Multifamily Financing - A Detailed Summary of a Borrowers' Options
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The blog post explores a variety of multifamily financing and the best fit for specific projects. Information in the article is updated regularly as loan programs change, and ancillary pieces that go into greater detail about the particular loans will be added over time.
Multifamily Financing Products
Multifamily agency financing options include Fannie Mae and Freddie Mac Conventional Mortgages, Freddie Small Balance Loans (SBL), and various supplemental options.
Perks of Multifamily Agency Financing
Competitive interest rates
Leverage (up to 80%) and interest-only available
Turnaround/funding timeframe
Assumable
Competitive Interest Rates
You'd be hard-pressed to find lower fixed-rate interest rates with longer terms (up to 10-year loan terms) when it comes to multifamily financing. Apartment buildings with green initiatives or are "mission-driven" with affordable housing requirements are also eligible for discounts (cheaper interest rates).
Leverage
Down payments can be as low as 20% or an 80% loan-to-value (LTV). A sliding scale of leverage/interest-only options (IO) will affect loan pricing. The higher the loan amount and the more IO years requested, the higher the total interest rate.
Non-Recourse
Non-recourse (meaning personal assets aren't required to guarantee the loan) is also very popular with investors. The property would secure the mortgage loan. There can be recourse if there is evidence of fraud or other unethical behavior.
Turnaround
And finally, unlike some HUD options, underwriters can typically turn agency loans expeditiously.
Assumable
If you sell the underlying property before the loan term is up, the property buyer could potentially assume the loan.
Drawbacks of Multifamily Agency Financing
Yield Maintenance (a hefty prepayment penalty)
Reserve requirements
No loan funding for renovations or repairs
Common Agency Products
Fannie Mae
Freddie Mac
Small Balance Loan (SBL) - Freddie Mac
Supplemental - Fannie & Freddie
Optimal Asset Types
Multifamily Housing
Student Housing
Seniors Housing
Cooperative Housing
Affordable Housing
Manufactured Housing
Property Performance & Condition
Agency financing is an excellent multifamily loan option when the property is stabilized. Lenders will commonly look at the current property rent roll the last twelve months of financials, and project future property tax liability with the help of property tax comps.
Agency financing can challenge new acquisitions or a refinance when the property exhibits low occupancy, elevated concessions (free rent), and bad debt (residents missing rental payments).
An alternative financing program may better serve properties with extensive renovation budgets, deferred maintenance, or other capital-intensive projects.
Perhaps you’ve heard HUD and FHA are used in real estate investment. Technically, the Department of Housing and Urban Development (HUD) oversees the Federal Housing Administration (FHA) agency. FHA mortgages are more prevalent in the residential housing market and HUD for commercial properties. There is much overlap between the two programs and many similar processes, and the federal government backs both agencies’ loans.
The most common HUD loan in the multifamily space I come across is HUD 221(d)(4).
Optimal Asset Types
Multifamily Housing
Cooperative Housing
Moderate-Income Housing
Multifamily HUD Loan Perks
For "build and hold" investors, HUD is a great option. Perks include:
Potentially higher leverage than conventional financing (85% - 90%)
Competitive interest rates
40-year amortization
Non-recourse
Interest-only payments during the construction years
Assumable
BSPRA Credit on for-profit market-rate developments and redevelopments
Multifamily HUD Loan Drawbacks
It's also important to note some of the less appealing features.
Hefty prepayment penalties
Mortgage insurance premium (MIP) at higher leverage levels
Elevated reserves and working capital requirements
No refinancing at stabilization
Slower underwriting turnaround
Tedious loan assumption process
Property Performance & Condition
HUD financing is best suited for new construction or distressed multifamily properties with a sizable renovation. It also may make sense for a 2nd generation buyer to assume HUD debt with a lower interest rate and higher leverage than a conventional multifamily mortgage. It's important to note that assuming HUD debt can be a lengthy process that can extend the sales process beyond traditional closing timeframes.
Your local real estate bank or credit union could be an excellent source of financing. I've seen firsthand banks that traditionally lent on smaller rental housing explode into the larger multifamily space over the last decade.
