Commercial multifamily financing provides essential capital for the acquisition, development, or renovation of multifamily properties, making it a crucial element to real estate investing. This type of funding is tailored to meet the unique demands of multifamily real estate.
Multifamily finance is particularly nuanced and there’s quite a bit of planning that goes into successfully acquiring the right funding for your property. In this article, we’ll discuss the essential elements, strategies, and terminology you should be aware of as a multifamily real estate investor.
The Fundamentals of Multifamily Financing & Strategy
Before digging into the strategies for multifamily financing, there are a few important terms you should be familiar with. Here are just a few of them:
- Loan-to-As-Is-Value Ratio: This is a financial term used by lenders to express the ratio of a loan to the value of an asset purchased. In multifamily financing, it determines how much of the property’s value can be financed. For multifamily properties, the ratio is typically 75% – 80%, but can go as high as 85%.
- Loan-to-After-Repair Value Ratio: This is a financial term used by lenders to express the ratio of a loan to the value of an asset after its built or rehabilitated. In multifamily financing, it determines how much of the property’s value can be financed. For multifamily properties, the ratio is typically 60% – 75%.
- Debt-Service Coverage Ratio (DSCR): This ratio measures the cash flow available to pay current debt obligations. It’s crucial in determining whether a property generates enough income to cover its debts. In today’s higher interest rate environment, lenders want to ensure that upon project completion, the cash flow that the property will generate will be around 1.25-1.35 X of the debt payment– assuming a 6.25%+ interest rate with a 30- year amortizing loan.
- Capitalization Rate (Cap Rate): A rate that helps in evaluating a real estate investment project. Cap rate is calculated by dividing the property’s net operating income by its current market value.
- Amortization: The process of spreading out a loan into a series of fixed payments over time. In multifamily financing, this term often refers to the repayment schedule of the principal and interest.
- Net Operating Income (NOI): This is the total income generated by the property minus operating expenses. NOI is a key figure in evaluating multifamily property investments.
- Vacancy Rate: The percentage of units in a rental property, such as an apartment complex, that are unoccupied at a particular time.
- Cash-on-Cash Return: A rate of return on a real estate investment property based on the cash income earned by the property that is divided by the cash that was invested.
- Due Diligence: The comprehensive appraisal of a business or property by a prospective buyer, particularly regarding its assets and liabilities and the evaluation of its commercial potential.
- Underwriting: This is a key component in the financing approval process and is when the lender determines the risk of funding a particular project.
Types of Multifamily Properties For Financing Consideration By MMTC
Now that you know the basic multifamily financing terminology, it’s important to research the landscape of the multifamily industry. Not all rental properties are the same, so it is important to find the right fit for your portfolio.
Additionally, different multifamily properties qualify for various financing options and sometimes have unique funding opportunities or challenges. In this section, we will review those types of multifamily properties that Merchants Mortgage and Trust can provide funding for.
Low-Rise Apartments
Characteristics: Typically, low-rise apartment buildings are 1-4 stories tall and often found in suburban or residential areas. These are great properties for individuals just entering the real estate investment industry, as it will allow you to learn the ropes on a smaller scale.
Financing Considerations: Generally, low-rise apartment buildings require smaller loans, making them accessible to first-time investors or those with limited capital. If you’re looking to move quickly, private multifamily loans can get you funded quicker than a conventional loan, oftentimes at 80-85% Loan to As-Is Value.
Townhouse Complexes
Characteristics: These are multi-floor units with one or two shared walls, often with individual entrances. Managing a townhome with 5 or more units is like managing a low-rise apartment building.
Financing Considerations: Financing a townhouse complex can involve a mix of residential and commercial loan components, especially if the units are sold individually.
Mixed-Use Developments
Characteristics: These properties combine residential units on top floors with commercial spaces, like retail or offices on the lower level. They are often found in urban areas but can also be found in suburban neighborhoods that have a smaller downtown area.
Financing Considerations: The diverse income streams from residential and commercial tenants can be appealing to lenders, but these properties often require more complex financing strategies. Luckily, MMTC provides funding for Mixed-Use Developments and has the experience to walk you through the process even if you are a novice investor.
Preparing for Multifamily Financing
Once you’ve decided which types of multifamily properties are right for your portfolio, it’s time to start getting your paperwork and financial documents together.
