Capital Markets Update
Lender Appetite remains for Multifamily and Industrial
Lenders take bifurcated approach to debt origination based on asset class and performance since the start of the Covid pandemic. An understanding of collections challenges and deferment plans have remained at the forefront of every deal. Although outlook is generally positive, lenders more than ever want a good story - on both the asset and sponsorship side.
Although rates could move up incrementally in the near-term with the passing of the new stimulus package and as vaccine distribution continues, Fed Chairman Jerome Powell has made clear the Fed will continue its bond-buying to keep rates down until substantial progress is made with the economic recovery.
Fannie Mae & Freddie Mac - FHFA has set lending caps of $70 billion each for Fannie and Freddie in 2021, which is down 14% ($20 billion) from the $160 billion they had combined last year. Additionally it has increased the affordable housing loan origination mandate to 50%, up from 37.5% this year. This could lead to higher rates, particularly for larger market-rate deals, which will inevitably open the door for life insurance companies to compete well. In December, Agency rates have already ticked up some, driven by increases to both the treasury rate and guarantee spreads.
Banks and Credit Unions have remained selective on asset class and leverage, with some outliers lending up to 75% LTV. Bridge and Construction lenders will keep their focus on Sponsorship experience, asset class, and business plan. Hospitality and Retail have mostly remained off-limits.
Recent Financing - $24 million, 75% LTV, 5-Years I/O
92-Unit Apartment Refinance - Walnut Creek, CA
Strategically pitched historical Income and Expenses to achieve 75% LTV and 5-years of interest-only on a 10-year fixed rate financing. Leveraged Freddie Mac's Green Program to achieve a sub-3% rate. There is a 27% annual return on cost for the required Green Improvements, apart from the upside in the lower rate from opting into the program.
Predictions - 2021
Prediction #1 - The Fed balance sheet will continue to grow. It's now above $7T and the Treasury does not want any sudden rate spikes. The Fed will give no indications of slowing down its bond buying program. Rates will slowly rise over the next 12 months, but the 10-year will remain below 2% by 2022. Floating rate Borrowers should sleep well for at least the next 3 years. The biggest risk of a large spike in rates will come from an inflation shock. This shock could be derived from Powell tapering bond purchases too quickly or even more and massive amounts of stimulus pass through a Democratic Senate.
Prediction #2 - SOFR will become the more prevalent rate index as more and more lenders shift away from LIBOR. Freddie Mac led this push in Q4.
Prediction #3 - The expiration of apartment eviction moratoriums will lead to shocks of tenant reshuffling and vacancy spikes in dense population centers. There will be a correction in rental rates in these urban centers as owners fight to refill units. Rent-controlled and below market rental units will be the most protected along with suburban locations in business-friendly states.
Breaking It Down - Yield Maintenance vs. Defeasance
Yield Maintenance is a prepayment premium that allows investors to attain the same yield as if the borrower made all scheduled mortgage payments until maturity. Yield maintenance premiums are designed to make investors indifferent to prepayment.
Defeasance is a substitution of capital, whereby the Borrower purchases government securities for deposit in an escrow account. Under the terms of the escrow agreement, the securities are irrevocably pledged to the payment of the outstanding loan. The securities are in a principal amount such that the principal and interest earned are sufficient to retire the principal and interest on the outstanding loan as they come due.
Which is better? While they are mechanically different, the prepayment consequence is largely the same with the exception of the below two considerations:
1. Yield Maintenance is a simple calculation and payment, while Defeasance requires a 3rd party and legal team to facilitate the transaction, thus higher transaction costs and a little more administrative leg-work.
2. Lenders typically structure Yield Maintenance as the greater of the YM calculation or 1.0% of the remaining principal balance, thus you're always stuck with a minimum 1.0% prepay. Conversely, Defeasance can put you in a gain position with a lump sum payment to you if the loan payoff happens when the note rate is less than the treasury rate.