There are different loan products and also creative financing options to acquire Multi-Family Apartments. Lets go through these so as a investor you will understand what type of deals you are investing in. Every lending option will have its own pros and cons. Also these are only few popular options listed here.
1) GSE (Government-Sponsored Enterprise) loans like Freddie Mac and Fannie Mae:
Freddie Mac and Fannie Mae (indirectly using their Delegated Underwriting & Services, DUS Lenders) lends to large amounts of Multi-Family Apartment Deals in the nation. These are typically non-recourse (not personally liable in case of default except for fraud and mis-representations aka bad boy carve-outs) loans with 30 years amortization, 5 to 12 year term, 1 to 6 year interest only. Loan-To-Value is around 65% to 80%. There are some options like full term interest only for 65% LTV. Interest rates are based out of 10-year treasury rate.
GSE is only offered for stabilized properties. The property should have minimum of 90% occupancy in the last 90 days. Sponsors have to meet net-worth equivalent to loan amount and liquidity of 9 months of interest+principle.
Loan amount has to be $1 M or above.
These are extremely popular loans and in some years they exceed their quota of $100 billion per each agency much before the end of the year.
There are 2 prepayment penalties Step-Down or Yield Maintenance. For example, for a 5 year loan, the Step-Down penalty to prepay the loan is 5% for first year, 4% for second year, 3% for third year, 2% for fourth year and 1% for fifth year. For Yield Maintenance, it's super expensive to prepay the loan as its almost you are married to the loan until the expiry. Unless the treasuries go really up where the lender can lend the money with higher interest, the person who took yield maintenance is on the hook to keep the mortgage till the end of the maturity date. If you have even 10% probability of selling the asset within few years of taking the loan, better opt for Step-Down penalty option. Make sure you invest in deals which you understand the prepayment penalty of that loan.
2) Commercial Bank Loans
In case occupancy doesn't meet strict GSE's criteria or loan amount is too small or if you don't want to go through the process of Fannie or Freddie you can approach a local commercial bank who can lend on the Multi-Family property. Sometimes lot of investors have relationships with a local bank that they never get loans from Fannie or Freddie at all.
Usually commercial banks have 10 to 25 years amortization which will reduce the cash-flow but you will be paying less interest and also paying off the loan much faster. Lot of investors who only look for wealth building and do not require cash-flow also approach local banks.
These are usually recourse loans but for lower LTV they do provide non-recourse loans.
Usually the guidelines are not that strict as Fannie or Freddie and also faster processing based on relationship. Interest rates tend to be higher than Fannie or Freddie loans.
3) CMBS (Commercial Mortgage-Backed Securities) Loans aka Conduit Loans
These are knows as wall street loans where the loans are converted to trusts and sold to investors as packages. This is really great alternative to Fannie or Freddie loans. Where you can still get 30 year amortization, lower interest rates and non-recourse loan. LTV is capped at 75% and prepayment penalty is only Yield Maintenance or Defeasance. So you are on the hook to keep the loan more time.
The advantage of CMBS loans is their rules are little lenient than Fannie or Freddie. Also their spreads on the treasury are not that high as Fannie or Freddie, so you can get better rates.
Minumum is $2 Million loan amount.
4) Mezzanine Debt
In conjunction with CMBS Loan or other loan products, the sponsors can get Mezzanine Debt which is a hybrid of debt and equity. Lot of Loan products like Freddie or Fannie or CMBS doesn't allow second mortgage. So Mezzanine debt can fill the gap by providing ability to convert debt to equity shares in the deal so in case of default the Mezzanine Lender is still protected and even sometimes they get preferred returns than the actual equity investors. This is really lucrative at the same time risky for the sponsors. And also passive investors need to carefully vet the deal if there is a Mezzanine Debt in the deal. This loan can the LTV to 90% of the purchase price.
5) Bridge Loans
These are pretty good loans for some scenarios where occupancy is really low, lot of deferred maintenance on the property, very high rehab costs, current rents or income is really low etc. These are extremely popular but at same time this is really misused to make a deal work in some cases.
You can get 80% of purchase price + 100% of rehab costs as a loan so total Loan-To-Cost is sometimes up to 86% to 90%. The term usually are 3 years with 2 year extensions. Usually non-recourse but lot of times they are recourse as well, especially on smaller loans. This product is really good for heavy or deep value-add deals where you can cash-out almost all of your money and keep the property for perpetuity if you execute the project as per the plan. If things go bad these loans become extremely risky and one end up losing all their money.
Larger deals are better for Bridge loan. The origination fee and other costs add up a lot. Bridge loans are really expensive.
Interest rates are usually 250 to 500 bps (basis points) above 1-month LIBOR.
6) Private/ Hard money loans
Sometimes on smaller deals, people do cash-close by getting private/ hard money loans and then refinance with long term loans. You need to be extremely careful as most of the hard money loans are recourse and interest rates are between 7% to 12% with usually high origination fee.
Will post about FHA, HUD and SBA loans in future blog post.
Please reach out to me for more info on any loans or i can refer you to few service providers i know that can help understand multiple options.
We mostly buy existing MultiFamily apartments here at Zovest. We are exploring avenues to do new development of MultiFamily in markets where the cap-rates shrunk so much that prices of 1960's to 1980's properties have skyrocketed, that it makes sense to do new construction instead of renovating old ones.
We are going through a process of new development in couple of markets and this is what we learn till now. 30,000 feet overview of phases.
1) Identifying the Raw Land which can be non-residential/ non-commercial
2) Entitling/ Rezoning the land to do residential/ commercial medium to high density
3) Going horizontal by grading the land, laying roads and adding utilities like electricity
4) Going vertical by constructing the building
Phase 1) Identifying the Raw Land which can be non-residential/ non-commercial
The first step to pursue new development/ construction is to select the markets/ sub-markets/ neighborhoods. Please refer to our earlier blogs to identify them. Other than that, you also need to find out the absorption rate which tells you how many new units are getting absorbed (rented) into the market with existing inventory. If absorption rate is low it will be difficult for the new units you are building to be rented. Typically if population in that market is growing more than double the national average, then it make sense to build in that market as a long term strategy.
Once you identify that location, we have to find any raw land which might be zoned non-residential or non-commercial or residential low density housing (low number of dwelling units per acre). For example, we are looking a land which is zoned a single family home for each 10,000 sq ft of land. This is really low density.
Phase 2) Entitling/ Rezoning the land to do residential/ commercial medium to high density
Once you find that raw land from #1 above, you need to go to city/ planning commission to apply for rezoning or entitling the land to make it medium to higher density. First, you need to identify if the land is suitable for development, make sure any environmental issues or grading issues that prevents new development. Second, you need to setup a neighborhood meeting to take their concerns of a new development. Third, submit an application with city to request for rezoning to medium to higher density or ask for commercial from residential or other ways of rezoning based on requirement.
Phase 3) Going horizontal by grading the land, laying roads and adding utilities
Once the land is rezoned then we have to grade the land to make sure the land is flat for development by removing all high and low spots, lay the roads based on site plan, add utility connections like electricity, water and sewer lines, make the land pad ready so we can do actual construction of buildings.
Phase 4) Going vertical by constructing the building
Since each building pads are ready, we can start constructing each building or construct multiple buildings at a time. Usually there will be phased approach so homes/ buildings can be constructed to sell or rent in a timely manner. This will help in not waiting till end of completion of the project to start selling/ renting.
Zovest will be doing new developments in future. Please reach to me at email@example.com to know more about the phases of development.