Overall, Private Lenders that offer commercial multifamily financing are looking for indicators of financial stability, profitability, and reliable management.
A strong credit score, healthy financial statements, and a track record of successful real estate management is very important and can help you secure the best rates.
What a Strong Credit Score Looks Like
Overall Score: A high credit score is ideal as it reflects your creditworthiness and reliability in repaying debts. A score of 680 or higher is preferred but some Private Lenders like MMTC may accept a credit score that is as low as 620.
The acceptable score is dependent on the size and complexity of the project. Some investors with less experience or bad credit will opt to include a coborrower on the application as it can help them secure funding and better rates.
Types of Financial Statements Lenders Request
- Documentation of Net Worth: Your net worth demonstrates your financial stability and capacity to support the investment. Some lenders might ask for bank statements or tax returns from novice investors. If you have a successful track record as an investor, this is often not required.
- Liquidity: Lenders will want to see that you have enough liquid assets to cover your loan obligation.
- Profit and Loss Statements: Lenders will often ask for the last 12 to 24 months of P&L statements for the property.
- Proforma Rent Roll: This shows the lender the projected gross income of the property after construction has been completed. This information is critical for the lender for the purpose of loan sizing. It is important to note that the rental income will be verified by the appraiser, so it is important to not overstate the rents.
Other Business Documentation Considerations
- Previous Real Estate Experience: This is especially relevant in commercial multifamily financing, as lenders prefer borrowers with proven experience in managing real estate investments.
- Business Plan or Property Plan: A clear, detailed plan can demonstrate the viability and profitability of the investment, increasing lender confidence especially for novice investors.
Navigating Multifamily Real Estate Financing Options
Funds for multifamily properties are best broken down into two types of loan groups: financing for the long-term length of four or more years or financing for the short-term, which is typically between one and three years.
Long-Term Multifamily Loans
Long-term loans represent a fundamental component in the acquisition or refinancing of multifamily properties. These loans are characteristically structured with an amortization period extending between twenty to thirty years, providing a prolonged debt repayment period. Borrowers have the flexibility to choose between floating (or adjustable) and fixed interest rate options.
Fixed-rate loans offer the security of consistent payments throughout the loan term, which is particularly advantageous for long-term financial forecasting. On the other hand, floating-rate loans can be beneficial in a declining interest rate environment, as they allow borrowers to capitalize on lower rates as they occur.
When delving into specific types of long-term loans, agency loans, notably those backed by Fannie Mae and Freddie Mac, are predominant in the multifamily financing landscape. These loans are frequently sought after due to their rates and favorable terms. In addition, traditional financial institutions like banks, credit unions, and life insurance companies offer long-term multifamily loans. These loans are often tailored to meet the specific needs of the borrower, offering a blend of competitive rates, flexible terms, and personalized service.
Short-Term Multifamily Financing
Short-term financing solutions for multifamily properties and developments play a crucial role in the real estate sector, especially during the acquisition or developmental phases of a property. As mentioned previously, short-term loans can be between one to three years. While short-term loans often come with higher interest rates compared to their long-term counterparts, they also provide significant benefits to investors. Some of these benefits include:
- Bridging gaps in funding.
- Funding short-term improvement projects that increase a property’s long-term market value and rental income potential.
- Overcoming long-term funding challenges due to various reasons, such as income limitations or the need for rapid funding.
- More flexibility with underwriting standards.
Multifamily Financing for Purpose
Not every loan type is made equal and each serve a specific purpose. Certain types of loans are best suited for specific situations and finding the one that fits your needs is essential for a successful multifamily investment project.
Acquisition Loans
Like the name suggests, acquisition loans are used specifically for acquiring multifamily properties. These loans come in various forms, catering to both long-term investment strategies and more immediate, short-term needs.
Refinancing Loans
Refinancing loans play a pivotal role in the management of existing debt on multifamily properties, offering investors several strategic advantages. The primary motivation for refinancing is often to capitalize on more favorable interest rates. For instance, if an investor initially opted for variable-rate financing and the interest rates begin to climb, refinancing to a fixed-rate loan can be a wise move.
