Optimism continues to be the mood of the year for the multifamily industry.

Editor’s Note: We is used as a reference to “the investor.” Rate quotes in this article are sourced from TMUBMUSD10Y | U.S. 10 Year Treasury Note Overview | MarketWatch.

First quarter 2021 was one of continued optimism for the multifamily industry. Although we saw a notable jump in the 10-Year Treasury yield, loan volume remained steady. We started the year with a 10-year Treasury yield of 0.92% and finished the quarter with a more than 75-basis point increase to 1.74%.

The increased cost of debt did not curb investors’ appetite for multifamily assets, and deal volume remained strong. This strong investor interest to move into the multifamily asset class has created an extremely competitive bidding process to lock down purchase contracts.

Additionally, this strong demand has helped maintain low cap rates, and many investors are expanding their scope of investments to include more value-add, renovation projects to find the desired returns for their investors. We have seen a number of new bridge lenders reestablish credit facilities and enter the lending arena once again. This is positive because it creates a very attractive capital structure for borrowers looking to offset the additional cost of raising higher-priced renovation monies from investors.

Fannie Mae and Freddie Mac

Although a 75-basis point jump in the 10-Year treasury is a substantial increase within a 90-day period, agency lenders maintained their typical rate discounts for rent affordability and green initiative property improvements.

We also saw each lender target a specific space to aggressively go after deal flow. Freddie Mac proved to be the more competitive lender in the small balance space, and Fannie Mae often found itself priced out of those deals. This may have been a function of the jump in Treasury yields and Freddie Mac’s pricing structure, because they establish the rate at application rather than locking rates shortly before closing, as is the case with Fannie Mae.

Fannie, however, was much more competitive on larger deals through their DUS Loan program. Their approved DUS lenders found that delegated authority was very valuable in expediting processing and closing deals quickly. Freddie Mac requires their lenders to prescreen loan requests before issuing an application and funding, which can sometimes slow processing during periods of heavy volume.

As they have for decades, Fannie Mae and Freddie Mac continue to provide an industry standard for multifamily debt structure and underwriting guidelines. Each agency lender structures its own specific COVID-19-related initial debt service reserve requirement and implements other protective measures as it relates to leverage, debt service coverage ratios (DSCR), and ownership experience.

Their protective policies were always short-term in nature on acquisitions and R&T (rate-and-term) refinances. As always, a more conservative approach was used with cash-out refinances, but even then the terms were healthy. Neither Fannie nor Freddie reduced leverage on cash flowing market rate acquisition loans, which is representative of their bullish position long term. It’s important to note this going forward, because they continue to reduce or eliminate the COVID-related principal and interest reserve requirements.

Bridge Loan Market

The bridge loan market is much more fragmented and does not have that dominant national lender presence to set the industry standard. The lower-priced, more attractive short-term bridge lenders are seeing heavy volume given the increase in value-add transactions. You will find attractive bridge debt priced in the 4% range on a 24- to 36-month term at approximately 75% loan to cost. Higher leverage is available; however, you will likely see a higher coupon or accrued interest structure associated with that debt.

The next tier of bridge lender you will see is priced in the mid 6% range and will offer 75% of the purchase price and 100% of the renovation budget. Although it’s a slightly higher rate than other loan programs, this is still a substantially lower cost of funds than typical equity returns. These lenders can usually close approximately 30 days from engagement, which is also a competitive advantage when trying to win a purchase contract. Private money lenders have also been quite active for the deeper value-add deals and very fast closings. Although this debt structure can be quite expensive, these lenders offer tremendous value in the form of fast closings, higher leverage, and more creative rate structures.

Some investors have turned to these low-priced bridge lenders for their acquisition funding to avoid the principal and interest COVID reserves agency lenders have imposed. Although these reserves are scheduled to be returned to the borrowers within the first year of operations, many investors have found that acquiring an asset using bridge debt, with the anticipation of refinancing into long-term debt at a later date, has proven to be quite attractive. Healthy appreciation has allowed investors to pull out equity at refinance and really boost their investment returns.

Commercial Mortgage-Backed Securities

While the Commercial Mortgage-Backed Securities (CMBS) market came to an abrupt halt between early and mid-2020, many conduit lenders reestablished their credit facilities and reentered the market with attractive loan terms as well. Although CMBS execution is historically more expensive with limited options compared to agency loans, some lenders are now offering what could be considered a more flexible loan structure. Rather than offering loan terms of only five or 10 years and prepayments structured with defeasance, these lenders are offering loan terms of five, seven, or 10 years with step-down prepayment penalty options. This offers borrowers agency-style flexibility without the heavy COVID reserve requirements, which in some cases were as high as 18 months of principal and interest payments.

Impact of Competition

The multifamily sector has proven to be a haven not only for existing multifamily operators but also for investors from other sectors (e.g., retail and hospitality) who were looking for more predictable returns. Although hospitality is currently making a solid comeback, multifamily deal volume has not seemed to

slow as of the time of this writing. Many operators are taking advantage of the low cap rate environment and choosing to sell. This has created a large number of 1031 buyers looking for higher yields in secondary and tertiary markets across the country.

The increased competition for multifamily deals has forced investors to get more aggressive on more than just price to make their offers more attractive to sellers. We are seeing more aggressive purchase offers in the form of non-refundable earnest money at signing, expedited due diligence periods, and subsequent closing timelines. These types of aggressive terms offer sellers greater certainty of execution, and buyers have a greater commitment to close. This situation will often have a greater influence on who wins the contract than just price alone.

In addition to finding creative ways to make an offer more attractive, this increased competition for deals has forced investors to reassess and potentially modify their conventional investment strategies to consider both smaller deals and smaller markets than they would normally entertain.

Overall, market fundamentals are strong. Although there are pockets of COVID-19 related delinquencies, the majority of multifamily operators report better-than-expected collections. As government rent relief programs continue to support renters who reach out for assistance and owners continue to work with their tenants, multifamily operations on a national level remain healthy. A first quarter 2021 uptick in rental rates throughout the majority of the U.S. was also a very bullish indictor of market health.

Forecast: Hot Summer Ahead

Optimism has continued to grow into the summer 2021 months. Capital markets continue to fuel the buying frenzy and offer exceptionally low cost of funds to multifamily investors. This is coupled with an overall easing of the restrictive COVID-19 reserve requirements that have been in place for most of 2020 and first quarter 2021.

In mid-May 2021, we saw both Fannie Mae and Freddie Mac either drastically reduce or altogether remove their COVID-19 principal and interest reserve requirements. This action can be viewed as the most positive indicator of an end to the pandemic to date and a huge vote of confidence in the health of the markets. Some investors who may have been sitting on the sidelines may be encouraged to get in (or back in) the game.

The combination of healthy market fundamentals, low cost of funds, and an investor base that is eager to acquire assets is extremely encouraging. Couple that with existing owners who are open to transitioning out of their properties and reinvesting those proceeds into higher yield markets, and it creates very positive expectations for the remainder of 2021. Although we haven’t officially seen an end to the COVID-19 pandemic, current market characteristics indicate we are moving in the right direction, and investors are clearly positioning themselves for a return to normal in the near-term.