Multifamily is a smaller yet lucrative subset of the broader commercial real estate industry. While one wishes to experiment with the chances and profit, starting off with a smaller two-unit affordable housing is also profitable. Time and again multifamily investments have proven to be a medium for investors to increase their net income and profit margins. When partnered with the right lender to secure the most appropriate multifamily financing loans, these investors can generate a stable cash flow.
In this article, we will discuss the various multifamily financing loans that enable investors to invest in multifamily apartments and get attractive returns.
What are the different types of Multifamily financing loans available for investors?
Among several kinds of loans for multifamily properties that are available to investors, some of the most popular include:
1. Government Sponsored Entities (GSE)- the most sought-after multifamily financing option:
Government-sponsored entities like Fannie Mae and Freddie Mac have emerged as agency lenders to multifamily investments.
To incentivize the development of affordable housing these Government-sponsored entities generally offer the investors high leverage levels up to 80%. In addition to this, their interest rates are also lower than any other loan program.
Moreover, the investors who reduce the environmental footprint of the investments by adopting the ‘green program’ get pricing incentives.
The loan terms from both these agencies can start from 5 years to 12 years with fixed or hybrid interest rates. Fannie Mae also offers terms that extend up to 30 years. Besides, both Fannie Mae and Freddie Mac issue small loans to multifamily investors who operate less than 50 units or $7.5 million.
Furthermore, Government backed multifamily financing imposes several requirements on its borrowers. These include providing income documentation and proving one’s creditworthiness.
In addition to this, the borrowing investors must go through an approved lender to obtain a Fannie Mae and Freddie Mac loan.
2. FHA loans:
FHA loans are also known as FHA-insured financing. These government-insured loans are for investors with the benefit of the longest terms with the lowest fixed interest rates. Besides their leverage levels are some of the highest among multi-family financing loans, sometimes soaring up to 90%.
However such agency loans require as much as 6 to 12 months for approval. Moreover, multifamily investors who are seeking FHA loans must fill out myriad paperwork and follow strict FHA guidelines.
The terms of such loans are often 30 to 35 years. Moreover, multifamily investors can utilize FHA- insured financing for ground-up construction and refurbishment of distressed properties.
3. Commercial Mortgage Backed Securities (CMBS):
CMBS loans are also known as conduit loans. Their terms are more flexible making them similar to bank loans. Multifamily lenders can secure CMBS loans through several commercial banks, investment banks, and conduit lenders.
In this financing type, the property and its profits act as collateral for the loans. However, CMBS loans require higher interest rates and offer lower leverage to their borrowers. Moreover, CMBS loans are non-recourse and get pooled into a Real Estate Mortgage Investment Conduit (REMIC) trust. Therefore they are sold as security in secondary markets to investors.
4. Bridge Loans:
Bridge loans act as short-term loans to finance a gap while an investor waits to secure financing from other conventional multifamily loan programs. Therefore, bridge debt is a crucial alternative to financing multifamily housing investments.
These mortgage loans have shorter terms that range anywhere from 18 months to 2 years. These are generally issued by banks and are risky, temporary loans with higher interest rates. Therefore, it helps the investors to upgrade their properties to act as rental houses while waiting for agency loan approval. Hence once the property is stabilized the investor can either sell or refinance into a traditional loan type.
5. Bank Loans:
Lastly, bank loans are still one of the most popular mortgage options for multi-family investors.
These loans are typically recourse in nature. This implies that if the borrower fails to repay the bank can seize all their assets and the collateral. These offer comparatively less leverage of 80%. Furthermore, as a part of their strict underwriting process, bank loans generally require lenders to submit their tax returns.
Key Performance indicators (KPIs) for Multifamily financing loans:
1) Loan to value (LTV):
It refers to the quick ratio that the lenders use to predict the risk score of a loan that appears to be secure.
Typically, it is calculated as:
Loan to Value (LTV) = Mortgage amount / Value of the Multifamily property
The greater the Loan to Value (LTV) ratio, the more leverage a Multifamily property has.
2) Debt Service Coverage Ratio (DSCR):
DSCR determines the investor’s operating cash flow that is readily available for repaying the current owed debt.
There are two formulae to calculate this ratio:
Debt Service Coverage Ratio = Total debt on the property /
(Principal amount +interest charged)
Debt Service Coverage Ratio = (Total debt on the property- Capex)/
(Principal amount +interest charged)
3) Recourse V/s Non Recourse Loans:
Recourse loans allow the lender to seize all of a borrower’s assets, collateral, and income if they default or fail to repay the full debt.
On the other hand, in a non-recourse loan, the lender cannot seize any of the borrower’s possessions if they are unable to repay the loan. While it is an attractive option for borrowers, lending institutions often refrain from lending such loans.
This is because, if the lender cannot obtain the entire amount even after selling the collateral asset, they have to bear the loss.
Therefore, lending institutions do not prefer non-recourse loans.
4) Stabilized V/s Distressed Properties:
Occupancy rate is the most distinguishing factor between stabilized and distressed properties. A Stabilized Asset has a ‘stable’ occupancy rate of over 90% in the last 3 months. However, Distressed properties witness less than 90% occupancy rates in the preceding 90 days.
Read our blog here to know more about how value-add multifamily investments generate higher returns.
Why is Multifamily financing the key to more investments in commercial real estate?
The present demographic statistics, fuelled by the strong market fundamentals have been quite prudent in maintaining the standards of commercial multifamily financing.
While the availability of lending supports multifamily investment, loan originations have been evidently soaring high. Hence, multifamily financing alternatives having diverse lending terms enable commercial real estate investors to enhance their net worth. Furthermore, as investments in multifamily asset classes and apartments rise, it multiple opportunities for more investments. As a result, the commercial real estate multifamily sector booms with value creation and growth.