How Bridge Lenders Review Apartment Underwriting Opportunities
Bloomfield Capital has been particularly active in the apartment space in recent years, funding over $24 million in multifamily loans over the last 24 months. Market-rate multifamily bridge lending is becoming increasingly competitive across the country, as more and more sponsors and lending platforms target the asset class. The apartment landscape has been supported by improving consumer sentiment and economic trends, which have created resilient demand for value-add project financing, including new developments and rehabilitation opportunities. With heightened transaction activity and growing asset valuations, prudent bridge lenders are becoming increasingly conscious of a few key elements in the underwriting process.
Borrowers vs. Assets. These two key components are responsible for supporting the majority of value in a transaction, and weighing the pros and cons of each is generally the first step in the evaluating a new deal.
On the borrower side, operating experience, credit scores and presence of foreign capital are few valid initial considerations. Continued growth in the multifamily market has drawn interest from a wider scope of buyers, and it’s becoming increasingly common to see requests from borrowers with less experience operating and managing the asset class. Lenders must be cautious that necessity to deploy capital or strong collateral value does not overshadow the borrowers’ investment experience, or credit history for that matter. With regards to foreign investment, lenders have increasingly seen interest in US residential and multifamily real estate from overseas buyers as a long-term capital preservation strategy. These buyers are less focused on liquidity and consequently tend to bid up valuations above U.S. buyer appetite.
Valuation cycle, pro forma projections and secondary market liquidity are some of the considerations bridge lenders evaluate when looking at asset viability. Many investors are beginning to view multifamily as nearing peak asset values, with cap rates trending lower and development costs continuing to creep up, pressuring construction margins. Lenders are also running up against scenarios where they must determine how much rents can be realistically and economically pressed to accommodate debt service while also meeting equity return requirements. Finally, in secondary markets, the key question remains as to whether assets are liquid enough to sell as-is today and, more importantly, in a recessionary economic environment.
Deal Killers. There are many factors that contribute to a non-financeable deal including geographic limitations, aggressive capital structures, and constrained timing to execute. On the geographic side, local market supply has increasingly become a consideration when evaluating new multifamily projects, where the appeal of financing a new Class A asset can overshadow the competitive dynamic or demand capacity of a certain market. With regards to more aggressive capital structures, gradually rising interest rates and near peak valuations have driven inherently lower cap rates, which can cause sponsors to seek higher leverage to maintain their IRR thresholds. Execution timing is frequently top-of-mind for bridge lenders, as oftentimes borrowers seeking bridge capital have exhausted other outlets for financing. These scenarios can necessitate a faster closing than some lenders in the space can (or should) accommodate.
Loosening Underwriting Criteria. Q4 2016 was a sharp reversal of what had appeared to be more conservative lending trends for the past 3 quarters. During the quarter, lenders accepted 0.15x lower debt service coverage ratios and loosened their LTV thresholds by 1.0% vs. Q3 2016. Most notably, the amount of partial or fully interest-only loans increased 15% QoQ.
Looser underwriting criteria has not necessarily been a new trend, as we observed average multifamily LTV levels creep up from lows of ~65% in 2010 to almost 70% during 2016, with an increasing prevalence of interest reserve components for project financings. However, it is particularly alarming that after what appeared to be a more conservative first 9 months of 2016, lenders are right back to underwriting to max capacity in the face of a fully valued market.
Bloomfield Edge. Access to discretionary capital and the ability to underwrite loans in-house continue to be key factors that distinguish Bloomfield Capital from the majority of our peers. Experience investing across national US markets, spanning both rural and metropolitan geographies, allows our platform to be selective and diversify our multifamily exposure. Depth of diligence coupled with execution speed and creative financing solutions are a rare combination of characteristics that allow our platform to capitalize on unique opportunities across the commercial real estate landscape.
Industrial Bridge Loan Trends
Bloomfield Capital is a direct lender with a strong history of originating commercial real estate bridge loans on industrial properties nationwide. The firm has recently completed bridge financing for a number of industrial properties across the central and eastern states. Below are several industrial transactions that the firm completed in 2016.
