non-traditional lenders appear to be a best bet. Lenders across the board, however, are competing on value-add, acquisitions and refinancing.

In the past 12 months, 20,312 units have been delivered to the New York City market, according to the recent market research report compiled by CoStar Market Analyst Lauren Baker, and vacancy is at 2.4%, showing still-formidable demand. Nearly 63,000 units currently remain under construction, with the peak of net deliveries forecast to take place in 2018.

"There's no question that conventional lenders, particularly commercial banks, have pulled back significantly on new construction. Their risk appetite is very limited," says Drew Fletcher, president of The Greystone Bassuk Group, who added that although it is a very challenging environment in which to source funding for ground-up new construction, there is still capital available for new construction, though the composition of that capital has changed.

More expensive, but also more flexible, financing structures are being offered by private equity, debt funds and other private lenders, who base their decision upon the strength of the sponsor's business plan. These structures can work well for a sponsor with a shorter-term hold period, such as a merchant builder targeting an exit immediately after stabilization, Fletcher notes.

As an example, non-traditional lenders are willing to underwrite as a senior loan up to 75% and take a syndication risk, which will give a borrower more certainty of execution, especially for larger loans. Other groups may only be interested in holding the B-piece, and will underwrite the full loan but sell the A-piece to the bank at 40-50% LTC, keeping the balance as mezzanine debt. Debt funds are offering floating-rate, short-term transactional loans to cover the stack of execution and then will refinance, Fletcher says.

Meanwhile, traditional lenders are very focused right now on depository relationships, even if moving 5-10% of their liquid funds to the new lender, notes Paul McCormick, senior vice president of investment sales and capital services at Ariel Property Advisors.

"For a sponsor who can deliver this, in return, these lenders are willing to be more lenient on interest rate, going 0.125% or 0.25% reduction. Or they might offer a non-recourse loan, or a more flexible prepayment," says McCormick.

"If you have a wealth management relationship or large depository relationship, banks will be more willing to find a way to make a new-construction loan work," Fletcher concludes. "It's amazing how quickly the market turned. It is becoming very hard to secure conventional bank financing even if you have 30 years of sponsorship experience."

A Favorable Time for R&R: Refinancing and Repositioning

Lenders targeting value-add or repositioning projects are particularly aggressive, says Gideon Gil, executive director of equity, debt and structured finance at Cushman & Wakefield. A large number of higher-yield debt funds going as high as 80% leverage on first mortgage financings, if they see a credible business plan and strong track record on behalf of the sponsor, he says.

Moreover, banks and life insurance companies are competing heavily on pricing for the best assets with their targeted sponsors when it comes to lower-leverage existing multifamily acquisitions and refinancing, Gil notes.

"We are reaching a point now where lots of projects going into the ground from 2013-2015, borrowers are wondering whether to sell. Because in many cases, the partner is an institutional investor that needs to exit. Or, do they hold and look for a new partner? The refinancing environment is extremely favorable, and it is possible for them to buy out the partner and hold," says Fletcher.

Regarding the trend of increased refinancing on newly-completed multifamily projects in various stages of lease-up, Gil says that banks and some life insurance companies are seeking to provide permanent loan solutions, and that in some cases they are providing bridge loans that enable sponsors to return equity sooner.

Traditional lenders at this point have a great deal of exposure to construction loans, sources say. But all lenders are continuing to watch the cyclical clock tick, and calculating the implications of a possible higher-interest-rate environment.

For a five-year quote, lenders may underwrite at a higher interest rate, for instance at 200 basis points above, according to McCormick, who added that acknowledgment of a possible higher-interest-rate environment in the future is not dramatically impacting proceeds, but it is being looked at and taken into account.

"One thing lenders are strategizing over is the level of rental revenue growth going forward for the next two to three years. Can we expect more muted growth due to supply and the recent run-up in rents?" Gil wonders.

New York market rent growth stands at 1.3% over the past 12 months, and rent growth is decelerating, according to CoStar Market Analytics, which has found the impact particularly pronounced for 4- and 5-Star luxury apartment properties. Concessions are on a precipitous rise, according to Baker.

Supply Burps in the Boroughs

A surge of new supply in a few key areas around the City have not gone unnoticed.

Banks, for instance, have become more reticent about finished product in areas that have seen a great deal of units delivered, says Andrew Dansker, a licensed real estate salesperson in Marcus & Millichap's Manhattan office who works in the realm of commercial debt financing. Dansker says he has had conversations with banks whose regulators have redirected them from high-supply areas.

Because of high land values, developers can only justify new construction at high rent points. But this begets a chicken-and-the-egg scenario for luxury multifamily property.

"Lenders across the board are increasingly skittish about the high-end rental market. They are increasingly scrutinizing for downsize market risk and cash flow on those assets," warns Dansker.

"The biggest challenge we are seeing in multifamily currently is that there is ample new supply that is coming online in specific submarkets of Queens, Brooklyn and along the West side of Manhattan. Although these buildings are leasing up quickly, more buildings will be coming online in these submarkets" Gil says.

Not only has Brooklyn seen significant new construction, but it also has a shadow market of new construction, wherein a great deal of existing product has been repositioned to quasi-new product, adds Dansker.

Deliveries over the past 12 months for Long Island City total 2,102 units, according to CoStar Market Analytics, with 7,108 units under construction. The 12-month delivery figure totals 2,183 units in downtown Brooklyn alone, with an additional 908 units under construction in the submarket.

"While sponsors are generally hitting or exceeding their pro forma target numbers, the competition to fill new buildings has resulted in concessionary environment," says Gil.

Diana Bell, New York City Market Reporter  CoStar Group   
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