Multifamily Turns to Alternative Financing in a Down Market

In the fall of 2022, it was already becoming clear to many in CRE that markets would cramp up until there was some price discovery to reduce bid-and-ask gaps. In multifamily, that is still happening, with buyers and sellers waiting for each other to blink.

“Buyers are cautious, facing higher financing costs and downgraded projections of future rent growth,” wrote Paul Fiorilla, director of research at Yardi Matrix, in February. Cap rates were up from low-to-mid-4% range at the start of 2022 to 5% by the end.

“Most apartment owners are holding on to properties unless there is a reason to sell, such as a death, the dissolution of a partnership, or a capital event like a maturing mortgage that creates a need for restructuring,” said Fiorilla, who was expecting higher levels of distress.

Does that mean everyone goes home, leans back in a recliner, and waits for things to change? Not according to an April virtual meeting of experts at NAI Global, hosted by Alex Waddey, senior managing director and co-head of the capital markets group. The answer, at least for the time being, is greater reliance on alternative financing arrangements.

“The heretofore sluggish deal making since the Fed started tightening monetary policy may have some relief coming, in the form of creative deal-making and specifically, assumable debt and seller-backed financing,” Waddey says. “A number of meeting participants discussed active deals in which the seller is offering it (on a deal in Iowa) and buyers are working with sellers and the sellers’ banks to keep existing loans in place under new ownership – and at a discount, comparative to new mortgages (in Wichita).”

Assumable loans aren’t a direct transfer between parties so much as a restructured loan with new guarantors. “For these hybrid/assumable loans to work, the basics of a loan still apply, such as the requirement for appropriate loan-to-value ratios, sufficient net operating income and good credit ratings for the buyer and entity assuming the debt after acquisition. In best case scenarios at the moment, a seller exiting a property with a 3.5% to 4% loan may be able to transfer its property to a new owner who then takes on a loan with the same bank the seller used for a mortgage and pay a new rate of 4.75% to 5%.” That is still below debt rates frequently running around 7%.

Another example was a deal in which the seller kept a percentage of ownership for a year or two “to get the interim sale price to work for the buyer and the allow property’s cash flow to make the deal work now by covering the debt service.”

“Using creative financing tactics isn’t going to open a floodgate of transactional activity, of course, but it’s the start of a process we’ve seen before in down markets when the situation requires alternative practices to get deals done,” Waddey says.