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In this Issue
 Subprime Sneezes, Commercial Catches Cold
Flexible Fannie Finance
NMHC Survey: Subprime Meltdown Increases Apartment Demand
Remodeling Projects Decline, Following Housing Market Trends
Subprime Sneezes, Commercial Catches Cold
By Michael Bellissimo
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| Michael Bellissimo |
Current instability within the single-family mortgage sector presents an interesting dichotomy for the commercial real estate industry. Defaults on home loans in the residential housing market are giving rise to losses on real estate-backed securities and a tightening debt market. This is to be expected due to the interconnection of capital markets and will likely put a damper on highly leveraged property deals –– driving some players out of the market
Why is the commercial sector suffering from the residential market’s ailments? There are a number of reasons:
- Guilt by association. As mentioned above, the capital markets are interconnected, so if mortgage lending in the single-family arena falters because of weakening standards, that translates into the commercial markets.
- Lowered credit standards. Credit standards weakened primarily due to the conduits’ need to find product to keep their CMBS volumes up.
- Conservative agency standards. While agency lenders lessened their standards to compete with the conduits, they maintained a greater sense of conservatism, especially from the standpoint of interest-only (I/O) structures.
- Lower interest rates. Lower rates have resulted in lower cap rates and higher valuations in multifamily lending. Most deals have been debt service constrained (as opposed to value constrained) and to the extent cap rates rise and the interest-only product was pushed, some refinance problems will come home to roost.
As we move forward, the interest-only product line will likely fade as a concept and only be available for more conservatively sized deals. And while Fannie Mae will leave the exit analysis to their lenders, most will hold the line to the structured analysis currently in use.
There is, however, a silver lining to this cloud for the multifamily industry. Many potential home buyers will stay in their rental homes, resulting in reduced vacancies, greater demand and increasing rental rates (see NMHC Survey results below).
Michael Bellissimo is Arbor’s Chief Underwriter. He can be reached at mbellissimo@arbor.com.
Flexible Fannie Finance
By Ronen Abergel
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| Ronen Abergel |
Due to the intense competition from alternative lenders such as CMBS or community banks, Fannie Mae has evolved into a more flexible and creative capital source by reducing Debt Service Coverage (DSC) ratios from 1.25 to 1.20 to accommodate the low cap-rate environment and offering interest-only terms for up to 10 years for lower-leverage mortgages.
Fannie Mae also offers supplemental financing which allows for the acquisition of additional debt after 12 months without triggering any penalties on the pre-existing mortgage. For instance, if a property’s NOI improves after one year, a DUS® lender can provide additional debt on up to two occasions without any consequences.
The “Fixed+1 Product” adds to the end of mortgages a one-year, adjustable-rate term for loan repayment without penalty. Another new program allows borrowers to swap the collateral securing the loan. Finally, Fannie Mae now offers a new prepayment arrangement whereby the yield maintenance is based on the Treasury benchmark plus 50 basis points. This can result in as little as half the penalty that would be charged under the old method of calculation.
The conventional DUS® mortgage offers competitive, tiered pricing for the acquisition or refinancing of multifamily projects nationwide, including recently completed projects. A borrower can choose between a fixed-rate and an adjustable-rate mortgage that balloons or fully amortizes. The minimum loan amount is $500,000 with loan terms ranging from five to thirty years. The amortization period is up to 30 years. Non-recourse execution is also available, however, standard carve-outs for “bad acts” such as fraud are required. Pricing is tiered and based on the risk attributes of the individual loan. Generally, higher DSC and lower LTV loans receive lower pricing. Loans are assumable for 1% subject to lender's review and approval of the new borrower’s operational and financial capacity.
For the standard DUS® mortgage, Fannie Mae offers borrowers three prepayment premium options: yield maintenance, defeasance and graduated prepayment premium. Yield maintenance calculates prepayment costs based on prevailing market rates. It allows the investor to attain the same yield as if the borrower had made all scheduled payments until the end of the loan term. The graduated prepayment option, however, offers a fixed prepayment cost schedule based on the year in which prepayment occurs. For example, the prepayment premium schedule for a five-year loan may be 5% in year one, 4% in year two, 3% in year three, 2% in year four and 1% in year five. The last option, defeasance, removes the lien on the property prior to maturity in exchange for the borrower’s purchase of a Fannie-Mae provided bond that pays investors the same cash flows as expected from the original mortgage. Fannie Mae has the most borrower-friendly defeasance product in the marketplace since it can be accomplished with the purchase of a single bond. This makes it much easier and less costly for the borrower than defeasance accomplished by purchasing a series of Treasury or other government securities.
For apartment property loans under $3 million (or up to $5 million in specific MSAs), the Fannie Mae 3MaxExpress® product can streamline the entire loan process with reduced documentation requirements, more straightforward report formats and flexible legal/closing requirements.
