As cap rates cratered over the past couple of years, apartment buyers migrated to different sources for financing.

For instance, investor-driven instruments, which include debt funds, claimed 12% of the market share in 2021 — the highest percentage ever, according to MSCI Real Assets.

“The debt funds over the last 18 to 20 months picked up volume, especially on the acquisition front,” said Kyle Draeger, senior managing director
 of multifamily debt and structured finance at CBRE Capital Markets. “If you have a 2% or 3% cap rate, you can't get the leverage you need with the agencies. So most of that volume has been flowing to debt funds.”

Commercial mortgage-backed securities grabbed 15% of the volume, while government agencies claimed 41% in 2021. That was still the largest slice of the pie, but a much smaller piece than in years prior.

But the recent volatility in the Treasuries market and rise in interest rates could interrupt borrowers’ march away from the agencies, say many observers. They may once again move back to government-backed sources of capital and commercial banks, as spreads have widened this year. 

“It has caused the borrowers who are going to those debt funds to relook at whether they need that much higher-cost debt or if they can take a little lower-cost debt and maybe go with a fixed-rate loan with one of the agencies,” Draeger said.

Even though debt funds are currently less attractive, not everyone thinks that relatively high-leverage loans from investor-driven instruments will disappear. Other sources of capital, like insurance companies and commercial banks, are still in the market. 

New York City-based ACRE, an institutional fund manager that invests in multifamily as an owner and debt fund, offers debt at 65% to 70% loan-to-cost. “There is still a value proposition for floating-rate debt to get additional leverage,” said Daniel Jacobs, partner and head of credit at ACRE.

Debt funds back off

As rates have moved, the ability of some debt funds to close loans has come into question. Some of these lenders have retraded out of deals in the past few months, but it’s not universal, according to Draeger.

“For the most part, if you have signed an application or are down the road, the better debt funds are trying their best to hold to whatever the terms were, to the extent they can,” Draeger said. “They will do that more with their better clients. The lower-tier debt funds may need to retrade.”

Some debt funds have left the market altogether. 

“Most debt funds are largely out of business for at least another quarter or two because the CLO markets are not receptive,” said Max Sharkansky, managing partner at Trion Properties — a multifamily investment sponsor and private equity real estate firm based in West Hollywood, California, and Miami. “The very large ones are a little more competitive, but not to where they're competitive with other lenders. The are other ways to finance without going to debt funds.”

Return of the agencies?

When one source of debt starts to back off, borrowers will begin to look for other options. 

“The debt funds are all private market, and they’re relooking at where their spreads are,” Draeger said. “There is less certainty of execution with them in general than there is with the agencies. You do tend to see a little bit more of a flow back into the Fannie and Freddie pipelines when something like this happens.”

Sharkansky is one of those borrowers taking a closer look at Fannie Mae and Freddie Mac. “In the current environment, agencies are starting to look a little bit better,” he said. “The agencies are sizing better relative to what the buyer has to pay.”

In previous cycles — such as during the Global Financial Crisis of 2008 and the COVID-19 pandemic — apartment borrowers turned to the agencies when other lending sources dried up.  

“What we've seen historically is that as those conventional deals become more difficult when there's a dislocation in the capital markets, there will be much more demand for the agency programs,” said Richard Ortiz, managing partner with New York City-based Hudson Realty Capital, a multifamily lender that offers bridge and agency loans. 

Commercial banks remain active

At Trion Properties, Sharkansky has been able to secure bridge loans through large regional and national banks even as debt funds have backed off. “We just closed a couple of those and we've got a few more of those in the pipeline,” he said.

Large national banks are offering 50% to 60% leverage, according to Draeger. “Banks have still been relatively aggressive,” he said. “They’re still looking to put out money and they have a pretty cheap cost of funds.” 

But Draeger says these large banks are starting to get a little pickier.

“Everybody has plenty of money to lend,” he said. “They’re just being a little bit more selective on what you're doing.”

That selectivity goes beyond the large banks to other lenders like insurance companies, according to Draeger. “They’re making sure that the exit yields that they're looking at are appropriate,” he said. “So they’re just fine-tuning their underwriting a little bit more. If they’ve got 15 deals on their plate, they don't want to do all of them. They do a few of them.”

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