Across the Mid-Atlantic, the multifamily market continues to expand, but the money game is shifting for new construction projects. Because of these shifts, the region’s developers must have new strategies to successfully finance their projects and maximize profits.
The Financing Shift
From 2010 to 2015, banks were the largest source of construction financing, typically providing loans for near-total construction costs at a relatively cheap rate of 2.50% on top of LIBOR. Now, due to changes in regulations, the previous 75-80% leverage has dropped to about 65%, and developers are paying almost twice the interest rate due to rising spreads and increase to the LIBOR index.
The new, more conservative approach to bank financing has caused loans to become smaller and more expensive than before. This, paired with rising construction costs, has created a “funding gap”, forcing multifamily developers to seek alternative approaches to finance their visions.
The Quest for Equity in Construction Funding
Because bank financing simply does not stretch as far as it once did, developers face the challenge of funding total construction costs while also ensuring future returns. Most employ one of two options:
• Take the funds out of their own pockets; or
• Find additional equity partners.
Neither choice is ideal; funding a project in-house diminishes returns and increases risk – not an attractive combination.
On the other hand, developers who choose not to self-fund must find additional capital to get the project built, which requires navigating a segment of the market where they may not be well-versed. Moreover, developers who choose institutional or preferred equity partners to provide funds often find that these relationships come with trade-offs such as: higher rates than traditional bank financings, in the range of 12-15%; or a required ownership stake with balance accrual. Payments of this nature add up quickly and can build up quickly once a project is completed, when properties are still building both their occupancy and the resulting income.
Because developers are incented to pay off equity funding sources as soon as possible, bridge loan financing has become an increasingly attractive option. This solution allows prepayment options as well as the ability to convert to permanent debt once the project achieves a certain level of occupancy.
Increasing numbers of developers are now coming to the conclusion that they need full-service partners with the contacts, expertise, and creativity to navigate this increasingly complicated process. These experts bring a team with access to multiple funding sources to lock down the best bank loans for initial construction, then leverage their contacts to identify and connect with the right equity partner to close the “funding gap.”
Overall, in the Mid-Atlantic and nationwide, the funding cycle has become much more complex for developers. There are challenges at each step, from construction funding and stabilization to ultimately securing a permanent loan.
All of this change has made the composition of the capital stack more important than ever in development and new construction. It is now imperative to work with a commercial real estate finance company that has full-service expertise and can be a ”true consultant” and help developers make the right choice at every stage. Partnering with such a skilled firm to develop a streamlined strategy ensures a leg-up on the competition, ultimately leading to more returns and success.
About the Author
Brendan Coleman is a managing director and the head of Walker & Dunlop’s Combined Origination teams based in Bethesda, MD. He is primarily responsible for new loan origination and specializes in Fannie Mae and Freddie Mac multifamily products, while also developing other lending relationships for the company’s Mid-Atlantic Debt and Structured Finance Group. n
Brendan’s leadership and expertise also forms a key element in the combined go-to-market structure comprising Walker & Dunlop’s lending and investment sales teams. Since joining Walker & Dunlop, Mr. Coleman’s team has originated more than 400 transactions totaling over $5 billion dollars’ in financing. For more information, please visit www.walkerdunlop.com.