As Lending Lags, Residential Developers Add More Layers To The Capital Stack

Not even South Florida’s reputation as a beacon of pandemic-era growth and booming population can keep residential development bustling in the region.  

Developers searching for financing in South Florida today are facing a decline in institutional lending as market fundamentals soften, pushing down new construction starts. That has sent builders in search of creative solutions to raise money as they wager that the region’s growth will eventually outpace a wave of new supply coming online. 

“In the multifamily development world, we’ve gone from an environment with a record amount of starts into an environment where basically nothing gets started,” said Rafael Aregger, head of U.S. investments at Empira Group. “That itself breeds opportunity in the years to come.” 

Lenders have pulled back from multifamily financing as South Florida’s torrid growth has flattened. Rents rose 52.6% from 2019 through 2023, according to Zillow, but have slid 0.9% in the last 12 months, according to Apartment List. 

The slowdown in rent growth comes as the 42,500 apartments that were under construction in 2022, the highest number since at least 2006, begin to deliver. But construction starts have since dropped, with 40,700 units under construction as of May, according to CoStar data reported by The Real Deal. 

Developers at Bisnow’s South Florida Development and Construction conference Wednesday were optimistic that the supply bubble currently weighing down rents would easily be absorbed. 

That’s made them eager to break ground on projects now because they expect to deliver into a much tighter market in three to five years. The problem is that it has become exceedingly difficult to lock in financing, panelists said onstage at the Margaritaville Beach Resort in Hollywood. 

“You’ve had a huge pullback of regional banks,” said Alex Witkoff, co-CEO of New York-based Witkoff. “You are seeing lenders being very pointed on who they lend to, really lending to best-tier developers with best-tier projects. Construction financing is tighter than cash-flowing assets.”

The scarcity of capital means lenders have few competitors and can be more selective in the deals they finance, leveraging their position at the negotiating table. For a bullish developer, that means moving ahead on a project that might not even pencil in today’s environment, said Dan Sheehan, president at Vista Bank.

His bank recently did a deal with a developer building a project pegged at a 6% capitalization rate but borrowing from them at an 8% rate.  

“He was willing to endure negative leverage for the first three to four years, 18 months to build it and another 18 months to stabilize it, just to get this project out of the ground,” Sheehan said. Vista Bank provided around 35% of the capital structure, with the rest of the funding coming mostly from limited partners that had a long-term investment horizon and were willing to start off upside-down.

The borrower Sheehan described is like most others in today’s market, bringing in as many outside capital sources to pull loan-to-cost ratios down as low as possible before looking for financing. Keeping LTC ratios below 60% is the only way to even find a lender willing to entertain a request for financing, Aregger said.  

“We're talking to hotel brands, and we now almost have to require that they invest capital in the project as opposed to just putting the brand on and operating the project,” said Javier Cuadros, senior vice president of development at Newgard Development Group. “You have to get creative and get people to invest and partner with you. You can’t do everything with financing and equity.”

The broader availability of capital at lower leverage points is part of the reason South Florida continues to see proposals for new condo towers and, in some cases, developers swapping planned apartments for condos. 

There are more condo buyers in South Florida than there are apartment investors, and a condo developer can pre-sell development units and leverage deposits — which can approach as much as 50% of the unit value at a luxury condo tower — for construction costs.

Access to buyer deposits has also helped spur the wave of combined condo hotels that are popping up across South Florida. 

There are more standalone short-term rental projects under development in Miami’s urban core than there are traditional condos, and the combination properties, like the planned redevelopment of the Mandarin Oriental on Brickell Key, both leverage buyer deposits to make deals pencil. 

“A freestanding luxury hotel today that you spend over a million dollars per key to build is virtually impossible,” said Christian Glauser Benz, head of development for the Americas at Mandarin Oriental Hotel Group. “You need to have the condominium product involved to help you with the capital stack.”

His hospitality firm is partnering with Swire Properties to build a 400-foot-tall hotel next to an 800-foot-tall condo tower, which will share 100K SF of amenities. It’s a model that the luxury hotel group is looking to adopt at nearly all of its new U.S. developments, said Glauser Benz, who previously told Bisnow that Mandarin Oriental was in active talks for new properties in Aspen, Jackson Hole and California’s Sonoma and Napa Valley.  

Those markets, like Miami, experienced surging interest during the pandemic, Glauser Benz said. And panelists at the event Wednesday were bullish that South Florida would continue to capitalize on its recent growth. 

Witkoff said his firm believed there was going to be “a huge deficit in multifamily” in the region in the next few years. Nestor Mejia, president of development and construction at Miami-based Shoma Group, said South Florida “was on a different planet” compared to the dynamics playing out nationally. Aregger said both apartments and condos still have “way more takers than there is supply.” 

But as the panelists sounded notes of optimism, they also conceded that today’s cost of debt and construction was holding them back from capitalizing on what they see as opportunity coming tomorrow. 

“As a developer, you want at least a 150 basis point spread from where you think an asset trades to where your project pencils out,” Aregger said. “With everything the way it is today, you’re looking at 200 projects and maybe one pencils.”