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A Complete Guide to Financing Multifamily Real Estate

There are many different loan products available to commercial real estate investors. Which someone chooses to utilize will often depend on the nature of the deal (e.g., the size and/or product type). Not all loan products are available to every product type, for example.

There are many different types of multifamily loans that can be used to buy apartment buildings. It’s important to talk to several banks to ensure you’re getting the most competitive rates and terms. 

For example, Bank A might be willing to give you a 4.25% loan on a commercial building that is only 50% occupied. Bank B might be willing to give you a 4.75% loan on that same property but with a one-year interest-only period. At first glance, Bank A seems like the better deal. However, in this case, when an investor is buying an underperforming property, having a one-year interest-only period might be worth the higher rate. This gives the new owner some time to improve and lease-up the building, thereby stabilizing it prior to principal payments kicking in. These details must all be factored into a project’s underwriting.

Conversely, underwriting real estate also influences which loan products are available to a borrower. For instance, if underwriting suggests that a deal is relatively “safe,” it may qualify for an institutional loan product. If the underwriting indicates that a deal is on the riskier side, a borrower may need to seek out a hard money loan or recruit additional equity using an online marketplace. 

In this article, we look at the many ways to finance multifamily real estate, including which loan products are best utilized when. 

What are the Types of Multifamily Commercial Real Estate?

Before getting started, it is worth taking a step back and making a distinction between types of multifamily real estate.

Multifamily Housing

Multifamily housing is really a catch-all term to refer to any type of rental property with two or more units. On the smaller end, multifamily housing can refer to duplexes or triplexes. Multifamily housing also includes mid-sized properties (such as garden-style apartments) and larger apartment communities. Multifamily housing can be further segmented by its audience, such as student housing or senior housing.

Apartment Buildings

Apartment buildings are a specific type of multifamily housing. Typically, most people refer to buildings with 5+ units as “apartment buildings”. (The smaller buildings would be referred to by more exact unit size, such as duplex, triplex or quadplex.)

Buildings with five or more apartments begin to fall into the “commercial” financing category (vs. “residential multifamily”). In other words, the attractive financing options you might be able to get on a duplex or triplex (e.g., FHA loans with as little as 3.5% down, 30-year fixed rates, etc.) are typically not available when financing apartment buildings. Apartment buildings, even if owner-occupied, will usually require at least 20% or 25% down. 

Multifamily Construction

There are generally three categories of multifamily property that investors will consider: (1) stabilized multifamily apartments; (2) value-add multifamily properties; and (3) ground-up multifamily construction. The latter refers to a development opportunity in which a sponsor either buys land or otherwise permits a property for multifamily construction. Multifamily construction is one of the more challenging types of multifamily investing, and carries certain risks associated with permitting the project. Multifamily construction also utilizes distinct financing tools, such as short-term debt that is released in tranches as construction milestones are achieved. 

Multifamily vs. Single Family Real Estate

The multifamily real estate market includes both “residential” rental property (1-4 units) and “commercial” rental property (buildings with 5+ units). Residential multifamily is the easiest to finance and has the lowest barriers to entry. This is how most multifamily investors typically get started. Some will even owner-occupy one of the units in their first rental property as a way of securing the most attractive multifamily financing.

Residential real estate also includes single-family rental properties, though single-family rentals are not considered “multifamily” property. There are some investors, however, who have achieved great success by investing in one single-family rental property at a time. This investment strategy appeals to some, particularly in lower cost markets where property values are low but rents are high. 

That said, managing a portfolio of single-family rental properties is no easy task. There are more systems to manage, more landscaping to maintain, more travel time to factor in when traveling between properties. Investors realize more operational efficiency when investing in multifamily properties. Lenders also pay close attention to this reality when making multifamily loans.

Multifamily vs. Commercial Real Estate

People often confuse the terms “multifamily” and “commercial real estate,” as though these were two separate things. In fact, multifamily is just a type of commercial real estate. Commercial real estate refers to an entire asset class that includes multifamily, office, retail, industrial, hospitality and land development.

The exception to this rule, however, is when referring to 2- to 4-unit rental properties, which are considered “residential multifamily”. As soon as a building has 5+ units, it falls into the “commercial” real estate category and will require a different type of multifamily loan.

Seven Types of Multifamily Loans

Now that we’ve made the distinction between types of multifamily real estate, we provide a comprehensive overview of the multifamily loans available in the marketplace today. 

