By: Drew Weinstein, Vice President, Investor Relations, Parkview Financial
Since March 2022 the Federal Reserve has rapidly increased short-term interest rates from 0% to in excess of 5% - which is the fastest increase since the 1980s. This move to combat inflation triggered panic across the lending industry, and the failure of three regional banks in March 2023. While the FDIC had intervened to mitigate systemic risk, all lenders were forced to slow or halt activity for a period of time and are now moving more cautiously in lending decisions moving forward.
A primary concern is that elevated interest rates will lower multifamily asset pricing (and all property sectors for that matter) and increase the cost of debt. Lenders that are still financing the construction of new apartment projects are focusing on 1) flight to quality, 2) requiring upfront equity and 3) reducing their cost basis.
Flight to Quality: In a move to reduce risk and added exposure, lenders are focusing on exclusively moving forward with financing high-quality projects in primary and secondary markets that have established employment drivers. Primary and secondary markets such as New York City, Los Angeles, Charlotte, and Nashville are home to regional and national headquarters for high paying employers such as Amazon, Bank of America, and Blackstone, among others. These cities will continue to attract and retain workers even in an economic downturn. Given the housing shortage of 6.8 million units(Source: National Associate of Realtors), the multifamily sector continues to be the safest and most resilient commercial real estate asset. Lenders are focusing on multifamily lending and avoiding already battered sectors such as office and retail.
Upfront Equity: As a private construction finance firm with a significant percentage of our activity driven by apartment projects, Parkview Financial, as well as other lenders that are still active, has been requiring upfront equity contributions from sponsors. This move is a departure from previous practices that allowed pari passu funding. Lenders are concerned that if cap rates expand and sponsors abandon their projects, they may be left with undercapitalized projects in various stages of construction. By ensuring borrowers inject necessary equity upfront, lenders are ensuring sufficient funds are within the capital stack to complete a project if the economic situation turns at any time prior to the stabilization of the asset.
Reducing Cost Basis: As the interest rate environment currently shows no signs of rate decline any time soon, construction lenders are proceeding cautiously, providing loans at a lower basis. Financing is now constrained by debt-service coverage ratio (DSCR) and loan-to-value (LTV) based on higher interest rates and wider cap rates. As sponsors are being required to place more equity earlier on for any given project, a lenders’ basis improves, leverage is reduced and well-capitalized borrowers are able to move forward with their projects.
To conclude, now more than ever, it is important for both lenders and borrowers to work together strategically to successfully execute a development project that ends with a quality product that meets the needs of the local community now and for years to come. Ultimately, developers with the required capital are in a winning situation as they are able to embark on the planning and implementation of much-needed multifamily projects.
