Pandemic Helping Risky Real Estate Bridge Loans Make a Comeback

(Bloomberg) -- Real estate investment firm Harbor Group International, an owner and investor in apartment complexes for more than 35 years, recently sold its first bond backed by riskier construction projects and properties in development scooped up in pandemic dislocations.

Harbor Group became a lender to often beleaguered apartment-building owners and developers by offering bridge loans, a type of short-term financing for real estate that needs to be repurposed, rehabilitated or stabilized. The projects often need cash up front before they are able to secure more permanent financing lines from the likes of multifamily-lending behemoths Freddie Mac and Fannie Mae.

The company entered bridge lending as the pandemic hit while some mortgage real estate investment trusts, debt funds, and other property lenders struggled to meet margin calls. Harbor Group closed its first so-called bridge loan on apartment buildings late summer and sold a commercial real estate collateralized loan obligation, or CRE CLO, earlier this month.

The properties are referred to as transitional because business plans haven’t been executed yet. Bridge loans typically have higher interest rates than traditional commercial real estate loans.

“Covid was the catalyst for us becoming a multifamily bridge lender, and eventually doing our own securitization exit,” HGI president Richard Litton said in an interview. “About a year ago we really sensed liquidity shortfalls in the market for bridge lenders and mortgage REITs who were dealing with challenges on their books due to the pandemic.”

Its CRE CLO was comprised entirely of this new batch of loans on multifamily apartment buildings, which is rare. The firm intends to become a programmatic CRE CLO issuer, with a second deal slated to come out later in the year, Litton told Bloomberg.

Read more: CRE CLO Sales Swell Despite Delinquency Rise

In addition to peeling some business away from companies that stepped back during the pandemic, Harbor Group was able to fill a void for some clients after the Federal Housing Finance Agency decreased the size of the 2021 multifamily lending caps for Freddie Mac and Fannie Mae in November, Litton said.

“Fannie and Freddie have reduced their volume, and these are typically properties that are more fully occupied and stabilized,” Litton said. “So this opened up the opportunity for bridge lenders to lend to more stabilized products.”

Sunbelt Booming

Litton said Harbor Group’s lending initiative started gaining traction last fall, especially in parts of the Sunbelt where rents were growing. A metric used in real estate to measure the rate of return on a property, known as a capitalization rate, is showing better returns and higher prices for Sunbelt apartments than before Covid, Litton said.

“People are benefiting from stimulus checks and unemployment top-ups, so from an operations perspective, rent collection and occupancy have been terrific,” Litton said. “We expect strong rent growth and performance this year as we come out of the health crisis to a more robust economy, especially in the southeast and southwest.”

The same cannot be said for New York City, San Francisco and other gateway cities that have large downtown central business districts, Litton said. They “have a lot longer to go for recovery,” as workers decamped from those cities during the pandemic, he said.

Harbor Group joins a booming market this year for CRE CLOs, with year-to-date issuance reaching $16 billion so far, according to data compiled by Bloomberg. The complex bonds are a niche financing tool dusted off from before the Great Financial Crisis.

After issuance plummeted more than 50% in 2020 as coronavirus restrictions mushroomed, this year’s pace has doubled that of the same period in 2019, the sector’s best post-crisis year, the data show. A variety of Wall Street firms are now rushing to the market to get in on growing investor demand for the product, which offers higher yield than many other bonds.

Relative Value: Agency MBS

• Recent strong performance of agency MBS has mainly manifested in conventional MBS, analysts at Goldman Sachs Asset Management said in a recent research note
• Ginnie Mae MBS have significantly underperformed their conventional counterparts since the beginning of April due to lack of bank and overseas demand
• The GSAM analysts are overweight Ginnie Mae MBS versus Fannie Mae MBS, “as we think valuations in the former are attractive,” the analysts said

Quotable

“We find that fully open markets are showing strong employment recoveries, suggesting the commercial real estate recovery will be a function of further employment gains and how they translate into real world demand,” said Darrell Wheeler, head of securitized strategy at Cantor Fitzgerald, in a research note. “Cellphone traffic shows a spiked recovery pattern in markets that have reopened, but we expect sustainable employment support will be difficult to achieve.”

What’s Next

ABS deals in the queue include American Finance Trust (triple net lease), Zaxby’s (whole business ABS), Thrust Engine Leasing (aircraft ABS), Trinity Rail (railcar), Carvana (non-prime auto), and Sky Leasing (aircraft ABS).

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