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.

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