As with most forms of real estate investment, the deal structure will be a combination of equity and debt (or financing).
The amount of equity required will, of course, vary both in terms of its source and the amount of financing which can be secured from lender(s).
Naturally, therefore, the amount of debt or financing which can be secured for a REPE investment is important to the overall success of the deal and, again, the source and amount of such debt varies.
We have talked previously about loan-to-value ratios which represent the amount a lender is prepared to provide to a project or REPE situation in relation to the project’s estimated value.
But what about the sources of funding and how do lenders assess the amount they will lend? And what are some of the key factors involved?
Well, let’s have a look at how multi-family investments are usually funded and some of the typical sources of debt.
Key components of a financing to consider
- Interest Rates
Any commercial real estate lender will charge the borrower an interest rate based on the amount borrowed and this rate depends on the merits of the deal, the quality of the sponsor, and the source of the loan.
In short, interest rates are highly variable and deal-specific.
- Term (or duration of loan)
Again, the terms of any commercial REPE financing will also be deal-specific.
The duration of the term will depend on whether the deal is new construction or a value-add situation where short mid-term loans may be applicable. On the other hand for a fully stabilized property, long-term financing may be offered.
Conventional multi-family mortgages will usually be granted and amortized over a 15- or 30-year term, whereas short-term loans might be akin to a bridging loan and can be as short as 6 months to 3 years, perhaps with extensions.
- Loan Amount Limits
Generally, even though individual banks may have limits, in commercial real estate lending, there are no set loan total amount limits in commercial real estate. Often individual banks may partner with other banks to offer loans of greater amounts (“syndicating loans”) but many national banks can offer individual loans of $50-$100 million or more.
- Loan to Value (“LTV”) Requirements
Lenders for relatively small multi-family blocks, say 2-4 apartments, usually have more flexibility than commercial multi-family lenders in terms of LTV requirements. Usually, they will allow borrowers to put down less than 20% equity but there are cases where loans can be secured with a 100% LTV ratio. These may be in some special cases where the government is backing the loans.
Having said this, for most multi-family deals, the lender of the debt will usually want the borrower to have at least 20% equity in the deal with 80% being debt so an 80/20 LTV.
As you’d expect higher-risk deals will require a higher percentage of equity, sometimes maxing out at 65% LTV or 35% down payment. As with most debt cases, the exact details depend on the merits of the deal, the quality and experience of the borrower, and the specific lending entity.
Types of lenders
There are a variety of lenders active in the multi-family apartment sector; these include so-called “conventional lenders” looking to deploy their funds and generate fees:
- lenders such as national or regional or community banks will grant loans to buy, refinance, or construct a multifamily property, but it’s not unusual for terms to be very stringent.
These loans are typically recourse loans, which means that the bank can go after the borrower’s assets in the event of loan default—and not just the property securing the loan if you default. Most banks are likely to offer less than 80% leverage or interest only options and may require tax returns as part of their underwriting.
A number of the big-name national banks are also active in multi-family financing working closely with institutional investors. Depending on the specifics of a deal, a borrower might actually get better loan terms through a local or regional bank, given that they have a better understanding of the local marketplace;
- life insurance companies which offer so-called “LifeCo” loans at some of the lowest rates for those who qualify. Such type of debt is most often utilized on low risk and low leverage but large ($20+ million) deals;
- “agency loans” are those backed by government-sponsored enterprises (“GSE”s), with the most common of these being entities such as Fannie Mae or Freddie Mac which both operate under a congressional charter and hold a significant share of the multi-family property mortgages market.
Investors can use Fannie Mae and Freddie Mac loans to buy or refinance multifamily properties and these entities offer high leverage levels of around 75% to 80%, as well as low interest rates.
Often, these loans are packaged and sold as a form of bonds to investors. They also have an “implied guarantee” which means that, if the borrower defaults, the government will repay the debt on the bonds.
Multi-family is the only property type eligible for agency loans.
- FHA Loans are government-insured loans, and are popular with investors as they offer the longest terms, the lowest fixed rates, and the highest leverage levels— up to 85% to 90%.
