What You Need to Know About Multifamily Financing
You’ve found an ideal multifamily property, located in a strong real estate market and you have investors lined up so you can move on acquiring it. You probably have contacts at various lenders that you plan on contacting in order to get the financing handled. But before you begin exploring the best financing options, there are some things that you need to know about multifamily financing. In addition, due to the fact that the country is currently in a recession due to the pandemic, financing is harder to get. The good news is that lenders are still lending money.
To begin with, there are multiple financing options available to you. In addition, there are ways to qualify for financing that you might not know about. Also, during a pandemic, like COVID-19 that we’re experiencing now, financing is different. I’m going to take you through these key points to provide you with everything you need to know about multifamily financing.
There are Three Types of Financing
Type 1: Agency Loans
For multifamily properties, there are three types of financing available to you. The first is agency loans, which include Fannie Mae and Freddie Mac. When it comes to Fannie Mae, the most popular loan is the Fannie Mae DUS. These loans start at $3 million, and there is no upper limit on how much you can borrow. For Freddie Mac, the most popular loan is the Freddie Mac SBL, which is designed for loans between $1 million and $7.5 million.
Both of these loans are popular because they offer competitive terms and are non-recourse (which means that if you default on the loan, the lender cannot take your other assets as collateral, with some exceptions). Most loans are assumable with lender approval and interest-only payment options are available. The loans feature amortizations over 30 years, and also have 45-day closings.
Pre-COVID-19 era, agencies were lending for 3%-3.7% interest rates, 65% to 75% loan-to-value (LTV) for 25-30 years, and required 1.25x DSCR (debt to coverage ratio, which is the ratio between the Net Operating Income and the loan payment). Nowadays, agencies are lending at 65%-75% loan-to-value and 3.3%-3.8% interest rates. DSCR has increased to 1.35x to 1.55x, which means that loan proceeds are much lower than they were, which impacts returns. Another change today is lenders' requirement from borrowers to allocate 12-18 months of debt payments as an upfront reserve.
Agency loans look at the investor as to their liquidity and net worth. If you’re borrowing $5 million, for example, they’re going to want to see a net worth of $5 million. As for liquidity, they want to see that you have the ability to pay 9 to 12 loan payments in order to get approved. If for some reason you don’t have the net worth and liquidity to qualify, you can partner with an individual who does have the liquidity and net worth, and they can sign on the loan.
Type 2: CMBS Loans
CMBS stands for commercial mortgage-backed securities. This type of loan is a commercial real estate loan that is backed by a first-position commercial mortgage. CMBS loans are packaged and sold by Conduit Lenders, commercial banks, investment banks, or syndicates of banks.
These loans are secondary loans to the borrower, as they are not recorded on the books of a lender. This allows the lender to maintain their liquidity. The advantage of a CMBS loan is that it is non-recourse, eliminating any personal liability to the borrower. The loans have fixed interest rates along with terms of 5 and 7 years, with 10 years being the maximum term length.
The biggest advantage of a CMBS loan is that many investors can obtain these loans even if they don’t meet the typical credit parameters of local savings banks. In addition, these loans offer investors similar LTV and terms to agencies.
Type 3: Bridge Loans
The third type of loan is a bridge loan, which is funded by private money and private groups. These loans are much easier to qualify for compared to an agency loan or a CMBS loan. There is no loan minimum, and these loans usually come with a fluctuating interest rate.
Bridge loans are often used to quickly purchase a property when all cash isn’t an option, or you can’t get traditional financing (for example, if the property is not stabilized, which means it is less than 90% occupied for 90 days). Instead of looking at the income a property can generate or an analysis of the borrower’s creditworthiness, bridge loans are based on the value of the property. That means a bridge loan can close more quickly than an agency loan or a CMBS loan. The downside is that the interest rates on a bridge loan can be three- or four times the market rate of conventional financing. Closing costs are also much higher than other types of loans.
Bridge loans can be helpful if you’re planning to do an extensive renovation on the multifamily property. The bridge loan is used to keep the multifamily property financed while doing the value-add upgrades. Most bridge loans have a 65% LTV and a payoff that is usually less than three years.
