Small Balance Lending Activity Shows Consistent Growth

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In 2017, small balance lending (SBL) volume reached a record $49.8 billion—and this record continued in 2018. Commercial and multifamily lender Arbor recently announced that the small balance multifamily market finished 2018 with $51.7 billion in lending volume, an increase of 3.7 percent over the prior year. Meanwhile, Freddie Mac’s SBL division funded a record-setting 2,771 loans totaling $7.4 billion in 2018.

This year-over-year growth increase seems poised to continue in 2019, even as the overall global market slows a bit. There are several key reasons for the strength of the SBL multifamily sector, particularly:

  • Apartment buildings that qualify for the SBL program constitute a vast majority of the total multifamily units throughout the US. Large deals draw the headlines – and institutional capital – but most multifamily deals are smaller buildings with 100 units or less.
  • Lower equity contribution requirements, interest-only payments, and flexible leverage, often up to 80 percent of a property’s value, make SBL lending more accessible for the average investor.
  • Because debt is secured by the property a personal guaranty is rarely required. This can encourage investment from a broader pool, as many would-be investors may be reluctant to put their personal savings on the line.
  • Investors have seen greater returns from B and C properties since the recession, property classes that are more likely to qualify for the SBL program.

Although these reasons can help explain the significant growth in the SBL sector in recent years, the ultimate contributor is the strength of the commercial real estate market – and the multifamily asset class in particular. In 2019 alone, rents increased 3.6 percent year-over-year in February, according to data from Yardi Matrix. This surge can be attributed to demand side economic factors like low unemployment and increasing wage growth along with supporting factors like high occupancy and measured supply that hasn’t outpaced demand. Of the cities with the greatest rent growth, which include Phoenix, the Inland Empire, Las Vegas, Sacramento, and Atlanta, many are markets with active and robust SBL activity due to smaller property values compared to the largest markets.

These strong multifamily fundamentals have bolstered confidence among lenders, leading to a wide array of debt, from construction, subordinate, and bridge to permanent financing, at a lower cost of capital than in previous years. Investors looking to seize on traditionally riskier strategies – such as value add acquisitions – are increasingly able to find the leverage and rehab financing needed to successfully reposition an apartment building. This is in large part due to strong demand and the limited supply of such renovated buildings, which have positively factored into the pro forma underwriting analysis of historically risk-averse lenders. On the other hand, permanent lenders, who have a longer, more arduous loan process, but provide borrowers with 5 to 30 year loan terms and flexible payment options, are increasingly focusing resources into their SBL programs, providing long-term stability to investors looking to renovate qualifying apartment buildings.

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