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CMBS Finds a Narrow Niche for Multifamily Loans

The interest rates offered by CMBS lenders to apartment properties are not much better than they were a year ago, when the bond markets were hit by a spell of volatility.

Apartment borrowers still depend on CMBS financing for the deals that just can’t get done any other way.

Other lenders have been chipping into the markets where CMBS lenders once provided financing, including agency lenders, banks and even private equity funds. The interest rates offered by CMBS lenders have fallen a lot in the last year, but are still not low enough to lure many borrowers. However, for borrowers who can’t get other financing or need a little more leverage, CMBS provides a much-needed option.

“For multifamily borrowers, many of those that depend on CMBS have credit quality issues—meaning they’ve given a deal back to a lender, have a bankruptcy, etc.—or they have a property in a very tertiary location that needs higher leverage,” says Brian Eisendrath, vice chairman of debt and structured Finance for CBRE Capital Markets.

CMBS interest rates are almost competitive

The interest rates offered by CMBS lenders to apartment properties are not much better than they were a year ago, when the bond markets were hit by a spell of volatility.

The consensus among finance pros is that CMBS interest rates are a few basis points higher than agency financing and roughly comparable to bank financing—though CMBS loans are less flexible that balance sheet financing after the loan has closed.

Those CMBS rates now range between 190 to 210 basis points over the yield on swaps for a lower-leverage loan that covers around 65 percent to 70 percent of the property value with a debt yield above 8 percent. For a full-leverage CMBS loan, with a 75 percent loan-to-value ratio and a 7 percent debt yield, interest rates range from 230 to 240. “Most deals are getting three to five years of interest-only on a 10-year execution,” says Eisendrath.

In comparison, in early 2016 CMBS spreads rose as high as 275 to 375 basis points.

Some CMBS lenders even offer higher leverage, creeping upwards toward 80 percent.

Improved interest rates have stopped the damage for the CMBS business, which is now expected to issue $70 billion in bonds in 2017—about the same as in 2016. CMBS lending is not expected to grow this year despite better interest rates because of competition from other lenders.

Competition from Fannie, Freddie

Fannie Mae and Freddie Mac lenders in particular are dominating the apartment lending business. They are a big part of the reason only 2 percent to 7 percent of the loans in CMBS pools are to multifamily properties.

“Borrowers who do not qualify for Freddie Mac or Fannie Mae loans or do not want to go through the structured process from the agencies will consider CMBS financing,” says Gerard Sansosti, executive managing director for HFF.

Freddie Mac and Fannie Mae are especially interested in growing their business by lending to “workforce housing” properties with affordable rents.  “This translates into lending on class-B and class-C apartments,” says CBRE’s Eisendrath. Many of properties once depended on CMBS financing.

CMBS lenders don’t offer a seven- or 10-year, long-term floating-rate loan product, which makes up about 40 percent of agency loans.  “The product is exclusive to the agencies, especially for Class-B and -C properties,” says Eisendrath.

Non-CMBS lenders also benefit because borrowers don’t have to worry about the problems and inconveniences that come with CMBS financing, like the rigidity of the terms of a CMBS loan once it has closed and the loan is securitized—including the difficulty of pre-payment and the challenges of special servicing.

Apartment borrowers may choose CMBS if the properties they are financing are located in markets where Fannie Mae and Freddie Mac won’t lend, says Sansosti. However, the list of markets where the agencies are not active continues to shrink. “North Dakota, maybe… you’re probably not going to get Fannie Mae or Freddie Mac to go into those markets,” says one expert.

Competition from banks

Banks have also been making loans that CMBS lenders might have provided in the past. “Banks are now being very aggressive in the permanent loan space,” says Sansosti.

Commercial banks now commonly make long-term, seven-year or even 10-year loans to apartment properties, sometime with limited recourse or even no recourse. These banks often have branches in far-flung areas of the country, where borrowers may once have had to rely on CMBS loans. “Banks in their own backyard may be very comfortable,” says Bill Hughes, senior vice president of the financing division for Marcus & Millichap Capital Corp.

Recent regulations have forced banks to make fewer construction loans. Rules like the Dodd Frank Financial Reform Act and the U.S. version of the international Basel III rules require banks to hold cash in reserve to offset risky investments like construction loans.

“Government oversight has restricted bank’s ability to do high-risk lending. They have to find out how to make money in other ways,” Hughes says.

Private equity lenders are also chipping into the market for CMBS loans, offering mezzanine and even permanent financing.

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