How to succeed in financing a multifamily project, despite multiple challenges

What compelled developers and lenders alike to stay on the sidelines? In a word, volatility. Yields on the 10-year Treasury, a primary component in sizing multifamily loans, fluctuated by an average of 6 basis points on a daily basis, twice the rate seen in 2021.¹ That kind of volatility can swing financing costs by millions of dollars overnight, grinding deal activity to a halt.

So far in 2024, that measure of volatility has fallen only slightly, to just under five basis points. But that little bit of improvement, along with signs of life in equities markets and signals that the Fed may begin to cut rates later this year, boosted transaction volume in the first quarter. “Early in 2024, that measure of volatility had fallen. It was just a slight improvement, but that little ray of light — along with signs of life in equities markets and expectations that the Fed might start cutting rates as early as March — boosted transaction volume in the first quarter. Since then, however, the economic picture has gotten murkier, as stubborn inflation has prevented the Fed from lowering rates. Still, conditions are markedly improved from what they were at this time last year.”

Here’s a look at the ways in which conditions for multifamily financing have improved, as well as some new and lingering challenges impeding the market.

Better, but not all better

Despite a markedly more optimistic attitude among real estate investors, the nascent recovery in multifamily financing is still uneven.

On the positive side, commercial mortgage-backed security (CMBS) loans have come roaring back after being nearly nonexistent in 2023. CMBS loans are attracting interest from developers because they’re more flexible than agency loans. Permanent loans are also easier to come by than they were last year.

On the other hand, construction and balance sheet loans remain difficult to secure for all but the top clients and developers, and banks that do offer them are requiring deposits, cash management, permanent loans, or other products as the price of admission.

Life insurance companies are lending on multifamily loans, but their focus is on transactions with lower leverage in strong markets, such as Class A properties. This is where agency and CMBS financing have the upper hand, as they’re less rigid in this regard. The agencies, however, prefer to have mission business built into transactions, which is not as high a priority for life insurance companies.

The Federal Housing Administration (FHA) continues to offer construction loans through its Sec. 221(d)(4) program. However, the FHA has proposed underwriting changes to the debt-service coverage (DSCR) and loan-to-cost (LTC) ratios on (d)(4) loans that are expected to make this financing option less attractive,² especially for workforce and mixed-income projects.

Finally, debt funds have reentered the market, but are not as robust as we expect them to be by the end of the year.

Volatility lingers, and it’s not going away anytime soon

Regardless of the components of any financing package, volatility in the 10-year Treasury rate continues to make borrowers nervous about committing to deal terms. Capital providers, whether they be life insurers, Fannie Mae, Freddie Mac, FHA, or CMBS, find themselves in a cycle of quoting and requoting loans, hoping that borrowers will eventually pull the trigger. As that volatility subsides and developers have a better idea of the financing costs they’re dealing with, they should be more comfortable with locking in a rate.

The problem is that stubborn inflation is pushing out the timeline for the Fed to start cutting interest rates, which in turn injects volatility back into the 10-year Treasury. At the beginning of 2024, expectations were that the Fed would start reducing rates in March and follow that with two or three more rate cuts before the end of the year. Now, economists are projecting that the first rate cut won’t come until September.³ That cut is expected to lower rates by just 25 basis points — not enough to quell the volatility in Treasury — so it’s unlikely that there will be substantial improvement in volatility before 2025.

A pivotal moment for the affordable housing crisis

Unfortunately, the affordable housing crisis persists. An analysis⁴ of Census Bureau and Moody’s data by Hines says, the U.S. housing shortage was around 3.2 million units at the end of 2023. Efforts to close that gap have been stymied not only by the difficulty in securing financing but also due to the increased costs of construction and labor. Margins on affordable housing projects are generally lower than for luxury apartment developments, which amplifies the impact of these higher costs.  

That’s not to say, however, that anybody is giving up. Affordable housing stakeholders are working collaboratively with each other and with counterparts in government to come up with solutions. The Federal Housing Finance Agency (FHFA) and Fannie Mae and Freddie Mac are working on new financing ideas for affordable housing, and all parties are trying to be as creative and innovative as possible to create new products to help address the issue.

The general consensus, however, is that it will be up to the government to step in, close gaps, and remove barriers. Local and state governments have been taking action by relaxing zoning laws to spur more development. On the other hand, discussion in some municipalities and on the federal level of implementing rent controls could disincentivize developers and investors from participating in the market, reduce property values, and squeeze tax revenues.
 

In uncertain times, turn to the experts

While there’s no returning to easy days, multifamily financing is in a much better place than it was in 2023. There are plenty of options out there for navigating a landscape that remains uncertain, and bankers who specialize in residential real estate financing know the best ways to get started. They understand the challenges CRE stakeholders face, as well as the social, economic, and political variables behind those challenges.

To discuss the current market environment and what financing options are best for your next project, reach out directly to Janette O’Brien, Head of Production — Multifamily.

Visit www.key.com/rec where you can find our expertise in CRE market outlooks, affordable and senior housing, and more.