The Twin Cities apartment market is historically characterized by high occupancy and minimal volatility, with consistent and solid year over year rent increases, minimal concessions and sustained vacancy rates well below 5 percent. As a result, there is abundant interest from investors and lenders alike to place capital in the Twin Cities. The lending environment for Twin Cities’ apartment owners appears poised for another great run in 2019, with all lender types having a large appetite to place capital in the market.
Agency lenders (Freddie Mac, Fannie Mae, HUD) have been extremely active, and that will not change. Their allocations remain high, and all agencies are expected to compete aggressively for business. Additionally, there is an increased focus on products catering to affordable and workforce housing, not only for existing properties, but in providing loan commitments and locked interest rates for takeout financing for affordable or workforce housing projects The agency reach extends geographically to secondary and tertiary out-state markets as well with minimal impact on underwriting standards. Agency lenders are able to provide relatively high leverage, longer term, non-recourse financing for all classes of apartments. Their ability to offer partial or full-term interest only is a significant competitive advantage over other lender types.
Heading into 2019, life insurance company allocations are also up over last year, with nearly all lenders’ goals 10 percent or more as compared to 2018. Multifamily continues to be a favored property type, and while nearly everyone acknowledges where we are in the cycle, life company appetite for multifamily deals seems insatiable. Furthermore, in an effort to expand production volume, several life companies have introduced non-recourse bridge programs for transitional property, and most will consider funding pre-stabilized projects that are still in lease-up. Because of the velocity with which most new construction deals are leasing, lenders are comfortable extrapolating out the leasing trend and funding deals well before they are fully occupied. Many of our life company options are also willing to provide construction-permanent financing which removes interest rate risk by fixing the interest rate prior to construction for periods as long as 40 years. These segments of the market have traditionally been occupied by banks, but these new programs provide yet another option for multifamily borrowers.
As far as recourse lending goes, we are a very well-banked market. Despite a number of recent consolidations, there are still a plethora of banks with an affinity towards commercial real estate, and multifamily lending in particular. There is some caution, however, with not all lenders willing to pursue new construction as aggressively as they have in years past. However, repeat borrowers for well-located projects are still able to obtain construction loans with relative ease. The biggest determination of new construction may end up being rising construction costs as opposed to the availability of suitable financing.
Commercial Mortgage Backed Securities (CMBS) lenders and debt funds are yet a couple of other capital sources looking to capture their share of the multifamily lending market. Debt funds are targeting higher leverage transitional properties, providing up to 85 percent loan-t- cost on a non-recourse basis, with pricing that is typically slightly higher than bank and life company bridge options. CMBS lenders have been largely a non-factor in the multifamily space in our market. The CMBS market is currently more volatile and higher priced than alternatives, so very little CMBS business has been done as of late in the Twin Cities.
Internally, life company commercial mortgages compete with corporate bonds as alternative investments, and other lenders are reliant on bond markets to set their pricing. Chief investment officers would generally like to see a premium of 50-100 bps for commercial mortgages versus corporate bonds. Yields on corporate bonds widened in fourth quarter 2018, and commercial real estate investor loan spreads followed suit. To exacerbate the situation, Treasury rates also spiked around 3.25 percent. Since then, the market has settled back down to a point where spreads are 150-170 bps over the respective index for full leverage life company and agency loans.
With rates cooperating and lenders flush with capital, borrowers should have ample options for acquisition financing and refinances. The wall of loan maturities is behind us, so lenders are going to have to rely upon acquisitions, new construction and other transitional properties in order to fulfill their goals for 2019. They will look to stable markets such as the Twin Cities in order to do so. While lenders will continue to be prudent and keep a close eye on market metrics, their appetite for quality loan opportunities in the Twin Cities will exceed the number of available deals, leaving borrowers with ample options and continuing expectations for aggressive terms.