Multi-Housing News
By Jeffrey Steele
When the conventional market doesn’t cut it, multifamily investors explore new paths.
Structuring capital solutions today requires resolving the gap between the asset values of the low-rate era and the point at which today’s capital markets are willing to lend. The solution in many instances? Creative financing.
“It’s the art of bridging valuation gaps, liquidity constraints and execution challenges without relying solely on traditional senior mortgages,” said Mark Green, CIO of Cottonwood Group.
Today, that could mean mezzanine financing, performance-based loans, revenue-backed advances, rescue capital, loans that blend debt and equity or a combination of these and other structures.
A shortage of conventional joint venture equity has rendered development and recaps more difficult. For Adam Mengacci, senior managing director of capital markets at Institutional Property Advisors, virtually all such financing over the past three years could be deemed “creative.”
“We’ve seen a steady trend away from common equity to more debt-like investments, as institutional money managers are looking to protect their downside by limiting exposure in the capital stack to put more sponsor-developer money in front of theirs,” Mengacci observed.
Increased appeal
The higher interest rates of recent years have boosted the appeal of creative financing, Green said. Debt service coverage ratios tie traditional lenders’ hands. The result is materially lower senior proceeds than what sponsors require to transact or recapitalize. Meanwhile, current valuations often dilute equity to unpalatable levels, he added.
It’s not just interest rates, however. Several industry stressors favor creative financing, noted Joe Iacono, CEO of Crescit Capital Strategies. The sector has dealt with operating expense growth, including large insurance premium increases and, in some markets, it has endured slow to flat rent growth to boot.
Rather than being constrained by DSCR formulas, capital can be priced to risk with structures that delay cash pay obligations until performance improves, Green pointed out. Such structures give sponsors the flexibility to sidestep forced sales, extend their business plans or cost-effectively recapitalize and offer a way to transact “even when traditional financing would imply a valuation reset.”
Prime candidates
Which properties are fit for more creative financing vs. traditional loans?
For Green, prospects include projects with lease-up risk and/or a robust level of value-add or special operating needs that require capital that flexes with performance. He also considers projects where sponsors have vested interest and are amenable to structure, or projects with cash flow traits that don’t align with traditional amortization or DSCR tests.
It’s all about timing and the particular capital stack for Rick Porras, CFO of Neology Group. Will it be essential to move quickly to secure an acquisition? If so, he generally needs to find non-traditional financing that enables a swifter process. Are the lenders whose funds comprise the capital stack okay with exploring creative financing? “Some equity partners are only comfortable with traditional lenders,” Porras said.
Future creativity
If rates remain lofty by recent standards and rent improvement is limited, valuations will continue to feel the impact, Iacono suggested. “Creative structures will be a way to help solve these problems for the foreseeable future,” he added.
Green foresees three fundamental shifts. First, the industry will witness the institutionalization of structured capital, taking it from niche to the standard part of capital stacks. “Preferred equity, mezzanine and structured senior participations will become as common as traditional bridge loans,” he predicted.
Second, Green expects performance-based structures to find increased use. “Capital will increasingly be tied to revenue, occupancy and operational KPIs, (allowing) lenders to take targeted risk while giving sponsors breathing room.”
Finally, there will be more hybrid products that blend credit protections with equity-like upside as investors hunt for yield in a continuing higher-rate environment. “Fundamentally, creative financing will move from being a solution of last resort to a core financing tool for transitional and value-add multifamily,” Green said.
Case studies
Some of the most-used creative approaches include mezzanine and other structured credit approaches, preferred equity with pay rates flexing with DSCR or lease-up, loan assumptions, joint ventures with family offices and rescue capital aligned with operational benchmarks.
Experts cited several other financing strategies they’ve employed recently:
Ground-lease financing: “A ground-lease provider who has long-term investors executes a sale-leaseback transaction of the property to the sponsor,” said Danielle Ash, a partner in the real estate group at Adler & Stachenfeld. “Any purchase price used to fund the acquisition and sometimes additional tenant improvement dollars advanced post-closing can be used by the sponsor for its business plan.”
Seller financing: The fees, third-party reports and reporting obligations all go away when you find a seller comfortable enough with the property that they don’t need third-party underwriting said Douglas Kelin, a real estate attorney at Honigman LLP. “They know the asset and are not that concerned about how it will function, and if they have to take it back they will,” Kelin said.
C-PACE: C-PACE can fit within a capital stack in multifamily scenarios that include ground-up construction, repositions and energy-related capital projects, according to Jason Schwartzberg, president of MD Energy Advisors. “C-PACE is on a par with bank financing and it’s readily available,” Schwartzberg said.
The FHA’s Section 241 program: FHA-insured secondary debt lets borrowers add units, renovate existing apartments and make improvements to properties with existing FHA-insured debt without disturbing already-existing, lower-cost debt, noted Myles Perkins, president of AGM Financial Services.
Local Initiatives Support Corp.: LISC NY finances acquisition, predevelopment, construction and mini permanent loans, setting credit criteria and underwriting terms to ensure its investments meet the intended outcomes, detailed Valerie White, a senior executive director at the company. On an ongoing basis, LISC raises capital sources that can be used to blend down interest rates, serve as first loss capital or sometimes be structured as a recoverable grant, she added.
Emergency Rental Assistance 2: ERA2 funds from the COVID-19-era American Rescue Plan represented one of 24 federal, regional and local capital sources used in funding the mixed-use redevelopment of Cleveland’s Warner & Swasey industrial building to prepare for an early 2026 groundbreaking. Geoff Milz, Pennrose director of development, applied for ERA2 funds expiring on Sept. 1, 2025, and used them as components in a sizable capital stack along with Historic Tax Credits, HOME funds, LIHTC and other sources.