The State of the Small Balance Multifamily Market
(The Small Balance Multifamily Q&A — Part 2b)
Arbor has helped shape the small multifamily loan market into what it is today, partnering with Fannie Mae to develop the first-ever agency small loan program over 20 years ago. More recently, Arbor helped develop the Freddie Mac Small Balance Loan program that launched in 2014 — and was the program’s top lender in 2015 and 2016.
Ivan Kaufman, Chairman, President & CEO of Arbor, recently sat down with Stephen Johnson, vice president of the Small Balance Loan business at Freddie Mac, for a conversation on the sector moderated by Sam Chandan, founder of Chandan Economics and the Silverstein Chair of the NYU SPS Schack Institute. Here is Part 2 of that conversation, which examines the role of small balance loans in the multifamily housing sector.
(The following is excerpted from the December 9, 2016 episode of The Real Estate Hour, a weekly SiriusXM Radio show powered by the Wharton School of Business. The text is edited for clarity and brevity. You can listen to the full show by clicking here. Part 1 of the Q&A is located here.)
The following is part 2b. Please click here for part 2a.
Sam Chandan: $2.6 billion isn’t a bad place to start for your first year in business. Now one of the things that I want to make sure folks understand in terms of the scope and scale of Freddie Mac’s activities, is that when you are working with partners like Arbor, you are not limited to a handful of markets. You are a presence in every market, ensuring some degree of liquidity. Is that fair?
Steve Johnson: We are a nationwide program. So when the sun comes up in the morning and it goes down at night, we are here. We are in the markets. We don’t — as I have seen people commonly refer to it — redline. Again, regardless of what the conditions are, we are in this business every day to provide liquidity. That means coast to coast, north to south.
We have offices all over the country, and we do that because we are a prior approval model. We believe in making our own credit decisions. We inspect every property, and we underwrite every loan. So we have got boots on the ground out there. When you combine that with a player like Arbor, who has reach across the country, you have something extremely powerful — an originations engine and our ability to make the right credit decisions.
Sam Chandan: Ivan, you have the benefit of a long-term perspective that most of us don’t. You have seen the small balance lending market grow over the past year and we are expecting 2016 to be the biggest small balance year on record. What is behind that? How much is Fannie Mae and Freddie Mac, and how much is underlying momentum and demand for small balance properties?
Ivan Kaufman: As financing and liquidity comes to this part of the market, I believe it will be a much more active sector moving forward. So, I think the standardization, the streamlined products and the growth in the market will make it more attractive. And clearly, outside of some of the gateway cities, financing has become a little bit less accessible with regulation and cutbacks from the banks. The agencies just fill a tremendous void here to keep the market moving at a very robust pace.
Sam Chandan: Ivan, as someone who is also active in the larger multifamily loan market, how do these small balance loans look different in terms of pricing, borrowing costs and leverage? Am I still going to find low interest rates and healthy underwriting? What does the loan package look like for me?
Ivan Kaufman: They are somewhat similar in terms of pricing. Because of Freddie Mac and Fannie Mae’s commitment to effectively serving this sector of the market, they have come up with price reductions to make it extremely attractive.
In terms of underwriting, small loans lend to have a different type of borrower. They are often not as sophisticated and lack the same kind of financial capabilities that larger apartment owner/operators have. They might, for example, lack audited financial statements. So there is some flexibility on the documentation. We have to spend a little bit more time getting to know the borrowers and getting to know their properties. So it requires a little bit more insight, and is a little bit more of ‘relationship lending’.
Sam Chandan: Ivan, you have talked about how the borrowers are different, can you tell us how the renters are different?
Ivan Kaufman: What we find on these small balance loans is that the renters are typically essential workers. They are firemen, teachers, police officers and young professionals — all critical components of the communities they reside in.
These professionals are not as interested in amenity space as long as the housing meets the needs of their family.
Steve Johnson: Ivan is absolutely right. If you look at the small balance business and apply an identity, it would be workforce housing.
Roughly 70% to 75% of our business is being done with renters who make less than 80% of area median income. And a large portion of it is for renters making less than 50% of area median income. That is our target audience. That’s where the affordability crunch is occurring in the market and that’s where we are looking to provide liquidity.
(Stay tuned for a future Q&A from a March 2017 episode of The Real Estate Hour on SiriusXM Business Radio featuring Ivan Kaufman and Sam Chandan discussing the state of the greater multifamily industry.)