Is Capital Back? A Conversation About the Availability of Debt

Matthews™ EVP Cliff Carnes examines differing perspectives from capital markets veterans David Treadwell and Geoffrey Arrobio.

A Mixed Market

Cliff Carnes: Today’s lending landscape changes weekly as new capital sources try to tackle growing demand and a limited supply. In the middle of a possible bottom, buyers, sellers, and lenders await news of the real estate market’s approaching rebound. Will interest rates finally drop? Have construction costs peaked? Is capital back? Most would argue that it’s still a mixed market where some lenders have been quick to return, and others remain on the sidelines. Matthews’ own David Treadwell and Geoffrey Arrobio comment on the availability of capital in 2024. 

Capital Market Opportunities

David Treadwell: Lenders have capital, and they want to deploy that capital, but they’re still being selective about where and how to deploy it, depending on the product type. That was the sentiment among lenders during a recent Mortgage Bankers Association (MBA) conference. There’s plenty of capital out there, but it helps to understand each lender type.

The Agencies

Most of the capital circulating the market is in the multifamily sector. One of the main reasons for this is that the agencies, Fannie Mae and Freddie Mac, have annual allocations (or volume caps) to deploy throughout the year. The 2024 volume caps for the agencies are $70 billion each, totaling $140 billion. While the agencies are inclined to put out capital, they also need to meet specific mission-driven, affordable housing criteria. According to the Federal Housing Finance Agency’s (FHFA) website, at least 50% of the agencies’ multifamily business this year must be mission-driven, affordable housing. So, while Fannie and Freddie are great multifamily lenders for permanent loans, not every deal fits into that box. That’s where bridge lenders come in.

Bridge Lenders

The market is full of numerous bridge lenders who bridge to a sale, an agency, or some other permanent loan execution. Bridge financing is highly demanded for assets that need more time to stabilize or cannot be underwritten to a conventional fixed rate. There are also many “bridge-to-bridge” financing structures for existing assets. While bridge capital is still expensive, it’s abundant and active across multiple sectors as traditional lenders have tightened up.

Life Insurance

Many lenders would jump at a multifamily opportunity but rarely get to because of the agencies. Life insurance companies, from small and medium to large firms, have their own allocations they want to deploy. None of them are taking a discount this year. Even conservative lenders are putting out more capital because 2023 was such a down year. They’re making up for lost time. This year, life insurance companies are focusing on industrial, retail, self-storage, and multifamily if they can win it.

CMBS

Commercial mortgage-backed securities (CMBS) are active and want to deploy a lot of capital. CMBS lenders have a competitive advantage over agencies, banks, and credit unions because they can price their debt. Buydowns enable buyers to “buy down” their fixed rate and essentially prepay interest from the start, which helps with the underwriting process and allows buyers to borrow more proceeds. So, instead of getting a 65% leverage, a buyer can get up to 75% leverage based on buydowns and a lower fixed rate. In a market where 10-year treasuries are at 4.3% and interest rates feign normalcy, buydowns appeal to customers. They make refinancing easier. While the agencies and life insurance companies also offer buydowns, they’re typically capped lower than with CMBS shops.

Banks and Credit Unions

Yes, banks are active but conservative. Credit unions are much more active than banks. Banks remain selective because they need to shore up their balance sheets, have troubled assets, or have overallocated in certain product types or lending types (like construction, acquisition, or refinancing). Banks are more likely to quote only for their existing clients and want an onerous deposit on the loan they deploy. If they put out a $10 million loan, they want a 10% (and sometimes even 20%) deposit from the borrower, which can be a non-starter for many.

There’s plenty of capital across the agencies, bridge lenders, and more “conservative” lenders like life insurance companies, credit unions, and banks. Capital is also abundant among private lenders, whose annual acquisitions turned positive in 2023. There’s reason to be optimistic, especially in the middle market space where deals close for $5 million to $35 million. Middle market buyers, sellers, and investors are all active because they’re incentivized to make a return on their investment.

However, it will take time for the market to grasp that the new norm is not a 3% interest rate but a 6% to 7% interest rate. So, expectations about cap rates must accommodate higher interest rates for buyers and sellers to feel good about trading.

Capital Market Challenges

Geoffrey Arrobio: Plenty of lenders are not back in the market yet. Investors have been reluctant to deploy capital due to several factors: rising construction costs and a void in construction financing, sponsorship concerns among conservative lenders, and a lack of joint venture (J.V.) equity across the board.

Construction Financing Void

Local and regional banks typically account for 90% of the U.S. construction loan market. Construction financing has been difficult to obtain since federal regulators asked banks to scale back on credit, shore up balance sheets, and ensure sponsors have global cash flows, stable credit, and ample liquidity. Because of the regulatory issues banks face, borrowers are under increasing pressure to find alternative financing sources. While alternative financing is possible from private funds or some life insurance companies, it requires creativity to make sense to borrowers. Alternative approaches include short-term bridge financing, mezzanine financing, preferred equity, or bringing in an equity partner.

Conservative Lenders

Sure, lenders are in the market, but they’re incredibly conservative. Lenders everywhere—from life insurance companies to private debt funds to credit unions and banks—are more careful about borrowers’ sponsorship, liquidity, net worth, or sponsor experience. Sponsorship and global cash flows are essential to lenders and the agencies that have liquidity and net worth thresholds. Annual net acquisitions from REITs and institutional lenders remain negative, and fewer banks are providing capital than before. Banks may face future headwinds as they navigate overleverage issues. There’s still plenty of bridge lending for existing assets that need a bridge and CMBS lenders who take on more risk at a higher price to borrowers.

Lack of J.V. Equity

Another gap in the market is the lack of J.V. equity, the “normal cast of lending characters,” per se. A classic J.V., or joint venture, equity group partners with a company on the asset side and shares the risk and upside. Most J.V. equity groups aren’t deploying capital. They’re in wait-and-see mode. Because of this, a new quasi-institutional lender has emerged as preferred equity shops try to replace traditional J.V. equity. Preferred equity is different since it’s less involved in the upside and looks more at existing assets or recapitalizations over new developments. This gap is a strong indicator that capital isn’t back.

While many market participants wait on the sidelines, investment capital is likely to be highly selective about debt transactions and equity investments. Given high construction costs and the void in construction financing, new developments are seeing the most significant impact. Challenges in securing capital may exist, especially with banks, but deals will always find a way to get done.

The Power of Creative Structuring

Cliff Carnes: The deals that close today just don’t look like the ones that closed two years ago. Clients can’t go to their bank for capital even if they’ve borrowed from them five or six times before—they need experienced debt professionals.

Two examples come to mind that prove the power of structuring. Matthews™ Capital Markets (MCM) recently closed a three-property, multifamily portfolio deal with $85 million Freddie Mac and $10 million preferred equity. With some creative structuring, MCM arranged the financing for the portfolio to make it cash-neutral. In another recent deal, MCM worked on a $20 million construction loan request. We explored a dozen bank lenders who quoted low leverage parameters and wanted a mandatory deposit. After weeks of searching, MCM built a relationship with a private lending source who quoted an ideal leverage point. In both cases, it paid off for the clients to work with a team determined to find the right lender.

While the debate about debt capital—and how much of it waits to be deployed—keeps unfolding in real time, deals are still happening. However, those deals take longer, involve more work, and require creative structuring. Because of this, working with the right company is more important than ever.