Financing During a Pandemic
One-click of any news channel and you’ll find yourself inundated with a barrage of talk about the current COVID-19 pandemic. Right now, according to worldometer, there are over 7,941,149 coronavirus cases globally and more than 433,000 deaths. That includes over 117,670 deaths in the United States alone. With many cities and states ordering people to shelter in place, and only go out for essential purposes like grocery shopping, trips to the pharmacy, or to see a physician, it’s hard to get a grasp of what this pandemic is doing to real estate investors, syndicators, and financing multifamily property deals.
Even though lenders are still lending, as you’ve seen, they have stricter requirements and they lend lower amounts.
You probably heard the word “forbearance” quite a lot recently. There’s no question that with unemployment figures in the 20% and up range, renters are going to have a problem paying their rent on time. If enough tenants are unable to pay rent, it’s going to put a major burden on the person whose signature is on the loan documents. Another problem is that many states have issued non-eviction mandates during the pandemic, so even if you have a tenant who can’t pay his or her rent, you can’t evict them in order to lease to a tenant who can pay their rent.
Instead of facing foreclosure, many investors consider forbearance. Forbearance simply means that instead of a lender foreclosing on the loan, they will issue a reprieve on the loan amount that’s due. Lenders will issue a repayment plan, which includes an increased monthly payment that includes a portion of the overdue loan amount that will help borrowers get caught up on the past due loan amounts. If you make payments according to the lender’s repayment plan, it won’t impact your credit report.
Just remember that while payments will be postponed, the interest on the loan will still accrue during the forbearance period. If you don’t adhere to the terms of the repayment plan, the lender will report it to the credit bureaus and it will ding your credit the same way that a foreclosure would. Forbearance should be the last resort and you should use it very carefully, and try to avoid it at all costs. If you go through the forbearance path, you won’t be able to make distributions to investors or pay yourself asset management fees, as long as the forbearance payments are made, which can range between 12-18 months. Additionally, you won’t be able to evict any tenant, even those who still have a job and have not been impacted by COVID-19, for the entire period of 12-18 months.
There are several different financing options available to multifamily buyers, and understanding the pros and cons of each will help you decide which type of financing loan is best for your unique situation. Agency loans are part of the Freddie Mac and Fannie Mae government programs, and qualifying for these loans is harder than other options that are available.
I personally prefer to use agency loans because they generally offer the best terms and low-interest rates. Agency loans have amortization over 30 years, and also offer interest-only payments. They are also conservative loans, with a low loan-to-value of 65% to 75%.
Another type of loan is a CMBS loan. They offer fixed interest rates, and are non-recourse loans, meaning the lender can’t go after your personal assets unless you committed fraud in obtaining the loan. One of the biggest advantages of a CMBS loan is that they are easier to qualify for than an agency loan.
The final loan option is a bridge loan, a very short-term (unusually under 3 years) loan. This is the easiest loan to qualify for, as it’s based on the value of the property rather than the creditworthiness of the borrower. They close quickly, but the downside is that the interest rates are usually three to four times higher than conventional market financing. Whichever loan you choose, make sure you understand the terms of your loan and determine which loan you can qualify for.
With the current COVID-19 pandemic, there are many issues relating to financing. Be sure to understand forbearance so you can avoid foreclosure on your property if you run into a large number of tenants who can’t pay rent due to unemployment.
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About the Author
Ellie is the founder of Blue Lake Capital, a real estate company specialized in multifamily investing throughout the United States. At Blue Lake Capital, Ellie helps investors grow their wealth and achieve double-digit returns by investing alongside her in exclusive multifamily deals they usually don't have access to.
Ellie is the host of REady2Scale , a podcast that focuses on the "APS" of real estate: Asset, Process, and Strategy. Each episode discusses how investors can scale their real estate portfolio and/or businesses.
She started her career as a commercial real estate lawyer, leading real estate transactions for one of Israel’s leading development companies. Later, as a property manager for Israel’s largest energy company, she oversaw properties worth over $100MM. Additionally, Ellie is an experienced entrepreneur who helped build and scale companies by improving their business operations.
Ellie holds a Masters in Law from Bar-Ilan University in Israel and an MBA from MIT Sloan School of Management.