Toledo Warehouse/Distribution Funding. In August 2016, Bloomfield Capital closed on a $5.4 million senior bridge loan. The loan proceeds were used to purchase a warehouse/distribution property located in Toledo, Ohio. Toledo’s industrial market remains strong, driven primarily by Toledo’s interstate access and centralized location. As of Q3 2016, Toledo’s vacancy rate has decreased to 4.8%, down from 5.1% in the previous quarter. In addition, Toledo experienced net absorption of 390,554 square feet over the quarter. Quoted rental rates decreased only slightly, down to $3.30 from $3.34 in the previous quarter.
Knoxville Mixed-Use Industrial Funding. In June 2016, Bloomfield Capital closed on a $2.0 million senior bridge loan. The loan proceeds were used to refinance and renovate a historic mixed-use industrial property located in Knoxville, Tennessee. Bloomfield’s funds allowed the Sponsor to refinance the existing mortgage which had matured, and provided the capital necessary to begin renovating the property for new tenants. Knoxville has seen a recent spike in historic renovations and the adaptive re-use of older industrial buildings. East Tennessee office vacancy rates are hovering around 7.0% and no large deliveries of office space are planned for the Knoxville market. This, combined with Class B space being absorbed by new businesses, is creating a strong market for affordable and flexible office space in the metro Knoxville area.
Senior Bridge Loan Secured by 2 Industrial Buildings. In May 2016, Bloomfield Capital closed on a $5.4 million senior bridge loan. The loan proceeds were used to both refinance the existing debt on an industrial property located in northwest Mississippi and to acquire and redevelop an industrial property located in Lansing, Michigan. As the economy recovers, a number of investors are taking advantage of tightening markets where existing industrial assets can be renovated and repositioned at a fraction of the time and cost that it would require for new construction.
The team at Bloomfield Capital is known for our ability to successfully invest in commercial real estate through the origination of first lien bridge loans and the direct acquisitions of other types of collateralized real estate obligations – whether in the Midwest or in markets throughout the nation.
Avoid 3 Commercial Bridge Loan Mistakes
Yes, the cost of money for a bridge loan is higher than what is offered by a conventional lender. In a typical bridge loan transaction, borrowers will pay a premium for certainty of execution and speed; two things that traditional banks are not known for. Bloomfield Capital and other bridge lenders fill a very important niche roll within the commercial real estate industry by providing capital that conventional lenders are simply not able to fill in a timely fashion.
Focus on more than just the interest rate, look at term and points. With respect to points, the borrower needs to find out the true cost of a bridge loan by adding up all the fees that are being charged. A higher interest rate may be quoted, but expedited due diligence reports and limited pre-payment can often make up for the higher initial cost of the capital. Bloomfield Capital’s typical loan scenarios include an interest rate range of 9%-11% for a maximum term of 18 months and 2%-6% points net funded. It’s important to remember that no two bridge lenders are exactly the same, and borrowers should fully vet out each potential lender they anticipate using. Though many claim to be direct capital sources, always verify sources of funds and recently closed deals with both borrowers and brokers that have recently transacted with the lender.
Provide the bridge lender with the story. Often times, the story is as important as the typical due diligence items such as tax returns, financial statements and credit scores. While conventional lenders typically have a “check the box” loan process, a bridge lender takes many things into consideration when underwriting a new transaction. Bloomfield Capital looks at the entire situation surrounding the asset, including cash flow, imputed equity, debt yield and LTV. Some borrowers are afflicted with low credit scores, a prior bankruptcy, or pending foreclosure, however with the right explanation, a bridge lender might consider the request. The right collateral might be able to help ameliorate any concerns with sponsor credit or liquidity.
Have an exit strategy. A sponsor should consider how much time he has to pay back the loan and plan accordingly. The ability to secure a real estate bridge loan often times depends on the exit strategy. Bridge loans are short-term, interest only, and often times have a balloon payment due at the end of the loan term. A sponsor should focus on the exit strategy because without a well-planned takeout strategy, bridge lenders may decide to pass on the opportunity to fund and focus on opportunities where they know sponsors have a takeout plan in place.
Private money can creatively help urgent deals close quickly, and by avoiding the mistakes outlined above, sponsors will be able to utilize bridge financing to close fast moving transactions that would have otherwise been missed.