However, this type of agency loan can sometimes take as long as 6 to 12 months for approval and there are a lot of FHA-mandated requirements and guidelines. Yet, by working with a lender who is familiar with all the intricacies and details of the FHA approval process, the process can be streamlined.
FHA-insured loans are also generally non-recourse, meaning the loan is secured by the property only and can be for terms of 30 or 35 years.
These loan can be available for property purchase and refinancing as well as ground-up construction and substantial rehab work;
- “commercial mortgage-backed securities” (“CMBS”) are loans which are structured through an intermediary and packaged and sold as bonds. CMBS loans are usually offered through commercial and investment banks and life companies and are sometimes called “conduit” loans, secured by a first lien against commercial property.
The property and its cashflow are collateral for this type of loan, which can be used for multi-family apartments but also mixed-use, industrial, retail, storage, office, and hospitality assets.
The terms are more stringent that a loan originated under an agency type program and borrowers still need to be highly creditworthy.
Additional, alternative financing options
In addition to the aforementioned conventional or traditional loan types, there are several other financing options available for financing multi-family real estate. These include real estate syndications, debt funds, hard money lenders and online funding platforms, amongst others
- Real Estate Syndication or REPE investment
Fundamentally, real estate syndications involve a pooling of funds from a selection of investors which are then used to provide funding or debt to multi-family properties.
Some well-known forms of syndication are as follows:
Real estate or general partnerships where each partner receives something in return for their investment. Typically, this might be a share in the equity or an expected return on their investment via the cashflow generated or when the property is sold or refinanced.
Real estate crowdfunding involves two distinct options. One option is for investors who “invest” without money but are responsible for instigating and managing the investment. The other common option is to invest with a limited amount of money and earn passive income without being directly involved in the operation or business decision making.
- Equity Share Investor
An equity share investor receives equity in the multi-family property in return for providing all or part of the funds for the purchase. The equity share investor is entitled to a percentage, based on the amount invested, of the monthly cash flow and of the profits when the property is sold.
- Hard Money or Private Money Lenders
Hard money lenders are private lenders who lend funds on a short-term basis, often when the borrower cannot find anyone else to provide funds and, therefore, such loans generally attract the highest interest rates.
However, this may be a good option for borrowers who may have had credit issues in the past as hard money lenders only focus on the earning potential of a multi-family investment property and not the borrower’s credit history.
For any borrowers using hard money, it’s wise to have a solid execution strategy which will allow the loan to be repaid in good time.
- Bridging Loans
Bridging loans are short-term loans which “bridge” a gap whilst a borrower is waiting for a more permanent type of loan to come through. They typically attract higher interest rates with terms ranging from 18 months to 2 years, sometimes with an option to extend for a further 1-2 years.
Lenders often provide this type of short-term financing in conjunction with, or in anticipation of, long-term permanent financing options.
- Multi-family Short-Term Loans
These can, in fact, be said to be a subset of hard money loans or bridging loans but are specifically for financing the purchase of a multi-family property. Terms range from 6 to 36 months and payments are interest-only.
Investors frequently turn to short-term multi-family loans if they need cash to make property improvements in order to meet the stricter requirements of a permanent multi-family loan or to buy a property when the investor is working on meeting the personal qualifications necessary for permanent financing.
- Portfolio Loans
A portfolio loan is a non-conforming loan used by investors who want to finance multiple properties simultaneously.
- Debt Funds
Debt funds are pools of private-equity backed capital and are generally used by borrowers undertaking complicated commercial construction projects, for bridging loans or lease-up financing, and for certain property rehabilitation projects.
- Online funding platforms
These online marketplaces or platforms pool capital from a variety of investors across the globe and then provide both debt and equity financing to borrowers. They have emerged as an alternative financing option in recent years, being very much structured to be match-making services, bringing debt seekers with debt providers together.
At CPI Capital, we work with lenders every day when we are assessing the viability of the huge number of REPE opportunities which we are regularly offered. We understand the benefits of securing and maintaining long-term relationships with debt providers, and also comply with the terms and conditions of all loans we secure.
Clearly, as we continue to grow and our track record solidifies we will try to achieve even more favourable LTV ratios and interest rates in respect of our borrowings as, at the end of the day, this can only be good for our passive and other investors!
CSO, COO, Co-Founder CPI Capital