Optimal Asset Types
In theory, the property types banks and credit unions lend on will vary from bank to bank. Banks can offer borrowers financing on various product types for new construction, renovations, or turnkey properties.
Major Multifamily Bank Loan Perk
More relationship-based lending preferences
I've seen countless examples of investors who started investing in single-family homes or duplexes, and as they evolved into more significant properties, the banks grew with them. They also may have more flexibility with certain borrower shortcomings that an agency lender or HUD lender may shoot down the deal immediately. Good banks understand entrepreneurs and offer "outside of the box" solutions on a borrower-to-borrower basis.
Multifamily Bank Loan Drawbacks
Costlier than Agency and HUD
Less leverage
Recourse (project sponsors will generally be required to guarantee loans personally)
Generally not assumable
Property Performance & Condition
Banks I'm familiar with will lend on:
Turnkey assets
Rehabilitations
New Construction
On properties requiring significant repairs, they'll often lend on a "loan-to-cost" (LTC) basis, providing funds for a portion of the budgeted repairs. They also may offer a unique solution for new construction, such as a "mini-perm" loan option. Mini-perm debt stipulates an interest-only period during the construction years. Then, it converts to a permanent, amortizing payment schedule once the property cash flow supports the fully amortizing debt payments.
I've seen investors that traditionally utilize conventional financing for their multifamily acquisitions switching to bridge loans as of late. Terms have been stellar, and for properties renting "below market" or needing a lot of capital investment, bridge loans can be a great choice.
Optimal Asset Types
Bridge financing probably has the most extensive use of an application. It can be an excellent tool for various underperforming asset classes or properties needing extensive repairs.
Multifamily Bridge Financing Perks
Full-term interest-only (usually 1 - 3 year terms)
LTV up to 80% of Purchase Price
Up to 100% CAPEX funding
Non-recourse
Negotiable terms
Quick turnaround and approval from the lender
Multifamily Bridge Financing Drawbacks
Short-term loans
Higher interest expense than agency or HUD financing
Refinance post-stabilization required
Potentially an investor-funded interest reserve
Risk of ‘cash-in’ refinance in a rising interest rate environment.
Property Performance & Condition
I saw bridge financing used earlier in my career when a severely distressed property needed renovation funding or ownership was repositioning/redeveloping a project. Bridge debt would be used to fund extensive CAPEX and then would be refinanced to conventional financing.
Lately, I've seen bridge financing used when properties are simply under-rented or underperforming (not necessarily because of property conditions). In instances limited by property performance, the agencies can only lend up to 60% - 65% LTV. Bridge financing will allow owners to take on more leverage early on vs. more conventional financing products.
Construction financing terms are generally reasonably similar across the board, and the mechanics of the construction loan don't seem to change much from lender to lender.
Optimal Asset Types
Ground-up developments spanning any asset class are prime for a construction loan. I've used the Tactica Multifamily Development Model for self-storage, mixed-use, and industrial development and even heard of a customer using it for a strip mall. No matter the asset class, a construction loan serves the same purpose:
Fund the development of an asset before there is cash flow. Most lenders will fund an interest reserve or capitalized interest account to pay interest expenses while the property is constructed, and cash flows do not support the monthly debt service.
Multifamily Construction Loan Perks
Full-term interest-only (usually 1 - 3 year terms)
LTV up to 80% of the construction budget
Multifamily Construction Loan Drawbacks
Short-term loans
Higher interest expense than agency or HUD financing
Refinance post-stabilization required
Interest expense accrues interest (capitalized interest)
Property Performance & Condition
Any new development is a candidate for a construction loan. It could also be suitable for a property undergoing a significant addition. A "gray" area can exist between construction debt and bridge loans. A knowledgeable lender should help you select your project's best funding source.
Mezzanine debt is a tool you can use to fill a funding gap. Let's say you are about to embark on a $20 million development and have a $15 million construction loan lined up. However, you only have $3 million of equity and need to find another $2 million in proceeds to fund the project. Mezz could fill that void.
