MORTGAGE LENDING: INSTITUTIONAL LENDERS

APARTMENT FINANCE TODAY • MARCH 2008

Still the One

Portfolio lenders, once the standard in multifamily lending, are now helping to fill the void left by a dormant CMBS market.

By Jerry Ascierto

Multifamily developers are getting reacquainted with an old friend in 2008.

Before the emergence of conduit lenders, institutional lenders like life insurance companies and pension funds dominated the multifamily debt industry. These portfolio lenders use their balance sheets to make loans and hold onto them, in contrast to conduit lenders, which bundle mortgages and sell them as commercial mortgage-backed securities (CMBS).

Since institutional lenders are typically conservative, requiring more cash down and featuring more stringent underwriting standards than securitization deals, they lost much market share to conduit lenders over the last two years.

But 2008 CMBS sales are expected to be less than half of the record $230 billion recorded in 2007, according to Moody’s Investors Service, and many institutional investors are re-emerging from the shadows to provide capital to multifamily developers.

“With the CMBS market being shut down for all intents and purposes, the life insurance companies are starting to step up and fill some of that void,” said Greg Leadholm, a managing director at Heitman, which manages pension funds and places debt on behalf of insurance companies.

Life insurance companies like MetLife and Prudential Financial and pension funds like those managed by TIAA-CREF and Principal Financial have jumped back into the market for both long- and short-term debt.

“The second half of ’07 was a very busy time for portfolio lenders, and my guess is that portfolio lenders’ share of the business has gone up,” said David Durning, Prudential’s managing director of originations. “Life insurance companies put out more money last year than they have in history.”

Prudential Financial’s institutional lending arm saw a big jump in multifamily loan production in 2007, to $1.2 billion from $845 million the year before. And Prudential wasn’t alone. In October 2007, insurance company lending for commercial real estate increased 41 percent over the previous October, to $4.8 billion, according to the American Council of Life Insurers.

That’s because portfolio lenders now have the pricing advantage over conduits. Permanent loan spreads over benchmark rates for strong, stabilized assets are in the 200 basis point range, which is about 100 basis points lower than what the conduits were offering in early February. For short-term, interim financing, most institutional lenders are pricing a strong multifamily deal at 300 basis points over the London Interbank Offered Rate, for a 6.85 percent rate in early February.

Heitman’s new venture

Heitman, a real estate adviser that manages equity investments for institutional clients, plans to open the doors on a new debt group in the late spring or early summer. The company has been busy raising capital to close a fund from which it would make bridge and interim loans to developers.

Heitman will offer short-term (two to three years), floating-rate debt, averaging about $20 million per transaction, and it plans to do as much as $700 million in debt financing in its first full year of operation. The company will target repositioning deals, as well as provide bridge loans for new construction in major markets.

This is the first new debt product that the company has introduced in a long time. Heitman has placed senior debt for many of its institutional lenders, mostly insurance companies, for 40 years. But its volume of permanent loans dropped drastically in the last few years—from $800 million in 2004 to just $350 million in 2006 as the CMBS market took off.

The company wasn’t willing to follow the debt industry’s trend toward looser underwriting standards in an overheated market. “When the CMBS market was doing 1.05x debt coverage, we didn’t go there—we were at 1.15x or 1.20x, which is where we stuck in the multifamily market.” said Stephen Bailey, a managing director at Heitman. “But we are definitely ramping up that placement business again this year.”

While short-term debt will be the new venture’s focus, Heitman anticipates being a one-stop shop, offering senior as well as subordinate loans.

Focus on strong deals

Prudential also hopes to expand its portfolio lending business in 2008. Like Heitman, Prudential targets repositioning deals and structured loans for unstabilized assets.

Prices and underwriting terms for Prudential’s debt financing haven’t changed much despite the volatility in the capital markets. Although spreads have widened throughout the industry, benchmark rates like the U.S. Treasury have fallen, leaving all-in mortgage rates affordable to developers.

The company’s portfolio lending division offers fixed-rate loans ranging from three- to 25-year terms and up to 80 percent loan to value. The company also offers both fixed- and floating-rate construction/permanent loan combinations, and rehabilitation/permanent loan combinations.

Prudential’s 2008 activity will be centered on strong borrowers in major markets. But in markets most affected by the subprime mortgage industry’s meltdown, such as Rust Belt cities in the Midwest, Prudential’s underwriting has grown more cautious, Durning said.

The weakening U.S. economy has given many portfolio lenders pause at lending in secondary markets in the first half of 2008. Instead, moderately leveraged deals focusing on high-quality assets in strong markets are the focus of most insurance companies today.

“We’re really focusing on high-quality sponsors and doing most of our lending in the first-mortgage space at about 60 percent leverage,” said Mark Wilsmann, a managing director of the commercial real estate operations of MetLife. “I think where the CMBS void is going to be most obvious is going to be in secondary and tertiary markets.”

The re-emergence of institutional lenders is expected to continue throughout the year, as these conservative companies do what they’ve always done: provide a certainty of execution that, once again, has gotten the attention of multifamily developers.