Top 10 Things to Know About Multifamily FinancingPaul Winterowd
Many of the clients I work with, who are new to commercial real estate lending, have a lot of questions about how these loans work. Because there are so many different facets to commercial multifamily loans, the purpose of this post is to introduce the 10 most important things to know about obtaining a multifamily commercial real estate loan.
- Line It Up Before You Need It
Any competent loan officer and underwriting team will always do their best to expedite the process of loan inquiry, all the way to loan funding. It isn’t always the case, but typically there are speed bumps along the way that delay the process. It could be the underwriter’s backlog or delays in the borrower’s ability to gather the necessary items for analysis. It doesn’t really matter what causes the delays, but it’s good to be aware they can happen.
This is why it always makes sense to get an early start on the process. Talk with your loan officer about typical timelines for the loan type you’re seeking. Be proactive in gathering the property’s operating data, rent rolls, and your Personal Financial Statements (PFS). The time you spend here will go a long way in reducing your stress level and speeding things along.
- There Are Multiple Options
This will not be an exhaustive explanation about the different alternatives out there for multifamily mortgages. Suffice it to say, options include banks, credit unions, life insurance companies, Fannie Mae, Freddie Mac, HUD, CMBS, and a myriad of other private sources of capital.
The important thing to note is this: you have options. Just because you are familiar with one loan type, doesn’t mean it is the best choice for you. It is important to be clear about what you’re trying to achieve so your loan officer can put the best possible loan in front of you.
- Pro Forma vs. Underwriting
Be aware that underwriters are conservative. Their job is to mitigate and eliminate as much risk as possible in a loan. Your pro forma for next year may be realistic, but the underwriter is going to focus on how the property actually performed the last couple of years—not on how it could perform.
Typically underwriters will adjust vacancy rates and expenses to suit the loan criteria. Even if you have 98% occupancy, the underwriter will typically use somewhere between 92-95%. Even if your expense ratio is only 30%, they will typically use 35-38%. Be aware of this so you can estimate what the underwritten Net Operating Income (NOI) will be. Again, different loan types and funding sources may be slightly different, but the above is a good rule of thumb.
- Location, Location, Location
We’re talking about real estate, right? Location is hugely important. Lenders have very different levels of interest in lending against properties in New York, Seattle, Washington D.C., or San Francisco, versus Boise, Chattanooga, Albuquerque, or Buffalo.
How urban or rural the location is will also have an effect of maximum loan-to-value ratios (LTV’s), interest rates, and the ability to fund the loan. There are programs and products for the vast majority of loan needs, but where the property is located, and what is going on in the surrounding market will definitely influence the loan terms you’ll ultimately secure.
- Market Rate vs. Affordable Rent
Loan programs for affordable (government-subsidized) housing can be quite different than market rate projects. Always know what type of tenant will occupy the property you are going to finance. This may seem obvious to experienced multifamily investors, but to the newcomer it can be confusing because there are a lot of nuances and differences between how you operate and finance market rate, versus affordable multifamily properties.
- Best Time To Lock Your Interest Rate
It may sound simple, or even trite, but the best time to lock is as soon as your loan is approved. Everyone will have an opinion on which way rates will move, but nobody “knows” for sure. If you’ve come far enough down the path to get the loan approved, and you need it, the best decision you can make (which will also take stress off the table) is to lock your rate upon approval. This way you eliminate any rate movement risks, and move forward knowing exactly what your rate will be.
- Loan-To-Value Requirements
The lender underwriting the loan will come up with their interpretation of what the property’s NOI is. They will also have their opinion (or will get one from an appraiser) on what the cap rate is for that market. Even though it is more complex than this, it is essentially how they’ll derive the value of the property for lending purposes.
A very common max LTV for a market rate property in an urban location is going to be 80%. FHA will allow up to 83.3%. That is what you’ll typically see advertised, but the max doesn’t always equate what your property will get. Always push for the max LTV if that is congruent with your investment strategy, even if the best you can do is 70-75%. It’s always best to plan for a greater equity requirement and be pleasantly surprised, rather than expecting the max LTV and having to go scrambling for more money before closing.
- Debt Service Coverage Ratio Constraints
Multifamily lenders want to know there are sufficient funds to cover the debt payments for the loans they provide. They want to see income in excess of what the borrower will be required to pay. Low debt-service coverage ratio requirements will start at 1.25 and increase from there. It is calculated by taking the NOI and dividing it by the annual debt service obligation.
For example, if the NOI is $500,000 and the debt payments (principal and interest) for the year totaled $400,000, the DSCR would equal 1.25. The LTV and DSCR are constraints to be aware of because both can affect the maximum size of your loan.
- Typical Terms & Amortization Schedules
Typical commercial multifamily loan terms are 5, 7, or 10 years, with a balloon payment at the end of the term. The majority of these loans have a 30-year amortization schedule, but you will also see 25-year amortizations. FHA loans are relatively unique in their terms and amortizations, which can both be up to 40 years.
- Be Aware of Prepayment Penalties
Most commercial real estate loans have prepayment penalties. Billions of dollars are financed this way every year so it is nothing to shy away from. The point is to be aware that when you select a term, make sure it’s the right holding period. Some multifamily loans are assumable if you were to sell the property, but ideally you select the term that matches your holding strategy and you shouldn’t have to worry about it.
If you’re interest is piqued, or you have more questions, do not hesitate to reach out to us. We are more than happy to speak with you at your convenience.