Optimal Asset Types
I've only seen mezzanine debt utilized in multifamily development, but I suppose it could be called upon a much broader project scope. Mezz is lower on the capital stack than the senior loan (the construction debt) and is generally paid off when a project undergoes a refinance.
While mezzanine debt is always structured somewhat similarly in each deal (essentially bridging an equity gap), the terms vary significantly from lender to lender. Examples include:
Simple interest vs. compounding (or an IRR requirement)
Interest payment paid monthly or at mezzanine loan paydown
Interest pre-drawn or standard accrual upon draws
Origination fees are paid upfront or at mezzanine loan paydown
I usually see interest and origination costs paid down at refinancing to be less burdensome early in the project's life, where cash flows aren't yet prevalent.
Multifamily Mezzanine Debt Perks
Higher leverage (as high as 90% of total project cost)
Full-term interest-only
Less investor equity is needed
Potential for higher returns
Quick turnaround and approval from lenders
Fees and interest paid in arrears
Cheaper than equity on a high-yielding project
Multifamily Mezzanine Debt Drawbacks
High cost of debt (double-digit interest rates are ordinary)
Incredibly risky due to the heightened leverage
Costlier origination fees
Specific lenders may want a "promote" or more significant payment if the project is successful.
Mezzanine financing terms will juice the IRR in the proforma. Less equity in the deal can create the potential for rock-solid returns in a new development. Understanding how much additional risk is being layered into the project when adding a secondary financing tranche is essential, as well as being confident that the increased return potential matches the more significant leverage threat.
Commercial mortgage-backed securities are another option for stabilized, cash-flowing commercial real estate investments. A CMBS option exists for all asset classes without significant disrepair. CMBS loans are made, secured, and sold off as bonds in the secondary markets to investors looking for stable, risk-adjusted cash flow.
Optimal Asset Types
Any stabilized multifamily asset or commercial real estate investment could suit CMBS.
CMBS Multifamily Loan Perks
Competitive interest rates
Decent leverage (up to 80%)
Non-recourse (with standard "bad acts" carveouts)
Assumable
CMBS Multifamily Loan Drawbacks
Prepayment is challenging
No supplemental or additional financing
Because the loan is securitized and an investor depends on the property/cash flows from the CMBS debt service payments, prepaying the loan is nearly impossible from a cost standpoint. Defeasance is the typical prepayment process that involves replacing the loan with other risk-free collateral (typically treasuries) to backfill the cash flow from the loan.
In most instances, the cost of defeasance isn't sensible, and the owner will either ride out the remaining loan term or try to convince the buyer of the property to assume the loan. This tactic has been a hard sell in an environment with a decreasing interest rate.
A refinance or adding subordinated debt (like mezzanine) isn't generally allowed when electing CMBS financing.
CMBS lenders may qualify loans with the debt yield metric that can be more stringent than typical DSCR and LTV levels.
Property Performance & Condition
Stabilized properties, solid cash flow, and no immediate renovation plans are the best suitors for CMBS debt. The borrower better be comfortable holding long-term as the cost of terminating the loan agreement before expiration is very expensive, confusing, and generally won't make much sense.
Multifamily loans offered by Life Cos are typically reserved for institutional borrowers purchasing turnkey assets in core locations. Generally, leverage levels will be low (40% - 60%), and the loan term will be full-term interest only.
I have seen Life Co loans used in smaller, "ma and pa" type deals, but I can only think of one example. Life Co's lending appetite tends to be larger projects (higher dollar value) perceived as "de-risked" due to phenomenal local demographics, asset quality, and historic solid performance at the underlying asset.
We have a separate article on seller financing and how to incorporate it into your proforma analysis.
Summarizing Multifamily Financing Options
Multifamily financing options in commercial real estate investing are like a tool belt in construction. There are different tools for different projects, and specific tools are better equipped for other investment objectives.
Multifamily financing terms are no different. Depending on your investment plan, it’s best to research which mortgage options help fulfill your objective and maximize return for you and your investors.
Related: If you're considering a floating-rate loan, don’t forget to research interest rate caps and why you should avoid forecasting future interest rates from the forward SOFR curve.