Underwater Multifamily Borrowers See Chance For Off-Ramp With Fed Rate Cuts

The Federal Reserve's stance that it expects to reduce interest rates beyond the half-point cut last week has multifamily borrowers with underwater loans hopeful that they can now survive till '25. 

To do so, many are expected to turn to high-interest bridge loans to pay off nervous lenders who are facing a wall of commercial loans maturing in the coming year, panelists at Bisnow’s Southeast multifamily summit said last week.

“You’re seeing a lot of loans that are almost finished with construction and the bank’s like, ‘Get it off my books,’” Red Oak Capital Regional Manager Ken Wood said at the event, held Sept. 17 at the Atlanta Marriott Buckhead Hotel & Conference Center.

While the office sector has been the main source of distress in commercial real estate, multifamily hasn't been far behind, with delinquencies and defaults piling up among investors who gobbled up buildings during the pandemic.

Roughly 11% of multifamily CMBS loans were delinquent in August, up from 3% at the start of the year, according to securitized debt tracking firm CRED iQ. And MSCI projected last month that nearly $57B in apartment loans taken out by borrowers who capitalized on rock-bottom interest rates during the Covid-19 pandemic are potentially trouble.

With a record number of new apartments coming online in the U.S. this year pushing rents down, coupled with skyrocketing operating costs, borrowers are turning to short-term lenders hoping that further rate cuts will allow them to get less expensive permanent financing next year.

The Fed's 50-basis-point rate cut last week has fueled a new wave of commercial real estate optimism throughout the industry.

Wood said his firm is originating loans at 10% to 11% interest rates to allow borrowers to move on from their current lender, many of whom are itching to reduce their exposure. 

“[Borrowers] are saying, ‘Alright, I’ll take that bridge for a year, because I think we’re going to be sub-six, maybe even five and a half next year,’” Wood said, compared to current interest rates of roughly 6.5%.

While Freddie Mac and Fannie Mae are still making new loans, Sonya Rocvil, a principal with Bedrock Real Estate Investors, said that more borrowers are looking to bridge financing to get short-term breathing room under the belief that rates will be much lower next year and allow them to secure permanent, lower-cost loans.

“Some of the deals we’re looking at now, they’re distressed, so they do need some bridge, some level of temporary financing, to get done before they even convert them into agency debt,” Rocvil said. 

Both Freddie and Fannie clamped down on lending standards as they have grappled with fraud over the past year. Three developers pleaded guilty in August to a $119M mortgage fraud scheme involving Fannie Mae loans, a conspiracy that forced JLL to take an $18M loss in the second quarter for originating those loans. 

Some title insurance companies, appraisal firms and brokers have been blacklisted from working on loans with the two government-sponsored entities, which have focused on borrowers inflating the rents and investments they make to try to secure bigger loans — an issue that came to a head as interest rates rose and those borrowers struggled to make payments.

Todd Robinson, a partner with the commercial real estate law firm Robinson Franzman, said the agencies now are requiring new borrowers to partner with seasoned developers when applying for loans as part of those increased underwriting standards. 

“I’ve had two deals recently in the last two weeks where it was what we call an emerging sponsor, maybe their first deal. Two or three years ago, Fannie, Freddie would rubber stamp that deal,” Robinson said onstage. “Now they're requiring that the [general partner] bring in an experienced operator ... so that was kind of new to us.”

Robinson added that the agencies told his clients, “We've got to have somebody who's experienced on the team to redo all the documents to bring someone else in. But that's, I think, a shift [with] them getting burned over the past couple of years.”

Freddie and Fannie also have been shying away from lending money to older workforce apartments, panelists said. Over the past few years, some buyers of older apartments did so with a plan of upgrading and flipping them but failed to secure capital for the revitalization program. Now, with more maturities approaching, prices for those apartments could be on a downward swing.

“Just in my world, I mean, working on anything with the '70s in front of it is just like so taboo. Equity won't touch it. Debt has a problem with it. Forget JV equity,” Robinson said. “'70s vintage is just really hard these days to finance.”

The Fed rate cut could also spur developers to move forward with new apartment projects despite the deluge of new apartment towers that are flooding the Southeast market, panelists said.

The glut of new units coming online in Metro Atlanta has led to declining rents and incentives like free rent to sweeten the pot by landlords looking to lure new renters, Bisnow previously reported.

But in the multifamily development world, the decision to move forward on a new project involves a longer-term view. Experts say that the more recent precipitous dropoff in new developments will leave a lull of options for renters later next year. That will likely drive rents up again and encourage developers to break ground on new housing. 

“We have to absorb that and have rents at the bottom and see some kind of growth before equity starts showing up,” Mill Creek Residential Senior Managing Director Patrick Chesser said.