Lenders become increasingly selective about projects and grow wary of market saturation.

The multifamily housing market remains one of the strongest sectors in real estate. Still, the nation's lenders are approaching the next six months with caution.

Although capital still is readily available for development, acquisition, refinancing and renovation, some lenders are becoming much more prudent and selective. Additionally, the number of lenders is shrinking as mergers and acquisitions on Wall Street and in the banking industry point to a consolidation trend.

Housing affordability also is becoming a problematic issue that lenders and developers will need to address as rents continue to rise past what many middle- and low-income families can afford. Despite the industry's growing cautiousness, multifamily housing remains one of the most popular investments today.

"There was some concern about nine months ago when it appeared the Federal Reserve Board might tighten sharply [increase rates], and the resultant rise in borrowing .costs would bring our 18-month-long string of stability to an end," says Mark Obrinsky, chief economist for the Washington, D.C.-based National Multi Housing Council (NMHC). "Last July's NMHC survey, however, has given us optimism that borrowing costs may have reached a plateau and might even edge down a little bit."

Strong demand spurs growth

Even though possible rises in borrowing costs have caused some concern, strong demand may continue driving the multifamily housing market's growth. "We expect the multifamily sector to remain strong in the foreseeable future mainly because of the continued demand for new construction financing," says Bernard "Bud" Malone, president of Dallas-based Malone Mortgage Co., which focuses on the Southwest market. "Because the phone keeps ringing, we haven't needed to go out and promote ourselves."

However, Malone's optimism doesn't reach into every regional market. On recent deals over the last four years, Malone Mortgage has increased its due diligence on all prospective projects and especially in markets that have begun to soften. "To some extent, demand has been met in parts of Phoenix, and we're watching Houston very closely," notes Malone. "Until downtown Fort Worth gets some absorption of existing units, that market has been sated as well."

On the other hand, Malone sees Austin and San Antonio, Texas, selected areas throughout Florida and parts of the Dallas Metroplex as areas with multifamily lending potential in the moderate-to upper-income bracket.

While some lenders are cautious about certain areas of the country, Jeffrey S. Juster, president and CEO of Newport Mortgage Co. LP, Dallas, which has a servicing portfolio that exceeds $1 billion, says there are no areas in the country in which his firm is hesitant to do business. "We might be cautious of an economic trend in a submarket, but today we primarily look at the number of projects in the area we're looking at," he says.

Cleveland-based Key Commercial Real Estate, which expected to generate more than $2 billion in construction and interim financing loans for multifamily developments in 2000, considers multifamily the strongest sector today. Key Commericial Real Estate is a subsidiary of KeyCorp.

"I think multifamily is the strongest market when you compare it to the office or retail sectors," says John Case, senior vice president and managing director of Key Commercial Mortgage, a division of Key Commercial Real Estate.

Another lender, New York-based American Property Financing (APF), a Fannie Mae and Freddie Mac specialist that was on track to close more than $1.3 billion in multifamily financing in 2000, favors multifamily projects as well. "Fewer financings in all product types are being done, but multifamily housing continues to be the product profile of choice for the majority of lenders," says Van Provosty, senior vice president of APF.

While the multifamily sector is strong, the first signs of a tightening market might be surfacing. According to Case, the strength, experience, and equity of a developer, combined with the equity of the project, the loan-to-value ratio and the projected lease-up are more stringently reviewed than ever before by lenders such as Key.

Consequently, fewer projects receive construction loan financing.

"From our perspective, we know what we can achieve in the way of a permanent loan, but I see other banks are only doing the open-ended construction loan with the hopes there will someday be a permanent loan in place," says Case. The difference between the permanent and construction loan amount is the equity the developer must contribute or raise.

"We're not going to gamble at the end of the day that rents are going to rise during the development cycle and in turn that will help enhance our permanent loan," adds Case. "So we want all parts of a deal identified before we even start a project. This might slow us from doing more projects, but it assures we've got everything covered upfront."

Juster echoes that point. "If there's one thing that's more prevalent today than in the 1980s, it's that lenders are much more disciplined," he says. "Plus, there's a lot more information available about how permanent markets operate and exactly how the takeouts are going to work when the construction period ends and lease-up occurs. This process alone has to slow up a lot of transactions."

Dan Charleston, regional vice president of Chicago-based Capri Capital, which services a $3.5 billion portfolio of almost exclusively multifamily properties, offers a different perspective. "Capital suppliers would love to be doing deals, but capital is being priced fairly, in my opinion, and that means not all the available capital is being put out there," he says.

Consolidation craze

Industry consolidation of multifamily lenders continued in 2000, and more acquisitions and mergers are expected this year. Bigger company infrastructures are now favored by lenders that are attempting to offer customers a one-stop shop of comprehensive financing products.

A recent consolidation example is KeyCorp's acquisition of Dallas-based Newport Mortgage Company LP. KeyCorp still is absorbing a recent acquisition of National Realty Funding to strengthen its CMBS origination and loan-servicing capabilities. KeyCorp, which is one of the nation's largest financial services companies, with $85 billion in assets, also recently acquired Cleveland-based McDonald Investments, an investment banking and brokerage firm, and brought the company into its newly realigned commercial real estate division.

Meanwhile, the proposed Newport deal will add another dimension to KeyCorp's ongoing strategy of developing a national mortgage finance company. Newport, which specializes in the origination, underwriting, funding and servicing of multifamily real estate loans under Fannie Mae, Freddie Mac Program Plus and other agency programs, will enhance Key's expertise in the multifamily sector, which represents nearly 30% of the $7.5 billion in total financing by its commercial real estate group.

The growing complexity of multifamily projects also is leading the trend toward consolidation. Developers are running into more challenges that demand a wider array of financial products and services from lenders. Therefore, more lenders are merging with each other to create comprehensive packages of services.

"From a macro point of view on the finance side, we're expecting the next three to five years of permanent financing to be slower than it was in the late 1990s," explains Juster, who will assume the title of agency director for KeyCorp once the acquisition is consummated. "There was a tremendous amount of refinancing activity that occurred between late 1996 and early 1999. The velocity of transactions literally doubled from the same period before. As everyone knows, the majority of permanent mortgages that get done today have lock-out, defeasance or yield maintenance requirements, which makes it very difficult to prepay in the early stages of the loan."

"Having a large national company provides for very beneficial economies of scale and almost creates a brand identity in today's market," adds Juster. "A company with a reputation of building a quality community that is a good place to live develops a brand identity that attracts tenants."

According to Juster, the branding trend is evident among companies such as JPI, an Irving, Texas-based multifamily developer that manages and/or leases more than 24,000 apartment units with another 17,318 currently under development. Cleveland-based Forest City Enterprises, a $3 billion real estate firm with a portfolio of more than 200 retail, residential, office and hotel properties in 21 states, is another example of the branding trend.