Ronen Abergel is a Director at Arbor Commercial Mortgage, LLC. He can be reached directly at 212-389-6548 or via email at rabergel@arbor.com
NMHC Survey: Subprime Meltdown Increases Apartment Demand
Consumer demand for apartments remains strong as the subprime mortgage meltdown has decreased the number of renters leaving to become homeowners, according to the National Multi Housing Council’s July 2007 Quarterly Survey of Apartment Market Conditions. On average, survey respondents reported few changes in the strong market conditions recorded three months ago, with the exception of a significant worsening of debt market conditions.
One quarter of respondents said that occupancy rates and/or rents rose during the first quarter of the year, but the majority (59 percent) reported no change. As a result, the survey’s Market Tightness Index was virtually unchanged at 55–it was 56 in April and 54 in January. (For all four of the survey indexes, a reading above 50 indicates that, on balance, conditions are improving; a reading below 50 indicates that conditions are worsening; and a reading of 50 indicates that conditions are unchanged.) This is the 16th consecutive quarter in which the index has been above 50, indicating improving demand in the apartment industry.
When asked specifically about the impact of the subprime mortgage meltdown on the flow of apartment residents leaving to become homeowners, 18 percent said that there has been a big decrease and 37 percent noted a small decrease. The continued strong demand conditions suggest that any supply spillover from the excess inventory in the for-sale market into the rental market has not exceeded the growing demand for apartment residences.
The biggest news in this quarter’s survey was a significant deterioration in the debt market. Thanks to higher interest rates (compared to three months ago) and noticeably tighter underwriting by lenders, the Debt Financing Index dropped to 26, from 54 in April. This may be the low point for the Debt Financing Index since interest rates have retreated since the survey was conducted, unless lenders continue to restrict credit further.
“Conditions remain generally favorable in the apartment markets, with demand for apartment residences continuing its gradual, but sustained, rise” noted NMHC Chief Economist Mark Obrinsky. “While debt financing conditions took a turn for the worse, equity capital remains abundant. This could lead to a shift in the composition of the investment market, however. If current conditions remain in place, highly-leveraged private buyers may lose their place to REITs and institutional investors who rely more heavily on equity financing.”
SOURCE: National Multi Housing Council. For the complete survey results, go to www.nmhc.org
Remodeling Projects Decline, Following Housing Market Trends
Remodeling activity has slowed in all sectors of the housing market during the second quarter of 2007, according to the National Association of Home Builders’ (NAHB) Remodeling Market Index (RMI). Based on surveys among remodelers regarding their expectations for current and future market demand, the RMI declined for the residential housing market as well as for homeowner and rental occupied housing units.
During the second quarter of 2007, the RMI for current residential remodeling projects declined from 46.1 to 44.8, while remodeler projections for future remodeling projects decreased by more than two points to 44.1. A RMI over 50 indicates optimistic expectations for the demand for remodeling projects.
Remodeling activity for homeowner and rental occupied units declined or remained stagnant compared to the first quarter of 2007. The RMI reflecting current trends for homeowner-occupied units remained relatively stable at 47.5 in the second quarter compared to 47.7 in the first. The rental-occupied RMI for current activity declined from 44.5 to 39.1. Future expectations decreased from 46.4 to 43.2 for owner-occupied units and from 41.4 to 37.3 for rental-occupied units.
Remodeling Market Indices reflecting current activity fell in all regions of the United States during the second quarter, with the exception of the Northeast. The RMI for the Northeast reflecting current market conditions increased more than 6 points to 49.5. However, future expectations for the Northeast remained stagnant at 44.1 for the second quarter compared to 44.3 for the first quarter. Both the RMI for the current market and the future market declined in the Midwest, from 47.5 to 44.5, and from 44.7 to 43.7, respectively. In the South, the RMI for the current market and the future market declined from 45.9 to 42.3 and from 50.7 to 45.0, respectively. The measure of current conditions in the South fell from 48.2 to 46.8, while the measure of future expectations increased from 45.0 to 46.0.
NAHB Chief Economist David Seiders claims that the decline in remodeling activity is a reflection of the downturn in the housing market as a whole, and although he does not think remodeling activity has reached its lowest point yet, he does expect conditions to improve within the next couple of years.
“Not surprisingly, the remodeling market is following the downswing we are seeing in the overall housing market,” said Seiders. “We expect some further erosion in the second half of this year and in 2008, followed by a gradual recovery in 2009 and beyond.”
SOURCE: National Association of Home Builders www.nahb.org.
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| Flexible. Innovative. Creative. |
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Arbor is a national, full-service real estate investment firm focused on executing the highest level of expertise in order to provide clients with the most expansive, creative, and flexible range of lending products in the real estate finance industry. At Arbor, employees approach business in a results-oriented, decisive manner, striving to serve its customers quickly and efficiently while offering a boutique of unique product lines that distinguishes the company from traditional lending firms.
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