The race for financing multifamily properties has grown more competitive as debt funds are increasingly moving in and offering rates that now make them more attractive compared with more established options.
Short-term loans from debt funds used to be punishingly expensive. They provided a useful alternative to borrowers who could not get traditional, short-term bank loans for their plans to develop or transition apartment properties. Debt funds could also help borrowers who wanted to add more leverage to loans from more conventional lenders. But interest from investors looking to diversify their real estate strategies and place money on the debt side has given debt funds dry powder and they are also now offering rates low enough to provide a reasonable alternative to a short-term loan from a bank. Institutional investors from around the world are putting money into private equity debt funds, and debt funds are leveraging this capital securitizing the mortgages they originate as collateralized loan obligations (CLOs).
That’s allowing debt funds to offer interest rates just slightly higher than the rates offered by banks—in addition to the high-leverage debt funds have always provided.
“The debt fund business has just exploded in the last year,” says Kyle Draeger, senior managing director of capital markets within CBRE Multifamily, working in the firm's Boston offices.
Debt funds busy making deals
Debt funds have been busy so far in 2021—roughly matching their volume from before the pandemic. Intermediaries, including firms like JLL, Eastdil and Meridian Capital, have arranged $29.7 billion in commercial and multifamily mortgages in the first half of 2021 with “investor-driven lenders,” including private equity debt funds and debt funds created by mortgage REITs. That’s up from $24.3 billion in 2019, which ended up being the biggest year ever for these kinds of lenders, according to data from the Mortgage Bankers Association (MBA), based in Washington, D.C.
“A wide range of different capital sources have found investing in commercial mortgage to be profitable,” says Jamie Woodwell, vice president of research and economics for MBA. “They have dedicated large pools of capital to these investments.”
Debt funds now offer attractive interest rates on short-term loans to apartment properties, typically floating just a few hundred basis points over the London Interbank Offered Rate (LIBOR).
“If you are a borrower who doesn’t need that much money and need a transitional loan, you can get a spread [from a debt fund] that is LIBOR plus 200-something,” says Draeger. “If you need 80-percent financing, you can get something in the 300s.”
That more than a full percentage point less than the rates typically offered by debt funds a few years ago.
Many investor-driven debt funds have created a new way to raise capital to make more loans. They now pool mortgages together and sell them to Wall Street bond investors as CLOs. For example, MF1 REIT, a multifamily-only REIT debt fund issued a $2.25 billion CLO in September 2021, the biggest closed this year according to Draeger.
Banks, which have traditionally dominated short-term financing for apartment properties, typically offer smaller loans, often covering up to 60 percent of the cost of an apartment project. Banks still offer the lowest interest rates for these smaller loans. “Banks can do spreads in the mid-100s if they like a deal and it’s low enough leverage,” says CBRE’s Draeger. “The banks are holding those on their books, so they can offer spreads that are really low.”
Some debt funds are considering ways to offer longer-term financing to apartment properties—but the vast majority of mortgages offered by debt funds are short-term loans, such as two-year loans with the option for three one-year extensions.
“There are different groups thinking of ways to offer longer-term financing as well—but mostly it’s still in the thinking about planning stage,” says Draeger. “The actual deals right now are still pretty much zero to five years to transitional properties.”
These debt funds are fueled by large investors that are eager to but money into real estate.
“For most part, it's institutional investors like pension funds and foreign sovereign-wealth-type funds," says Draeger. "For the debt funds I am aware of, investors are writing hundred-million-dollar checks, so those are big companies, or $50 million-dollar checks.”