The market chatter at the end of 2016 centered around the pending wave of CMBS maturities, as well as, what anyone’s guess would be as to the new administration’s early moves regarding regulatory changes or rolling back Dodd Frank and other policies that had constrained the credit market in recent years, which had particularly held back the reemergence of the banking sector.
The President signed an Executive Order in the first week of February to scale back the Dodd Frank regulations that were installed as a reaction to the financial crisis. Related to this Executive Order, we expect to see more details in the coming months with regards to the loosening of regulations that the banks have had to decipher and navigate in recent years. We anticipate that this easing of banking regulations should result in lower borrowing costs for consumers and businesses alike, as well as, will inject additional liquidity in the lending market.
That said, the New Year has brought with it tightening of loan underwriting standards for specific to construction loans – as bank credit officers are directed to pump the brakes due to allocation and exposure to construction loans (specifically Multifamily) after the run up in the past few years. As well, many banks have been active in the multifamily sector in recent years and thus are looking to diversify their exposure to other product types.
We are seeing loan underwriting criteria continue to evolve whereby Banks are underwriting un-trended rents and have increased their stress test levels on both debt yield requirements and debt service coverage ratios. This is lowering construction loans to size to 60-65% of cost in comparison with last year loans were sizing to 65%-70% of cost.
In the face of these constraints on bank debt leverage, coupled with the pending wave of maturities of CMBS loans, a number of new mezzanine and preferred equity lenders have proliferated in the middle market commercial real estate space.
We have identified several of these mezzanine and preferred equity groups that are willing to take on construction risk and are layering their capital behind construction lenders, enabling our developer clients to push leverage up to 85% of cost, at yields that range between 9 and 14 percent.
These mezzanine groups have been calling on us as they have capital allocations to deploy and are eager to expand their network of senior bank lenders and developer sponsors with which they transact. As well, a handful of capital sources are offering “full stack” construction financing up to 85% LTC as competitive rates, offering decreased deal costs and execution risk.
To conclude, despite the loosening of oversight that is anticipated from Washington this year, Banks have taken a more conservative approach to construction lending in 2017. Borrowers that still need higher leverage construction financing (beyond 60-65% of cost) do have a solution that we can help facilitate through the addition of mezzanine or preferred equity to the capital structure.
Despite all the noise out of Washington since the inauguration, so far things seem to be business as usual for our clients and the capital partners that we work with. We are not hearing about anybody making drastic changes to their capital markets plans for 2017 as a result of the election.
If you have a pending transaction in need of financing, contact a member of the Dekel Capital executive team to discuss how we can assist in getting your project over this hurdle and finding the best capital source for your needs.