High-Leverage Financing: Q&A with Hunt Real Estate’s Cope and Torres

Freddie Mac recently announced that the Federal Housing Finance Agency (FHFA) opted not to renew its Workforce Housing Mezzanine Loan and Targeted Affordable Housing Mezzanine Loan programs, which were launched as pilots in August 2018. Despite discontinuing the program, sponsors have other options when it comes to high-leveraged alternatives for workforce and affordable housing financing.

Connect Media spoke with Hunt Real Estate Capital’s Suzie Cope (Director, Loan Originations) and Precilla Torres (Senior Managing Director, Debt Strategies Group) about higher-leverage alternatives for multifamily.

Q. What’s happening with multifamily borrowers and financing at this stage of the cycle?
Suzie Cope: As prices continue to rise and cap rates continue to compress, we’re seeing a lot of deals that become debt service constrained. This means that with a lower loan-to-value requirement, clients need to bring more capital to the table when it comes to acquisitions. So, a higher number of borrowers are now trying to get additional leverage to make the deals work.

Q. How are the borrowers obtaining that leverage?
SC: You’re either looking for preferred equity or mezzanine debt. For Freddie Mac, although every transaction is approved on a deal by deal basis, Hunt is pre-qualified as a preferred equity provider; we can bring additional capital behind Freddie debt. We’re also an approved mezzanine lender for Fannie Mae debt.

Precilla Torres: The first difference between these instruments is the formats: one is mezzanine debt and the other is preferred equity. The Fannie mezzanine debt is sized to the minimum of a 1.10x debt service coverage ratio or an 85% loan-to-value, and is only permitted by Fannie Mae behind their fixed rate product. Non-payment of contractual amounts trigger a default, the mezzanine debt is subject to an intercreditor agreement with Fannie as the first mortgage holder, and as the mezzanine lender, one can foreclose on its collateral through a UCC foreclosure process.

In the case of the Freddie preferred equity, the non-payment of dividends doesn’t necessarily trigger a default. Having said that, under certain situations regarding preferred equity, you can agree with a property owner to step into major decisions without going through the foreclosure process. As the preferred equity proceeds are sized to the lesser of a 1.05x DSCR or a 90% loan-to-value, preferred equity also provides a little more capital compared to the Fannie mezzanine debt option.

SC: You have higher leverage with preferred equity; hence, you are also going to pay more for that capital.

Q: What are some examples of how these products might work?
PT: We’re seeing that the Fannie Mae mezzanine option is utilized in conjunction with stabilized assets, given that it is permitted only behind fixed-rate products. Freddie preferred equity can be utilized for both stabilized and value-add assets. In acquisitions in which clients believe that there is value upside from their distinct property strategy and expertise, preferred equity can be paired with Freddie’s value-add first mortgage program. Historically, Freddie preferred equity has been on portfolio transactions.

SC: What we’re finding is that most clients take advantage of realized cash flow upside to pay off the mezzanine debt or preferred equity with the agencies’ supplemental loan programs. One of the great ways we’ve seen Fannie mezzanine products work in the past is when borrowers are looking to go straight into permanent financing, even when a property’s full cash flow potential has not yet been realized. They want the attractive cost provided by a Fannie or Freddie first mortgage, while obtaining additional leverage upfront before such potential upside. Typically, they can achieve this objective with the preferred equity or mezzanine debt product originated at the time of the first mortgage, then end up with the supplemental financing that can take out the subordinated products in a few years.

Q: Do you think the GSEs will return to offering higher-leveraged products?
SC: I don’t think so. Both Fannie and Freddie are busier than ever in their core businesses. They’ll continue tweaking their products, and their regulator is pushing to find solutions for rural housing needs right now. Outside of that, I don’t believe that we will see the Agencies taking on that additional leverage, which would put them at risk. At Hunt, we feel there is plenty of opportunity in the market right now to fill those gaps that others aren’t filling. Our credit teams are picking the right deals that we need to be investing in, meaning there’s limited risk in taking on that additional piece while continuing to finance first mortgages.

PT: Also, Hunt has a huge infrastructure beyond debt. Frankly, among the key considerations that entered into approval from Fannie and pre-qualification with Freddie is that we have boots-on-the-ground, real-time market intelligence from the large number of multifamily assets that we own, and our ownership of the third largest property management group in the country. Because of that, we have a better eye toward which assets can support the additional leverage.

Pictured (l-r):
Suzie Cope, Director, Loan Originations; [email protected] / (212) 521-6391
Precilla Torres, Senior Managing Director,  Debt Strategies Group; [email protected] / (212) 521-6437

For comments, questions or concerns, please contact Amy Sorter