Steady Rise in Small Balance Lending

Michael Tucker mtucker@mba.org

October 12, 2017


Small balance multifamily lending--including acquisition and refinancing loans with original balances between $1 million and $5 million--is rising steadily and could set a record in 2017, said Chandan Economics and Arbor.

First-half small balance lending was 4.5 percent higher than a year ago, Chandan Economics and Arbor's Small Balance Multifamily Investment Trends report said. The $12.9 billion average volume across the first two quarters was 8.4 percent higher than last year's $11.9 billion quarterly average.

"While investment sales activity has dipped, higher selling prices and a flurry of refinancing action have put small balance multifamily lending activity on pace for a new volume record in 2017," the report said.

The Mortgage Bankers Association reported commercial and multifamily originations increased by 15 percent between first-half 2016 and first-half 2017 across mortgages of all sizes, exceeding the pace of growth for small balance multifamily loans.

Preliminary third-quarter analysis showed the small balance market on track to surpass last year's record, Chandan Economics and Arbor said. Last year's $47.6 billion small balance lending volume surpassed the previous year's $44.9 billion record by 6.1 percent. This year will likely see a "sustainable" small balance lending growth rate between 4 percent and 8 percent and next year could see 3 percent to 6 percent growth.

Cap rates for multifamily properties backed by small balance loans held steady at 6.1 percent in the second quarter. Cap rates have increased marginally since mid-year 2016 and are currently 20 basis points higher than one year ago. Small balance cap rates peaked at 7.6 percent immediately after the Great Recession, rising sharply from a 5.6 percent low when the commercial real estate market peaked in 2007. "While small balance cap rates have inched up from their recent nadir, they remain low by historic norms," the report said.

The spread between small balance cap rates and the overall multifamily market fell in the second quarter following four consecutive quarters of expanding spreads, the report said, largely due to slightly higher national average yields for large loans and the small balance market's stable yields. "Regarding the market cycle, spreads are wide--across dimensions such as primary and secondary markets and across large and small properties--when assessed in terms of the mature expansion," the report said, noting spreads are currently within range of the long-term average of 73 basis points.

Wider spreads should provide some "cushion" against the drag on values that may accompany higher interest rates if those higher rates coincide with stronger labor market trends, higher household formation rates for young adults and limited new construction in the non-central business district submarkets where small cap properties account for a larger share of the inventory, the report noted.

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