A Lesson in Student Housing Financing

By Will Baker – ApartmentFinanceToday.com

If you are a student housing owner and have needed to borrow money in the past 10 years, life has been pretty good.

A decade ago, conduit lenders were offering extremely cheap financing at 80 percent plus leverage and 1.20x debt-service coverage (DSC) with interest-only constants. And to say due diligence was “limited” would be an understatement.

In an effort to keep up with the commercial mortgage-backed securities (CMBS) guys, Fannie Mae dropped its DSC to 1.20x and underwrote student housing loans to the exact same parameters as conventional loans.

About halfway through 2007, when the CMBS engine ran out of steam, Fannie Mae and Freddie Mac were still there, cranking out loans at a time when no one else was even in the market. The banks and the life companies were effectively shut down, making the availability of cheap capital from the government-sponsored enterprises (GSEs) that much more crucial.

As all the major GSE competition was sent to the sidelines, both Fannie and Freddie got a bit more conservative on the underwriting for student housing loans. For most deals, DSC rose up to 1.30x and and the loan-to-value ratio (LTV) was reduced down to 75 percent. Starting in 2009, construction financing was scarce and sales took a dramatic dip.

Fast-forward to 2013, and things could not possibly look any different. Sales volume in 2012 reached approximately $3.7 billion, almost double the $1.9 billion reached in 2011. Fannie Mae’s $700 million in student housing financing, combined with Freddie Mac’s $1.7 billion, set an all-time record in the student space. Banks are pumping out construction loans all over the country as developers are aggressively chasing sites to meet the ever-rising demand as student enrollments continue to climb. The CMBS market started to pick up some steam in 2012 and presents serious competition for the agencies, especially as it pertains to the availability of interest-only financing.

Over the past year, cap rates have slowly dropped to the point where Class A cap rates hardly offer a premium over Class A multifamily projects. According to the ARA National Student Housing report, new student housing deliveries will increase dramatically in 2013 and 2014, which should stabilize Class A cap rates in the 5.5 percent to 6.5 percent range.

Fannie, Freddie, and many CMBS shops are offering 10-year, non-recourse, fixed-rate financing in the 3.9 percent to 4.2 percent range with interest-only periods available for a slightly higher rate. The GSEs’ regulator, the Federal Housing Finance Agency, has made it clear that it wants the agencies to be careful with their interest-only options and has told Fannie and Freddie to dial it back a bit in the coming year, in order to make sure the loans exit at an appropriate level.

Fannie is underwriting student housing loans to a 1.30x DSC at a 5.25 percent underwriting floor and a 75 percent LTV (70 percent for a cash-out refinance). Freddie is underwriting a 1.30x to the actual rate; however, if the property is less than three years old, it bumps it up to a 1.35x DSC. Freddie is one of the few providers out there that will offer a full 80 percent loan on an acquisition (75 percent for a cash-out refi); however, the deal must be in a strong market at a school with at least 8,000 full-time students and the borrower must have student housing experience. Most of the CMBS players out there will offer a 75 percent LTV and possibly even more with some mezz financing blended in.

If you are refinancing a brand-new development, the agencies are going to want you to keep some “skin in the game,” and not completely cash you out with a refinance in the first year. Typically, Fannie will allow up to a maximum 90 percent loan to cost, and Freddie will be somewhere between 80 percent and 85 percent.

Borrower credit has become increasingly important in underwriting student housing loans, and if you are a “mom-and-pop” borrower who is new to the student space, Fannie and Freddie may not be the best option. Both agencies like to see a proven track record in the student housing space. If you are an out-of-state owner, they also like to see a third-party manager with significant student housing experience implemented at the property.

With so much new supply on the horizon, lenders will start taking a closer look at borrowers’ schedules of other real estate owned to ensure that the new supply has not caused the operating performance of other properties to suffer.

One of the most critical features to student housing financing is the timing. If you are looking for financing in the spring, lenders will be taking a close look at your pre-leasing to make sure that it is at least as good as last year and at least as good as the market. There were many properties that were strongly pre-leased in spring 2012, but for whatever reason, those high leasing numbers did not prove out in the fall when students started school.

The absolute best time to close a student housing loan is in September or October, after your lender has seen a couple months of rental collections for the new school year at the new rent levels. If you must close a loan before August, it certainly helps if you close it before May. If summer is approaching and you are not 100 percent pre-leased for the coming fall, most lenders will likely tell you to wait it out until September (at the earliest) for funding.

In addition to the normal package of information that Freddie is accustomed to seeing on a new loan quote, it would also like to see a list of every new project scheduled for completion in the coming two years. As lenders, we need to be confident that your project is well positioned within the market to withstand the new supply and continue to grow rents throughout the loan term.

It can be rather daunting to try and figure out the rules and rates from the different capital sources out there, but it’s nice to know you have options. The underwriting, pricing, and process from each of the main student housing capital providers are all different, so it is wise to choose a lender who is very familiar with the student housing product and can guide you through the entire loan process.

Borrowers in this space have had it pretty good for the last 10 years, and as long as the increasing enrollment trends continue and markets don’t get oversaturated with new supply, the good times should continue to roll for the foreseeable future.

Will Baker is senior vice president at Walker & Dunlop, a national commercial real estate finance company, with a primary focus on multifamily lending. Contact him at wbaker@walkerdunlop.com.

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