Our Perspective 11/ 17/ 2020

Capital Corner: Which Equity Sources Are Most Active In 2020?

Private equity and institutional investors continue pursuing opportunities, particularly in the strong-performing multifamily and industrial asset classes. Since early 2020, we have seen an increase in equity coming from new sources, including sovereign money and new life company programs. Today’s equity sources are most interested in three primary categories: Opportunity Zones, value-add deals and development.

Opportunity Zones
Opportunity Zone (OZ) investors remain active, both in OZ funds raising capital and transactions closing. The OZ program, under the Trump administration, was launched as a means to spur private-sector investment in economically distressed communities. Those investing in OZs may benefit from capital gains tax incentives including the ability to defer paying capital gains tax if they hold the investment for 10 years. This is year three of the 10-year program, so the clock is ticking to take advantage of the tax incentives.

When the program was first announced, the hundreds of billions of dollars in investment funds were enticing. A project, however, has to make sense both financially and locally. Additionally, the OZ equity providers that actually have the capital to finance these often very large deals are a relatively finite group. (NorthMarq recently arranged $45 million in opportunity zone equity for a multifamily development in Seattle).

Wealthy family offices are fueling much of the activity and more are increasing their allocations in OZs.

Value-add deals
Multifamily value-add deals are growing larger, resulting in a need to branch out and find new equity. Due to delayed investing by some traditional institutional equity sources today, sponsors (primarily on behalf of private buyers) are seeking new relationships to advance or secure available opportunities. Sponsors are looking to nontraditional equity sources that were not necessarily on their radar screen. These new equity sources are seeking opportunities in low-barrier, high-growth markets like the Sun Belt states.

The equity available for both the multifamily and industrial sectors is wide-ranging including preferred equity, JV and hybrid-preferred financing (a hybrid of debt and equity). There is creative financing available for both sectors. Hybrid-preferred financing will typically fund high in the capital stack thus minimizing a Sponsors capital requirement. The hybrid cost of capital is well below most traditional joint venture equity and a good option to evaluate on projects with strong anticipated upside.

Another theme is the worldwide markets are seeking yield, so more sovereign money is looking to enter U.S. real estate, and that also is creating new sources of capital.

Development activity
Equity is available for both multifamily and industrial development. In industrial development, the rapid growth of e-commerce is fueling demand for logistics real estate. Some industrial developers are looking for a partner to put in some of the equity in a build-and-sell platform. Since industrial development is so favored, many new projects are getting snapped up by large institutional owners.

Another trend is life companies are offering high-leverage construction loan programs. By offering a one-stop-shop, high-leverage construction loan, it allows the developer to spread out their capital, put in minimal equity and sell the development quickly.

In closing, equity sources may not be as interested in retail or office right now, but we anticipate select opportunities in office redevelopment, suburban office, and retail asset renovation. While multifamily and industrial properties rule the day now, most active equity sources are always looking to be the first to find the next opportunity for yield.

UPDATE FROM THE AGENCIES

Freddie Mac
As Freddie barrels towards the end of the year, they are working to process almost $10B in loans by December 31. They are expected to hit their five-quarter cap of $100B in new loan originations by that time. Freddie is still seeing a record number of deals being submitted for quote with over $6B in new opportunities being submitted weekly. Due to this unprecedented demand, Freddie raised their spreads by 10 basis points. In addition, acquisitions have taken priority over refinances, particularly ones where the borrower is seeking cash out proceeds. We are still waiting to hear from the FHFA on 2021 cap limitations. In the meantime, Freddie has indicated that they are currently working on a long term strategy for processing in-flows, and are expected to speed up quote times in the near future.

Fannie Mae
The last few weeks have been interesting, to say the least. Political and economic uncertainty continue to dominate news headlines, which have led to continued volatility in the market and interest rates. The announcement of a potentially viable COVID vaccine flooded the markets with optimism, only to be brought back to reality by a rapidly worsening pandemic, all among the background of a Presidential election that remains unresolved. After spending the last few months banded between 0.65% and 0.75%, 10 yr Treasury Yields surged to nearly 1.0% before settling back to 0.90% in recent days. But despite all of that, the Fannie Mae platform continues to be stable, loan volume is at record highs, interest rates remain at all-time lows, and NorthMarq continues to structure competitive Fannie loan terms for its clients.

While NorthMarq continues to close loans in 2020, year-end is right around the corner, and we are looking forward to 2021. The FHFA scorecard is expected to be announced in the coming weeks, and we are confident it will allow Fannie Mae to continue to be a stabilizing force in the capital markets.

FHA/HUD
FHA entered its fiscal year 2021 on October 1 with a deep pipeline of new transactions. As a result, we have seen a lengthening of timelines for new deals by approximately 30-60 days. This has been a manageable, and we believe, temporary dilemma as FHA works through their current pipeline.

It is expected that a new MAP Guide (underwriting/processing manual) will be issued by the end of 2020 and will include a 90-day “grandfather” period before becoming mandatory. We expect some meaningful updates to the MAP Guide and will follow up with more detail as soon as it is available.

The volume of 223(f) transactions for newly stabilized deals (i.e. previous “three-year rule deals”) has been robust. Since lifting the restriction on these deals in early 2020 FHA issued firm commitments on $750/m (31 commitments) of transactions and has closed nearly $250/m (11 closings). This volume is anticipated to increase as we head into FHA’s 2021 fiscal year, allowing borrowers to enjoy the ability to achieve maximum leverage (and long-term rate stability) on newly constructed multifamily assets.

The hallmarks of FHA financing (maximum leverage, longest terms, low interest rates) remain constant during this challenging environment due to Covid-19. FHA maintains its goal of being a consistent and competitive source of capital during all market cycles.

Jeffrey Erxleben
Jeffrey Erxleben EXECUTIVE VICE PRESIDENT/REGIONAL MANAGING DIRECTOR
Patrick S. Minea
Patrick S. Minea EXECUTIVE VICE PRESIDENT/REGIONAL MANAGING DIRECTOR
William Ross
William Ross
PRESIDENT