Warning signs have popped up everywhere that suggest a shakeout in multifamily lending is imminent—namely rising vacancy rates and landlords cutting rents to lure tenants.
Regulators worry banks are continuing to pile into multifamily loans at a time when certain markets could be overheating, and some banks have heeded the warnings and pulled back from the sector.
But other bankers have shrugged off concerns and insist that the multifamily business has never been better and still has room to grow. Multifamily loans, as a percentage of all loans, rose from 2.62% at Dec. 31, 2008, to 4.11% last year, according to BankRegData.com. Credit quality is pristine, too; nonperforming multifamily loans fell from 1.77% to 0.18% in the same period.
“We’re not seeing any distress or cause for concern,” said Jason Pendergist, the president of consumer and commercial banking at the $5.1 billion-asset Luther Burbank Savings in Manhattan Beach, Calif. “We’re just seeing projects fill up at the expected pace and we’re seeing rent levels move up at a deliberate pace.”
Multifamily is one of four lending subcategories that regulators consider when assessing a bank’s exposure to commercial real estate. Dozens of banks remain above regulators’ preferred capital ratio for measuring CRE risk.
At some banks, regulators’ warnings have already started to take hold. Speaking at the Credit Suisse Financial Services Forum on Feb. 7, David Turner, the chief financial officer at the $125 billion-asset Regions Financial in Birmingham, Ala., described multifamily lending as “really a headwind.”
“We were not comfortable with certain areas in the multifamily sector, in particular … Houston, Nashville (Tenn.), the Carolinas and Atlanta,” Turner said. “We thought those were getting too hot.”
Then there is the $6 billion-asset Dime Community Bank in Brooklyn, N.Y. Dime’s ratio of commercial real estate loans to total risk-based capital stood at 1,008% on Dec. 31, one of the highest rates in the industry.
Regulators’ concerns, plus investors’ desire to see banks operate in diverse business lines, pushed Dime to branch out of its historical roots as a predominantly multifamily lender, and put more resources into retail and small-business banking, CEO Kenneth Mahon said in a December interview with American Banker.
“We felt like it was something we had to start down the road on,” Mahon said.
Regulators have pointed to the supercharged growth in multifamily lending in recent years as a sign it might be time to slow down. The FDIC, Office of the Comptroller of the Currency and Federal Reserve issued a joint statement in December 2015 to “remind financial institutions of existing regulatory guidance on prudent risk management practices for commercial real estate.” The report noted that multifamily loans rose 45% at insured depository institutions between 2011 and 2015.
Yet apartment development continues to surge and that has raised concerns about vacancy rates rising, Laurie Havener Hunsicker, an analyst at Compass Point Research & Trading, co-wrote with other analysts in a Jan. 12 research note.
Apartment construction, “most of which has been in the luxury end of the market" is expected to be impacted as the “national vacancy rate ... is expected to increase by nearly 1% over the next three years,” she wrote.
Other bankers have noted that luxury apartments could be the problem area for multifamily lending, as some cities have seen a surge in construction of high-end buildings. Since early 2007, developers have delivered about 1 million new luxury apartment units, far outpacing deliveries of apartments with lower rents, according to REIS, a commercial real estate data firm in New York. Further, the national vacancy rate for luxury apartments rose from 4.6% to 5.7% between 2013 and 2016, REIS said.
“I think luxury multifamily probably is the area of most concern,” Stacy Kymes, executive vice president of commercial banking at the $33 billion-asset BOK Financial in Tulsa, Okla., said during the company’s fourth-quarter earnings call on Jan. 25.
The $63 billion-asset Zions Bancorp. in Salt Lake City has been concerned about its CRE concentrations and intends to scale back its multifamily lending, Chairman and CEO Harris Simmons said during a Jan. 23 conference call.
“We’ve been talking about our concentration limits and we made some changes in 2016, particularly around multifamily,” Simmons said. “We have become increasingly concerned that the rate of growth in that product type was not sustainable.”
Luther Burbank Savings, on the other hand, has no plans to dial back its multifamily lending. Luther Burbank held $2.6 billion of multifamily loans at Dec. 31, making it one of the biggest multifamily lenders on the West Coast. One of Luther Burbank’s latest multifamily deals was the refinancing this year of a $12.2 million loan on a 104-unit garden-style apartment complex in Gardena, Calif.
Luther Burbank manages risk by limiting its lending to smaller nonluxury apartment buildings, which are inhabited primarily by working-class and middle-class residents, Pendergist said. Luther Burbank predominantly makes multifamily loans to buyers of new apartment buildings and refinances loans on existing buildings; it rarely finances apartment construction.
“These apartments are as stable as anything,” Pendergist said. “The workforce communities are not going anywhere. Homeownership is not attainable for this segment of the population. You see consistent, steady rent increases, quarter over quarter.”
Liquidity remains strong in this segment of the multifamily market. Freddie Mac purchased about $55 billion and securitized about $50 billion of multifamily loans in 2016, a yearly record in both categories.
“The multifamily market is being driven by solid economic fundamentals rather than leverage and speculation,” David Brickman, executive vice president of multifamily at Freddie Mac, said in a statement.
Pendergist also disputed the notion that some markets have an oversupply of apartments.
“From coast to coast, when there has been pent-up demand, it’s been met with construction,” he said. “I don’t see any markets that I would classify as overbuilt.”
“Strong demographic fundamentals with millennials continue to drive multifamily ... and the market is not getting enough multifamily product built,” Greg Reed, senior vice president of multifamily finance at the $399 billion-asset Capital One Financial, said in a February report. “You have an undersupply.”
Kevin Cummings, CEO of the $23 billion-asset Investors Bancorp in Short Hills, N.J., acknowledges that rising vacancy rates and lower rents could be a problem. But Investors Bank keeps making loans for projects with sterling credentials. The latest is a 200-unit building in Florham Park, N.J., that’s 98% occupied and has a historic occupancy rate of 97% to 98%. Those deals are hard to turn down, he said. Most of Investors Bank’s multifamily loans are for completed buildings, not new construction.
“There are some cracks in the armor, but multifamily is holding up very well,” Cummings said.
Investors held $7.6 billion of multifamily loans at Dec. 31, about 40% of its total loan book.
“We like where we are right now,” Cummings said.