The short-term borrowing rate is at its highest level since January 2008 after the Federal Reserve raised its key rate by another 0.75 points to reach a target range of 3.75% to 4.00%. The early November increase throws fuel on multifamily investors’ already burning desire for assumable debt.
“The biggest risk today in entering into a new deal is extreme interest rate volatility,” says Matt Frazier, CEO of Jones Street Investment Partners, a Boston-based real estate investment firm that focuses on multi-family assets in the Northeast and Mid-Atlantic. regions of the country. “Once a deal is contracted, and by the time you lock in debt, who knows what the rate might be? If you can completely remove that risk from the equation, you can focus on the fundamentals.
Jones Street, which owns and operates a portfolio of approximately 4,400 apartments totaling approximately $1.3 billion in assets under management, is actively negotiating transactions using loan assumptions and picking up quality properties with debt at fixed rate in place, notes Frazier. At the same time, the company continues to regularly analyze its portfolio, but with an additional examination of properties with assumable debt.
“As a buyer we are interested in deals with attractive debt, and as a seller we are very aware that the capital structure of our assets has become an asset,” he says. “In high interest rate environments, an assumable loan with an interest rate below the market has value. This will help market that asset. Sellers whose properties have assumable loans can s expect to attract more potential buyers and generate a higher selling price.
Just two weeks ago, Jones Street closed a suburban intercity apartment community with more than 350 units outside of Philadelphia for more than $100 million. The deal included an assumable debt with nine years of remaining term and an interest rate of less than 4%.
By taking on the loan, the company was able to mitigate interest rate risk and ultimately secure a higher leveraged return than would otherwise have been possible, according to Frazier.
The attractiveness of an assumable loan largely depends on the remaining term and the holding period expected by the investor. For example, a short-term holdback may not complete the prepayment terms of the loan assumption.
“It’s buyer-specific — beauty is in the eye of the beholder,” Frazier says, adding that Jones Street is keen to take on longer terms because of its long-term holding strategy.
Although Jones Street would have been interested in the Philadelphia property without the assumable loan, the existing debt made the deal “very compelling,” according to Frazier. Had the company needed to secure new financing in the current interest rate environment, the debt would likely have cost 5.5% or more, he speculates.
“Anyone who is currently in the market and considering a potential transaction – one of the questions they will first ask themselves is, ‘Is there a debt on the property and is it assumable?'” Said Frazier. “They will look at four things: the amount of debt, the interest rate, the remaining term, and any remaining interest-only term.”
Lower rates and better than market conditions
Geopolitical and economic uncertainty, coupled with the increased cost of capital resulting from rising interest rates, dampened multifamily sales activity. Banks, pension funds and even some alternative lenders have cut funding, making multi-family transactions harder to complete. As investors look for smart and creative ways to close deals, many have turned to hypothetical lending.
“In high or rising interest rate environments where credit availability becomes tight, lending assumptions may be attractive to borrowers for several reasons, such as the ability to take on debt in place with potentially higher rates low, better-than-market terms, provisions and lender requirements,” says David Le, assistant vice president of acquisitions for Atlas Real Estate Partners, a private real estate firm with offices in New York and Miami that focuses on multi-family investment and development.
Lending assumptions are attractive to investors because fixed rate debt that has been secured in previous years is very attractive compared to today’s higher rate environment. If the loan was taken out before June 2022, an assumable’s rate should be much more favorable than the rate a borrower can currently get.
Additionally, loan assumptions often allow sellers to avoid prepayment penalties, cancellation or foreclosure periods, which can result in a lower purchase price for buyers and a more favorable overall basis. , notes Le.
More complicated than expected
The complexity of a loan assumption varies by lender and type of loan, with some assumption provisions being more restrictive than others. A buyer’s track record and experience are key elements in taking on a loan.
And even though “assumption” is built into the loan documentation, lenders have approval discretion, which means there’s no guarantee that a buyer will be able to afford a ready.
“There is also the risk of not being approved by the lender, which can cause a deal to fall through, especially if there is not enough time left before closing or if financing contingencies have been waived,” says Le .
This is especially true today, given that some lenders, especially banks and debt funds, would prefer loans to be repaid so they can put that money back to work.
“Lenders have an incentive to force repayment of low-interest mortgages in order to create higher-interest mortgages,” Le notes. “Most importantly, lenders want good loans with good borrowers in order to maintain a high quality loan pool. [They’re] more likely to endorse a hypothesis if they view the new buyer as an improvement to the referral. »
Last year, when Atlas acquired an 800-plus-unit multi-family community in a secondary market, the company successfully assumed the debt in place, in part because of its track record and experience. This debt, coupled with the sheer size of the deal, forced many local players out of the market, according to Le.
Those hoping that taking on a loan is easier than getting a new one will be disappointed. Jones Street’s Frazier says the underwriting and approval process is equally rigorous and time-consuming, requiring 60 days or more. Most lenders will require the same or higher credit from the new borrower.
A loan assumption generally leads to lower leverage (loan-to-value). Maximum loan amounts are generally governed by the LTV or property income to repay that debt, whichever is lower. Today, the LTV test means “nothing,” according to Frazier. “What currently limits loan proceeds is the cost of debt and the ability to service it,” he says.
Low leverage impacts returns and requires a higher capital contribution to underwrite the loan, according to James Nelson, director and head of Avison Young’s New York-based tri-state investment sales group and host. from “The Insider’s Edge to Real Estate Investing” podcast. Typically, low leverage only works with patient buyers with long-term horizons, as low LTV on acquisition can negatively affect short-term returns.