It is also common for an existing owner to need funds to renovate their multifamily project. In this case, they will need to repay their existing loan and increase the loan amount by the renovation budget that is required to enhance the property. This strategy helps owners increase their rental income.
Another reason for refinancing a multifamily loan arises when there’s an improvement in the property’s status. For example, picture a scenario where a property was acquired with a 50% occupancy rate. Under those conditions, the initial financing terms probably weren’t great. However, after successfully leasing the remaining units and maintaining high occupancy over time, the property’s enhanced performance and stability can make it eligible for much better financing terms.
Finally, refinancing becomes a big consideration as the loan matures. Many multifamily property loans are not fully amortizing, culminating in a balloon payment–a large sum representing the remaining principal that is due at the end of the term. Since many investors don’t have the liquid assets to cover this balloon payment, refinancing is a good solution. By refinancing, they can negotiate a new loan, extend the repayment period, and avoid the immediate financial burden of the balloon payment.
Multifamily Construction Loans
Construction loans are designed for financing the building of multifamily properties and usually have a loan term of one to three years. During this period, borrowers often pay only the interest on the loan, providing financial flexibility while the property is under construction. Sometimes the lender will wrap in the interest payments so that the developer doesn’t need to make monthly interest payments during construction.
Bridge Loans
Bridge loans are a type of short-term financing that is used to cover the interval between the purchase of a property and securing a permanent loan. The loan term is generally between one to three years and is often structured as interest-only loans.
Bridge loans are especially valuable for swift loan closures during property acquisitions and provide the owner needed funds to renovate the common areas and/or individual units in an effort maximize the property’s value. Bridge loans are known for their quick funding times, making them a practical option while waiting for more favorable long-term financing, such as a HUD multifamily loan. Although bridge loans usually come with higher costs compared to other financing options, they are indispensable for certain investment strategies in multifamily financing.
Closing the Deal
Once you’ve found the right property for your real estate investment portfolio and have decided which loan type is right for you, it is time to move forward with funding. When closing on a commercial multifamily property loan, there may be room to negotiate terms with lenders. However, the extent of negotiation will depend on market conditions, the lender’s policies, and your financial standing, so it’s important to be well-informed of those factors before you make any attempt to negotiate.
Some areas that could be negotiable are as follows:
Interest Rates
Range: The range for negotiation can vary, but typically it can be within 0.25% to 0.50% of the offered rate.
Factors Influencing Negotiation: Your creditworthiness, the property’s income-generating potential, and prevailing market rates play a significant role. Stronger financials and a robust market can give you more leverage to negotiate a lower rate.
Loan Terms
- Amortization Period: You might negotiate for a longer amortization period to reduce monthly payments, although this could result in higher total interest over the life of the loan.
- Interest-Only Loans: Certain lenders can offer interest-only loans, which can be an ideal option for an investor who prefers interest-only payments.
- Prepayment Penalties: There’s often room to negotiate these terms, possibly reducing the penalty amount or eliminating it altogether.
- Term: Even if you think you will only need a 12-month loan, it is smart to also get a quote for an 18-, 24-, or 36-month loan. This can eliminate the need to refinance before the renovation or development is completed.
Fees
- Closing Costs: These can sometimes be negotiable, especially in terms of application fees, origination fees, or other processing charges. Typically, origination fees vary between 1% and 3%.
- Due Diligence Fees: Fees related to property appraisal, legal costs, and other due diligence aspects may have some flexibility.
Conclusion
As you continue investing, remember that a thorough understanding of key financial concepts is crucial. Equally important is recognizing the unique financing needs of different property types and aligning them with your investment goals.
Effective preparation is essential, with a strong emphasis on building a robust financial profile. A solid credit score, detailed financial statements, and a well-structured business plan are critical in securing favorable loan terms. This preparation, combined with a deep understanding of the diverse loan options available – from acquisition and refinancing–to construction and bridge loans – empowers investors to make strategic financing choices.
If you would like a fast loan quote on your next Multifamily project, feel free to reach out to MMTC. Our knowledgeable Loan Officers will assist you with securing the funds you need to make your vision a reality.
Since 1961, Merchants Mortgage and Trust has been the private lender of choice for real estate developers across the United States. If you are interested in learning more about our competitive commercial multifamily financing options and would like a no-obligation quote, contact us today!