SVN National Multi-Family Financing Update

By Eric H. Better

I would like to share exclusive market intel with you, your associates and clients. This report will provide a brief recap on the current liquidity crunch, current marketplace conditions, Fannie Mae/Freddie Mac changes, and creative strategies in obtaining higher financing leverage and how to close more deals.

Let's begin by briefly discussing the events that led up to the current liquidity crisis...

Liquidity Crisis:
    After the tech wreck or .com bust
  • Cheap capital flooded the market.
  • Foreign investors began buying real estate securities
  • Wall Street found creative ways to bring liquidity to market
  • We experienced the maturity of the CMBS market place and the creation of the CDO markets
  • Rates came down, spreads tightened, pension funds allocated more dollars to real estate
Basically, investors enjoyed positive leverage and a strong economy.

This brings us to the credit problems concerning domestic sub-prime mortgages and how they have spread throughout the global markets.
  1. Bond investors have basically gone on strike
  2. The lack of demand has sent spreads soaring
  3. CMBS lenders cannot determine their cost of capital
  4. Uncertainty and instability have taken over the markets
How did we get here?

In 2005 and 2006 residential and commercial loan underwriting standards weakened due to fierce lender competition.

Aggressive Residential Terms Included:
  1. Underqualified borrowers
  2. High leverage
  3. Minimal documentation
  4. Low teaser rates with resets at higher rates
Aggressive Commercial Programs Included:
  1. Fixed rate programs offering interest only notes
  2. Minimal impounds
  3. Aggressive underwriting ex. Interest only with no amortization sizing.
The 1st Market Disruption:
  1. Occurred in February 2007 as sub-prime residential mortgage delinquencies began to increase significantly
  2. Resets kicked in
  3. Home values declined or leveled off putting borrowers under water
  4. Residential markets panicked
  5. Bond holders took losses on investment grade bonds
Shortly thereafter this led to the first commercial disruption:
  1. As a CMBS pool went to market the securitization pools 10 largest loans were kicked out of the pool due to low DSCR's
  2. In an unprecedented move numerous other aggressively underwritten loans were also kicked out of the pool.
  3. Investors became very nervous that sub-prime losses would carry over to commercial even though CMBS pools offered solid market fundamentals.
This fear led to market panic, a lack of agency rating trust and a need for the fed to step in quickly.

Where are we today?

CMBS default rates are at an all time low at .27%. Although aggressive underwriting was heavily utilized, the basic fundamentals for CMBS pools are sound. Select analysts feel we are near a bottom and that it will take several more quarters of low defaults to demonstrate to the market that spreads are too wide. Some analyst feel once the market stabilizes, CMBS lending will continue.

In theory this all sounds great. Then there is reality! Lenders still cannot sell bonds in CMBS pools and therefore have no way of calculating their true cost of capital. This has turned into a liquidity nightmare for most lenders. It is conceivable that the cost of capital will stay high. The worse case scenario could be half of the transacting companies and half the industry literally disappear in the near future. It is also safe to assume a market is dead when deal volume falls to zero. This was the case with the January, 2008, CMBS issuance.

On a positive note, treasuries are enjoying an artificial flight to safety right now and this is driving down their yield. This morning, treasury yields fell to 3.55% after a government report showed the economy unexpectedly lost jobs in February and traders speculated that the Federal Reserve may cut interest rates by as much as 1 percentage point this month.

So what is the Feds view and Wall Street's take on their policies?

This morning, I read a Goldman Sachs report that stated that Goldman has revised their call on Fed policy to anticipate an additional100bp rate cut, versus the previously forecast 50bp reduction. This reduction would put the Federal fund rates at 2%. Goldman Sachs expects this to occur in two 50bp installments over the next two meetings. These meetings will occur on March 18 and April 29. Please note, it is quite conceivable that the Fed could react prior to these meetings.

So where are interest rates?

CMBS:
Lenders are still quoting breakeven spreads in the low to mid 400 bp range. The all in interest rate is currently pricing in the low 8% range. Basically, until a reasonable yield curve can be built on the bond side, I think its safe to say the conduits are out of business.

As a capital sector, the conduits financed over $240 billion in 2007. This year the conduits could finance as little a $25 billion with nothing really transacting until the fourth quarter of 2008. This means when we compare 2008 to 2007, $245 billion of capital has evaporated from the lending community.

Life Companies:
Life companies do seem to have money, but seem to be hoarding cash. Last year Life companies did about $40 billion of business. They have the ability to potentially provide about $50 billion of capital to the industry. The real issue is that investor confidence is still extremely low, while the secondary bond trades are so rich. This could lead to life companies financing as little as $20 billion as a capital sector in 2008.

Recently, Life companies have increased their purchases of CMBS bonds now. The wider spreads make them an attractive alternative to whole loans. Although life companies continue to originate loans, they have become more cautious. Life companies often originate with an eye towards securitization. Therefore most companies are underwriting new loans with lower leverage (50-65% LTV) and higher spreads. Pricing is in the plus 225-250bps (over treasuries) range with 25 year amortizations. All in we are looking at the high 5% range to the mid 6% range. Some Life Co's are even utilizing floors in the 6-6.25% range.

