In a fluid capital markets environment, brokers and developers are using innovative financing to raise capital for multifamily deals. Banks, REITs, and funds are eager to lend for core projects with strong borrowers.
By Cody Field
The capital markets tightened significantly during the pandemic. Those reins have loosened, and now more capital is available for ground-up multifamily residential construction in the Bay Area.
Lenders have a significant amount of capital that needs to be deployed, and the Bay Area’s multifamily market is fundamentally strong. Although the market struggled during the pandemic, it is on the rebound. For example, apartment rents in metro San Francisco increased 9.7 percent year over year through June, according to a Yardi Matrix report.
The housing story today in the Bay Area is similar to the story pre-COVID, housing is still in high demand. Even concerns about the increases in interest rates and construction costs and supply constraints are having little effect on the fundamental demand metrics for multifamily product.
After more than two years of pandemic-associated starts and stops, multifamily builders have returned to the marketplace and are eager to meet pent-up demand. Permitting accelerated, while materials and construction costs skyrocketed. However, in the past few weeks lumber and copper costs have started to soften. With materials costs coming back down, more multifamily projects are beginning to pencil out, becoming more favorable from a cost-on-return ratio.
Demand drivers for Bay Area
One of the primary drivers of demand for multifamily in the Bay Area is jobs. Venture capital still flows in the region, which creates employment and fuels the need for housing. While there are fewer initial public offerings (IPOs), there is still plenty of seed and early-round capital.
According to recent data by analytics firm Pitchbook, venture dollars are still very much focused in Northern California. The Bay Area attracted $52.3 billion in venture capital in the first half of 2022, which is 36 percent of the total across the U.S.
Additionally, Bay Area companies are encouraging employees to return to the office following COVID. In July, office occupancy in the San Francisco metro reached a pandemic high of 38.1 percent, according to data from Kastle Systems, which monitors keycard activity in 2,600 office buildings nationally. Although the Bay Area continues to lag behind other major metro areas, progress continues as companies attract workers back to the office to promote culture, connection, and creativity.
Bay Area is supply-constrained
The primary historical driver for the Bay Area’s multifamily residential sector is the pent-up demand due to geographic barriers. All parts of the Bay Area have defined geographical barriers, which limit the amount of city growth and expansion. This means the only places to find development sites are infill locations that are more susceptible to political/governmental challenges, which can make it difficult to get deals done. Multifamily construction often hits roadblocks due to restrictive zoning policies and not-in-my-backyard (NIMBY) attitudes.
When a developer can get through these challenges and has a viable project, she will need to obtain construction financing. Across the board, we have seen the cost of borrowing increase with the rise in interest rates. Developers and their brokers must monitor the capital markets to track which lenders are most active for what product type.
Multifamily rents are keeping pace with rising costs, and occupancy is at pre-pandemic levels. There are lenders that are very comfortable with projects in the Bay Area, particularly those that are shovel-ready. The location and type of construction matter, but capital is available to build.
Who is lending for ground-up multifamily construction in the Bay Area?
Real estate-focused commercial banks are fueling many recent multifamily residential projects in the Bay Area. These are typically groups offering low-leverage 60% to 65% loan-to-cost (LTC).
The Bay Area is also seeing significant capital from unionized pension funds, particularly if there is a union component or requirement to build, which is occurring in nearly every core market in Oakland and San Francisco.
Additionally, debt funds are offering high-leverage loans at 80% to 85% LTC.
Also, it is important to note in today’s construction lending environment, there is an increasing number of groups that will participate higher in the capital stack. They will participate with the senior lender and reach a higher leverage point. This can be accomplished through mezzanine debt or preferred equity. We are seeing that part of the market increase in this current environment where senior lenders are pulling back on their leverage points, and developers need more funds to complete their projects.
Deal reflective of today’s market
A current project that exemplifies what is occurring in construction financing in the Bay Area is a ground-up condominium development on El Camino in the heart of Silicon Valley. The owner obtained a low-leverage loan at 65% LTC and maintained the relationship with his senior lender. Northmarq introduced a local fund that was able to participate higher up in the capital stack by providing preferred equity, which brought the total leverage to approximately 80% LTC.
This allowed the owner/developer to have higher leverage at market cost, so he had a fixed rate, as opposed to having additional equity come in where he had to share in the percentage of return.
Although many national players were sourced to finance the project, the local preferred equity group best understood the project and the sponsor and was familiar with the market’s nuances and strengths. The condo project is slated to break ground in the fall.
The capital markets have always been selective when partnering with developers. In today’s atmosphere, it is important as ever to ensure that you are canvasing the market for the right lender for the right capital stack. Even in the Bay Area where demand drivers are constant and building costs are becoming more stable, knowing who and where the capital is coming from can make or break a project. Capital is available when you know where to look.
Cody Field is Senior Vice President of Debt/Equity in Northmarq’s San Francisco office. You can contact Cody directly at 415-433-2149 or at cfield /at/ northmarq.com.
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