News today paints a fairly dismal picture about the state of commercial real estate, and the plot points of most articles are the same. Elevated interest rates have led to disagreements between buyers and sellers about pricing and, in turn, sales transactions have plummeted. At the same time, the rates have also negatively impacted lending. Loans are now harder to get and significantly more expensive when they are available. Like other issues within the general economy today, inflation is a primary culprit.
Making matters worse is that a large swath of existing loans on commercial properties are coming due. Property owners are finding it much harder to obtain either transitional bridge loans or permanent financing to replace their existing loans. Certain properties — including numerous office and retail buildings — simply don’t qualify. Notably though, one property type is in a much better position for financing: workforce and affordable rental housing, and these properties have unveiled opportunities for those hoping to make socially responsible investments.
THE HUGE VOID
A critical subset of housing, workforce and affordable apartments are units that serve the needs of Americans with low and extremely low incomes, respectively. Like other multifamily assets, these apartments have traditionally performed better than many other types of commercial real estate, even hedging inflationary concerns when the economy sours. Supply and demand play a big role in these apartments’ ability to endure. A depressing statistic says everything you need to know about the current supply. The United States today lacks 7.3 million workforce/affordable and available apartments to meet the demand, and all 50 states are impacted.
Among the reasons for the missing supply of lower income rentals is a simple lack of new supply; the majority of new units built over the past decade or longer have been higher-end apartments. Meanwhile, pent-up demand for workforce and affordable units keeps most of the existing properties near 100 percent occupied. Many renters sit on exceptionally long waiting lists hoping for an apartment to become available. In other words, while the situation is less than desirable for renters, the rock-solid occupancy among these existing apartments ensures that they perform as investments.
There are a couple of ways investors can participate in opportunities surrounding these apartments today. One is via commercial mortgage-backed securities (CMBS) affiliated with the agencies who finance the apartments: Freddie Mac and Fannie Mae. They are driven by a mission to ensure finance is available for lower income rentals, no matter what is happening with the real estate industry, the greater economy or interest rates. Both have become primary sources of loans for these apartments today. Once originated, these CMBS agency loans are securitized and become investment opportunities.
CMBS LOANS AND B-PIECE INVESTMENTS
CMBS loans are a common type of financing for multifamily properties. After origination, they are pooled together to create a mortgage-backed security, then subsequently sold on the secondary market to bond investors who are driven to participate in CMBS investments because they receive and benefit from the interest paid by borrowers over time on the pooled CMBS loans.
The bond certificates available to investors are categorized into tranches, or classes, with key risk/reward differences that vary by class. A significant difference lies between A-class bonds and B-piece bonds. B-piece bondholders receive larger yields; however, they must wait for A-class bondholders to be fully paid before they are. Thus, the risk is slightly higher, but so is the reward.
In full transparency, the issuance of CMBS loans has also slowed lately in response to heightened interest rates, as it has with other types of real estate loans. However, within the multifamily sector, and more specifically among Freddie Mac and Fannie Mae, there is still a steady stream of loans being issued and securitized. Again, these agencies are fully committed to provide financing to borrowers, even during periods of economic lows. These loans are therefore not only continuously available to B-piece investors, but their credit quality is enforced by agency credit standards and performance.
Another opportunity to invest within this same asset class is through bridge-to-agency loan programs and partnerships. Many owners of workforce and affordable rental properties at times need transitional (i.e., temporary) financing while they prepare their property to qualify for permanent financing with Freddie Mac or Fannie Mae. This usually happens when an apartment property needs to undergo some minor to moderate rehabilitation first. This could include safety items such as handrails, paint and finishes, driveway or parking repairs, etc. Once the property improvements are complete, the borrower will then qualify for the agency loan, but needs temporary financing to get by in the interim. These bridge loans thus provide a critical solution in the affordable housing marketplace.
Make no mistake. Neither of these investment opportunities will completely solve the affordable housing crisis on their own. More workforce and affordable apartment units are desperately needed for us to be out of the woods. That said, investor support of the existing supply of rental units is also necessary. If owners of these properties are unable to finance their units, there is significant risk of them being converted to other types of real estate or to apartments that serve consumers with higher incomes. When that happens, the supply is even more limited.
Whether investing in B-piece securities of agency permanent loans, or in bridge loan programs for workforce and affordable apartment properties, investors are supporting a key need within our communities — affordable housing. Everyone deserves a home, and this sector needs help from the greater investment community to get closer to making that ideal a reality.
Pat Jackson (pat.jackson@sabal.com) is founder and CIO of Sabal Investment Holdings.