Commercial Banks:
Commercial banks are most aggressive in the multi-family category. Select regional, local and national portfolio lenders are competing effectively against the agency platforms such as Fannie and Freddie. Fixed rates are ranging from a low of 5.35% and averaging in the high 5% range for a 5 year fixed to the low 6% range for 7 and 10 year fixed rates.

Bottom Line:
The bottom line is brokers and borrowers need to be more aware of how different the capital market reality has become. We need you and your clients to rethink your strategies. We need to shed our memory of the glory days where 10 Year interest only financing was common and manage our client's expectations more efficiently. It may be a while before we see spreads below 200bps or LTVs maxing out. It is more than likely that we will see about half the capital flow that we saw in 2006 and 2007.

Capital is definitely going to be more expensive across the board. Fixed rate loans are being quoted and closed, but at higher spreads, tighter underwriting and stricter terms. Bridge and construction financing is relatively plentiful but non-recourse lending is limited as balance sheet lenders take back market share. Expect upward pressure on cap rates as high leverage and cheap financing become scarce.

Please remember that my firm and I have extensive market knowledge and strong lender relationships. We know which lenders are still in the market and which ones have closed up shop. I am here to consult with you regarding all your capital needs.

The Fannie Mae and Freddie Mac topics below were discussed during the call. Please feel free to call me with questions regarding these programs.
  • Current spreads, DSCR's (refinance & acquisitions) LTV's etc.
  • Baseline underwriting
  • Status of waivers
  • Sponsorship required and management and borrower experience
  • Agency Mezzanine and supplemental financing with timeline and pricing
How can Eric Better and my firm provide borrowers with higher leverage while endeavoring to maintain the cash-on-cash as close to projection as possible.

Financing strategies (See Below). Please call to discuss your specific property.
  • Bridge program with lower DSCR's, interest only option, and a decent exit story
  • Mezzanine program supplementing a low interest 1st trust deed to achieve a reasonable blend
  • Preferred Equity or Joint Venture
  • Crossing other commercial properties
  • Borrowing against other low leverage commercial properties at attractive interest rates
  • Some portfolio lenders are offering 2nd trust deeds at acceptable rates creating a workable blend
  • DSCR buster programs (Select Markets)
  • Low 1.10 DSCR's
  • Lender and borrower depository relationships for better rates, higher LTV's and lower DSCR's
  • Fannie Mae/Freddie Mac: Proforma rents on pre-stabilized assets.
  • 2nd and 3rd trust deeds for agency program above as the asset performs.
What a Broker Needs to Know about Financing in Today's Market!
  • Money is still available from multiple sources, but it more expensive (Property Type determines availability and rate)
  • High leverage is disappearing. Lenders are looking for more equity in deal.
  • More expensive money = less value on a purchase (higher interest rates do impact appraised value and lender underwriting.
  • Sellers need to focus on the current market, not the past.
  • Buyer/Borrower credit and experience is a real factor.
  • Brokers must qualify buyers. GSP can assist in asking the hard questions in advance.
  • Lenders can structure around many buyer/borrower issues. However, they must know them upfront.
  • Brokers do not sign up buyers/borrowers with unrealistic financing contingencies.
The bottom line is that there are still plenty of lenders actively lending nationwide at aggressive interest rates. We are quoting multi-family nationwide starting in the low 5% range and small loan programs averaging 5.50%-5.85% (+/-).

Commercial transactions nationwide are also aggressively priced starting at 5.50% and ranging from 5.50-6.50%

Firms like GSP are able to deliver in this unstable marketplace. This is where transactional volume and lender relationships really payoff for Eric Better and GSP. Our firm has originated and closed over $30 billion since 1992 and over $4 billion in 2007.

I look forward to quoting your deals and assisting you in closing your transactions in 2008.

Feel free to email or call if you need a quote, a client wants a refinance, or you need further marketplace analysis.

Please remember that I do offer SVN brokers a referral fee for all leads that fund. Have a great week! EB

Who are GSP and Eric Better?

Decades of experience afford Geroge Smith Partners, Inc. (GSP) a rich knowledge of current products and lender/investor profiles. This knowledge, combined with GSP's proficiency in real estate and finance, assures the best terms for even the most challenging transactions. GSP prides itself on thorough and accurate underwriting. Our services are comprehensive, including financial analysis, market research, developing marketing materials, leading site inspections, negotiating terms, coordinating third party services, processing final documents, expert witness/litigation support, debt restructuring and real estate consulting. GSP's personnel do whatever is necessary to close the transaction and satisfy our clients.

Based in Los Angeles, Eric H. Better is a GSP vice president working nationwide on all property types. He has totaled over $30 billion since 1992.

Eric H. Better, Vice President
George Smith Partners, Inc.
10250 Constellation Blvd. Suite 2700
Los Angeles, California 90067
Office: 310-557-8336 ext. 164
Cell: 310-418-5261
Fax: 818-647-6039
Email: Ebetter@gspartners.com
www.gspartners.com