10 Biggest Mistakes Made When Seeking Multifamily Agency FinancingPaul Winterowd
There’s lot of interest in Agency (Fannie Mae and Freddie Mac) debt in the multifamily universe these days. Because these loans limit your personal liability, net you higher cash flow, allow higher leverage (larger loan amounts) that increase your returns, provide you more surety of future results, and allow for virtually unlimited growth – there’s a lot to like.
These bank-beating features such as non-recourse, 30-year amortization, low interest rates, up to 80% leverage, long fixed terms, and interest only periods available garner interest from most multifamily investors.
That said – there are certain requirements to qualify so the purpose here is to provide clarity on Agency debt and what it takes to secure these loans.If you are planning on buying or refinancing an apartment complex – First, you need to know what will and won’t qualify for this type of debt.
And second, you need to know who can and can’t qualify for this debt before you submit an LOI because not everyone can qualify!
Here’s the list of top pitfalls we’ve seen as we’ve helped hundreds of investors and syndicators get into the Agency debt game:
1. Loan Amount is Too Small – While technically the Agency Small Balance platforms say they will allow a minimum loan amount of $750k, loans this size are virtually never done. The minimum loan amount really needs to be $1-$1.2 million. This means the property value should be at least $1.5 million to safely qualify. Small Balance Agency Loans range in size of $1 million to $7.5 million depending on the market and the program.
2. MSA is Too Small – The general rule of thumb here is the smaller the market, the more challenging it is to get the loan funded. There is simply more risk in the small markets because there isn’t the same economic vibrancy of larger cities. While a small market isn’t a deal breaker, expecting the same terms offered in larger markets will set you up for disappointment.
3. Property Isn’t Stabilized – 90 for 90 Rule, meaning at least 90% occupancy for the last 90 days is in full effect. Fully occupied properties typically qualify for higher loan amounts anyway, so check the rent roll and make sure the property is at least 90% full. Although more difficult to figure out without some digging, also find out if the actual rent collections reflect at least a 90% economic occupancy. You will have problems qualifying if you are 90% full physically, but only collecting 75% of the rent.
4. Books and Records Are Not Organized – I’m dumbfounded with some of the financial statements, or the lack of financial statements, that come my way to analyze loan viability. There is certainly opportunity for a buyer when the financials are in disarray or non-existent, but it doesn’t make it easy to qualify for permanent financing. Agency lenders must be able to verify the property performance. If they can’t, they won’t lend. You may be shocked to learn that sellers lie. Trust but verify. At a minimum we need a current rent roll and trailing 12-month Profit & Loss statement to underwrite the deal initially.
5. High Crime and Recent Criminal Activity at the Property – One of the first things the Agency underwriters will do is pull a crime report when screening a property. High crime can really impede a property’s success, and subsequently its ability to qualify for Agency financing. There are really two solutions. The first is to avoid properties where crime is high. The second is to have a strong crime mitigation plan for when you take over. Yes, you will be cleaning it up, but that takes time and concerted efforts. If there is a crime that happens around the time you are trying to close, it is likely we won’t be able to fund the loan. To see how the market stacks up around your property, check out www.crimemapping.com
6. Property is Unsafe or in a State of Disrepair – Agency debt’s primary purpose is to facilitate ample housing to the “workforce” of America on an affordable basis. Given that mission, there are minimum standards of safety and functionality that must be in place. Part of the loan due diligence includes a property inspection report from an engineer. This report will point out any life-safety issues and anything that needs to be repaired. Some of these items are required prior to closing, and some can be addressed post-closing, but they need to be done. In geographies with a high probability of seismic activity, un-reinforced masonry and/or tuck under parking structures are a non-starter for Agency debt unless brought up to current safety standards through retrofitting work. Having your eyes open for these items can prevent you from wasting a lot of time and energy on properties that won’t qualify.
Regarding the Sponsors/Borrowers
7. Lack of Liquidity (AKA Reserves) – With small balance Agency Loans you are required to show a certain amount of cash, or liquid assets such as equities, on your Personal Financial Statement to qualify. That amount is equal to 9 months’ principal and interest payments. This varies some, but it is usually in the 5% to 8% of the loan amount. This is post-closing requirement meaning you’ll need to show this wherewithal after your down payment for the loan. This liquidity needs to be outside any retirement accounts as those are not considered liquid. For simplicity sake, I recommend active investors keep 10% of their net worth in cash so they are readily able to qualify for financing when deals present themselves.
8. Lack of Net Worth – Agency loans require a 1 to 1 ratio of net worth to loan amount. The combined net worth of the sponsorship team must meet or exceed the requested loan amount. Before even looking at properties, it will serve you well to put together a good Personal Financial Statement that includes your Schedule of Real Estate Owned. By so doing, you’ll have it ready to show lenders you have the financial strength to qualify.
9. Lack of Experience – To meet this requirement, at least one person/entity in the ownership group needs to have owned a similar property to the one you are acquiring for 2 years. Two like-kind properties owned for 1 year will also qualify. Because this is a non-recourse loan, the Agencies don’t want inexperienced owners. It may sound harsh, but they don’t want you learning on their dime. This means if you are just starting out to begin with bank financing or the better solution is to partner with somebody with experience.
10. Property Manager Lacks Experience – Agency lenders will be looking at the Property Manager’s experience as well. There’s a questionnaire about their company, experience, reserves, etc. The general guidance here is to seek out the best property manager possible. Of course, this seems obvious, but it is easy to gravitate toward the “cheapest” alternative. This is rarely the best. Self-managing really isn’t an option unless you can show a long track record of success and a robust portfolio of properties you manage. Best to hire a manager with at least a dozen properties and 300 units under management.
Not every property or sponsor will qualify for Agency financing so don’t get caught writing a big earnest money check that you will lose because you assumed the deal would work.
If you have a deal you are working on that needs agency lending, book a call here and I’d be happy to help!