How Origin Vets Bonds for Our Private Credit Fund
As real estate equity investors, Origin Investments pays close attention to the quality, value and market momentum of our property acquisitions. When we participate in the bond market, the same risk analysis applies. Every asset in our Multifamily Credit Fund bond portfolio is vetted by Freddie Mac, then double-checked using our rigorous due diligence process.
For the Fund’s first series of debt securities, we applied the same underwriting scrutiny that has made our equity Funds best-in-class investments. Here’s a closer look at our vetting process for these mortgage-backed securities.
The Opportunity: Freddie Mac’s Multifamily K-Deal Bonds
The seed investment for the Multifamily Credit Fund is a Freddie Mac K-Deal backed by a pool of 10-year floating rate mortgages on multifamily properties. Institutions meeting Freddie Mac’s high equity requirements and stringent approval process are invited to bid on these conservatively leveraged mortgaged-backed securities; these were part of a $1 billion offering of K-Deals early in 2021.
Every risk should provide an appropriate reward, and the mortgages in this pool have an outsized yield. The interest rate is the short-term index rate plus 860 basis points, or 8.6%. That’s a substantial risk-adjusted return for real estate investors who wish to lock in revenue to hedge their equity investments. For our Origin’s first Multifamily Credit Fund deal, we successfully acquired $25 million of a $54 million tranche of K certificates, a comfortably sized investment that is expected to be 10% to 15% of the Fund at its final closing.
We compete alongside premier multifamily operators and top-tier institutions to acquire these debt securities, which, as noted, are already subject to Freddie Mac’s rigorous vetting process. However, we do our own due diligence on the loan collateral with our investors’ risk profile in mind. As part of this process, we take an especially hard look at the properties underlying the mortgage-backed securities.
What We Like: Risk Analysis
Among the items our team considered in this initial investment:
- Geographic allocation. The majority of loans were in Arizona, Florida, Georgia, New Jersey, Pennsylvania, Texas and Virginia. Those states represent a substantial overlap with our equity investments in growth markets. Our boots-on-the-ground corporate structure provides us with intimate knowledge of these markets and is further supported by our proprietary, AI-powered database of multifamily market drivers in 150 cities. That gives us confidence in the quality, value and future pricing of these underlying assets.
- Bond construction. Of the assets in this portfolio, 98% were multifamily properties, with the balance in manufactured and senior housing. Among these property types, multifamily represents the lowest risk, borne out by sales in our target markets across the southwest and southeast United States.
- Loan size and exposure. We did an underwriting analysis of the largest assets in this portfolio as if we were buying them as equity investments. The mortgages backing these securities were originated in October and November 2020, amid the COVID-19 pandemic. We looked closely at our exposure in California and New York, the contagion’s initial hot spots. From this bond’s $1.1 billion in unpaid balance, we only had about $10 million of exposure in one New York loan. In California, there was only $50 million of exposure across five loans. The 10 biggest mortgages had conservative loan-to-value ratios of 56% to 77%. We felt very good about the properties’ current value compared to our first dollar of exposure.
We also looked at the operators of multiple assets. The operator with the most concentration in the portfolio represented 16% of the loan pool and is a strong, vertically integrated sponsor with $22 billion in assets under management, including 40,000 multifamily units. Two other private investors sponsoring multiple properties have long and successful track records and low loan-to-value borrowing in the loan pool as well.
Double Vetted: Freddie Mac Plus Origin Underwriting
The Multifamily Credit Fund is a natural extension of our expertise as a multifamily specialist. Freddie Mac’s underwriting practices provide a source of conservative, high-performing multifamily debt securities in which the Fund invests. Also, its loan-to-value ratios are intentionally conservative relative to many other lenders and tend to range from 60% to 70%. In August 2021, 99.94% of the K-Deal loans were current and showed no defaults. The portfolio of loans in which our Multifamily Credit Fund invested were originated by Capital One, CBRE Capital Markets, JLL Real Estate Capital, KeyBank, Newmark Knight Frank and other respected institutional lenders.
Institutions that invest in these bonds, including Origin, are experienced asset managers and operators that can perform workouts on troubled properties if necessary. Our “origin” was in such a workout role, investing in distressed loans during the 2007-09 real estate recession. Although we view our relationship with Freddie Mac as a partnership and will try to protect the bond collateral, it is not required to take over troubled properties in the Freddie Mac portfolio, and the credit Fund will stay invested only in debt securities. However, we have the expertise to bid on distressed properties and offer them as sidecar equity investments.
We will participate in a number of other K-Deals to hold in the Multifamily Credit Fund, including fixed-rate bonds and interest-only strips. We also will bid on small-balance SB-Deals backed by smaller multifamily mortgages. The Fund’s next purchase will be an equity investment in bond collateralized by fixed-rate loans on the order of $30 million. Our team will review strengths and weaknesses of every underlying loan and property before moving forward with the investment.
Our Funds show that we are a true multifamily specialist. We are active in development, acquisition, operation and now credit. Our latest product continues our founders’ tradition of making significant personal investments with our shareholders and bringing institutional investments to retail investors.