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How Rent Control, Downturn Fears Are Reshaping The Capital Stack

Two monumental forces are bearing down on the world of multifamily financing: an impending economic slowdown and the spread of rent control.


While neither is forcing developers to toss projects out the window or pushing banks to pause lending, they are creating tangible shifts in the way that lenders and borrowers work together to capitalize and structure deals.

“It’s not that we or our borrowers are changing standards, it’s that we’re holding to our standards in a changing economic and legislative environment,” KeyBank Real Estate Capital Senior Relationship Manager Amy Schroeder said. 

“We’re maintaining the risk and return tolerances we’ve always held and making sure we’re not chasing the bottom, so that when there is inevitably a challenge, we come out the other side.”

Paring Back Leverage

Though the economy has shown remarkable resiliency, many lenders are still expecting an economic contraction in the next few years. Such a slowdown would mean sluggish rent growth, while construction and labor costs — which are already at an all-time high — would continue to rise.

In response, some lenders are underwriting deals with lower loan-to-value ratios in order to lock in the 8% or 8.5% debt yields they have come to expect. While a 75% LTV might have been normal five years ago, many multifamily construction deals are currently sitting around 65% or 70% LTV, according to Matthew Purtell, who leads the real estate capital teams in KeyBank’s Boston and New Haven offices.

Institutional lenders also face countervailing forces: regional banks and lenders who are chasing down deals in local markets and mezzanine debt and bridge lenders who are eager to lend in the 10% or 15% gaps between a developer’s equity and a bank-backed mortgage. By lowering the amount of equity developers need to get started, these lenders are compressing cap rates and driving LTV back up.

“Some local banks with significantly smaller balance sheets than KeyBank are able to cut $30M to $40M financing checks,” Purtell said. “As long as that competition is in the market, we’re having to sharpen our pencils. It’s a careful balance. We have to be prudent and also ensure we’re not losing market share.”


Careful Structuring

When it comes to preparing for new rent control measures, banks are not so much changing the leverage of their deals as they are changing the structure. Schroeder, who has extensive experience lending on multifamily in California, said the state’s new cap on rent increases means underwriters are looking more critically at developers’ financial projections to ensure they are attainable under the current and prospective rent control legislations. 

“If a developer is projecting 50% rent growth in a single year after renovation on their pro forma, that is going to raise some eyebrows,” she said. “Rent caps may mean that 15% or 20% is more likely.”

She added that rent control could mean longer wait times for properties’ income to stabilize: While her team may have been able to bring a developer into a long-term loan in two years, it may look more like three to five with rent control. Now, her team is paying special attention to rent growth benchmarks in contracts and ensuring that there is always an exit strategy if properties are unable to hit their targets.

At least in California, the financing landscape could change more dramatically if the state government reevaluates its position on vacancy decontrol. Currently, landlords in California can bring a rent-controlled unit up to market rent when a tenant vacates. If that right is revoked — as it was in New York — it could severely impact multifamily financing.

Weathering The Storm

The spread of rent control and the fear of an economic downturn both suggest that developers may have to stretch their timelines and work harder to ensure that they find financing that can weather the storm.

“Most people find that if they can sustain a longer-term hold and ride out a downturn, multifamily historically has been the asset class that more times than not bounces back,” Purtell said.

One of the advantages of working with KeyBank, Schroeder added, is the constant communication and collaboration between its real estate team and its capital markets team, which lets the bank offer a smooth transition from short-term to long-term funding and react nimbly to minute economic and legislative changes.

But Purtell anticipates some bank consolidation in the future and developers that historically have been borrowing from just the more aggressive bank’s may find themselves without a relationship lender when the tides eventually shift.

This feature was produced in collaboration between Bisnow Branded Content and KeyBank Real Estate Capital. Bisnow news staff was not involved in the production of this content.