Commercial real estate insider: Investors need to broaden their minds about funding sources


When it comes to debt, everyone seems to be eating from the same basic food groups. Banks, commercial mortgage-backed securities and big balance sheets dominate the market. If you’re a multifamily investor, there’s also Fannie Mae and Freddie Mac. But most folks are really missing the most important and liquid debt products out there.

For multifamily exclusively, Federal Housing Administration-insured debt sometimes gets a bad rap, but let’s just get right down to facts. For stabilized, market-rate product (as well as Low Income Housing Tax Credit, senior and so-on), there is no leverage or long term, amortizing debt priced better, or higher on the capital stack, than FHA 223(f) money.

Does it take longer to close than agency? Sure does. So, don’t use it for an acquisition unless you have a lot of flexibility on your contract for timing. Let’s say a good closing is 150 days from beginning to end. However, ladies and gentlemen, if you’re refinancing, there is nothing sweeter than tight spreads on a 35-year, self-amortizing, non-recourse loan at 85% loan-to-cost ratio.

HUD-insured debt is not just for low income housing, it’s not just for construction, it’s for your entire suite of multifamily assets (except outliers like student, sorry). Now if you need fast timing or prepayment flexibility, banks and balance sheets may be the way to go… or perhaps life companies.

The only debt less understood than FHA amongst most investors, from my experience, is life company debt. Let’s get right at the pros and the cons.

First, it’s available for all asset classes – storage, industrial, flex, retail, office, multifamily, senior, hospitality, etc. Second, it’s available in almost all MSAs… if you have a population over 25,000, you may have the opportunity to look at life company debt.

Third, it’s by far the tightest spreads you can get your hands on for long-term (or short-term debt). We are seeing 10-year deals with spreads tighter than 160 today, and with a flat yield curve that means a 25/25 is pricing pretty similar to a 5/25. Fourth, prepayment penalties can be flexible if they love the deal.

Don’t get me wrong, there are generally lockouts and yield maintenance but it’s their balance sheet, and if they want your deal they will get creative.

Now to the cons? There are two that come to mind, but aren’t really cons in my opinion.

First, lower leverage. These loans aren’t for folks who are looking to max out their capital stack: Think 65% to 70%. But a life company isn’t generally going to consider your three-cap value in downtown Los Angeles. More often than not, they are going to throw a 7% cap rate at it (or something to that extent) and then calculate the leverage. That means lower relative leverage in big markets and a pretty accurate 65% to 70% in smaller markets where cap rates are higher.

Second, they will compress amortizations for what they perceive to be riskier products or tenants. Both of these things really speak to the fact that they are conservative and adjusting for risk, and if you are a commercial real estate investor and don’t consider risk, perhaps you forgot about (or weren’t around for) the last cycle. This time is different is what everyone said before they realized that a cycle is just that, something cyclical, happening over and over again. Tighten your risk profiles!

In the end, these seem to be the least understood and least used products in the vast universe of commercial and multifamily real estate capital markets. There simply needs to be more education.

Life company debt and FHA debt aren’t reserved for institutional assets. They can be gotten for loans as little as $1 million to $3 million. Even the most sophisticated investors are still missing some life company debt or FHA-insured debt in their investment portfolio and sometimes, non-recourse, tight-spread products like these are just what the doctor ordered.

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