1. Traditional Bank Loans

When buying multifamily real estate, most borrowers will seek out a traditional bank loan (also called “conventional financing”) first before considering other types of apartment loans. A traditional bank loan is generally more customizable than other sources of CRE debt, which in turn, provides more flexibility to borrowers as they underwrite their deals.

Typically, smaller banks will have hyper-local decision-making, meaning they can be more flexible because they understand the nuances of the local market. However, small, local banks can only lend so much. This is where the larger banks come into play. Borrowers in search of multifamily loans worth more than $10 million will usually want to contact a national lender such as JP Morgan, Wells Fargo, and Bank of America as these banks have higher lending limits than smaller, more locally-based banks.

Each geography and market is very different with the banks that operate there, how well capitalized they are, how aggressive they’ll get. Boston, for example, is considered “over-banked” – you can go out and get great rates just by shopping deals around a bit. That’s not the case in every market. 

2. Life Insurance Companies

Life Insurance companies will typically provide low-leverage loans on properties that have very stable cash flows, and generally offer some of the most competitive interest rates for loans that meet specific criteria (e.g., stabilized properties in core markets or deals considered otherwise “safe” by a lender’s standard). 

The downside to utilizing a life insurance company loan is that they usually are less flexible than traditional bank loans. Moreover, most life insurance companies only look to do larger loans ($20+ million), though there are certainly exceptions. 

3. Agency Loans

Government-sponsored enterprises (GSEs), collectively referred to as “agency lenders,” include Fannie Mae and Freddie Mac. GSE loan programs were specifically created to make multifamily loans in an attempt to ensure the American population has abundant and affordable rental housing.

One thing to understand about agency loans is that Fannie and Freddie aren’t actually making these loans themselves. Instead, the loans are made through private lenders (i.e., traditional banks) and once the loan is made, the GSEs will purchase those loans to be pooled with others that are then packaged and sold as bonds on a secondary market to other investors. Agency loans carry what’s known as an “implied guarantee,” meaning that if the underlying collateral goes bad or if the borrower defaults, the U.S. government will step in and pay the debt on the bonds.

The biggest draw of agency loans is that most are non-recourse, meaning that the borrower does not have to put up other collateral to guarantee the loan personally. Another benefit of agency loans is that many are made at 80% or more loan-to-value, which limits the amount of equity the borrower needs to put into the deal. Lastly, these rates are usually below-market because the banks carry less risk since they have been guaranteed by the GSEs.

4. CMBS Loans 

Commercial mortgage-backed security (CMBS) loans are structured through a conduit, usually a large bank, which will go out and make loans, then package them up and sell them off to the public as bonds. 

CMBS loans can be used for all property types, not just multifamily as is the case with agency loans. The primary difference between CMBS loans and those offered by banks or life companies is that CMBS loans tend to be longer-term loans on properties with stable cash flows. There is less need to have an active lender.

The big knock on CMBS loans is that when something comes up, good or bad, the borrower has little flexibility to negotiate repayment options with the bank. The borrower will often have trouble tracking down a decision-maker who can modify the loan to better address their needs. 

Given the onerous nature of CMBS loans, these are usually lower down the list of options for most CRE borrowers. Deals with high-quality sponsors and high-quality assets will typically be snatched up by a traditional bank lender of life company before they make their way into a packaged CMBS loan. CMBS loans are more heavily utilized in markets that banks and life companies are less excited about, such as secondary and tertiary markets.

5. Debt Funds

A commercial real estate debt fund is a pool of private equity-backed capital that has a mandate to make certain types of loans – say, for multifamily housing in a specific geography. Debt funds are a great source of capital for those taking on higher-risk deals that other lenders might refuse to touch

Interest rates tend to be higher than the market average when utilizing a debt fund. These multifamily loans also tend to be short-term, usually no more than three years with an option to extend. This gives the borrower enough time to stabilize a property or put permanent financing on it with a traditional lender, life insurance company, or CMBS loan.

Debt funds will often consider doing non-recourse loans but in exchange, will expect the borrower to pay higher up-front fees.

6. Hard Money Loans


Hard money lenders are third-party financiers that generally offer loans at above-market rates. For example, a hard money lender might charge 12% interest on a deal that a traditional lender might charge just 5.5%.

Given the major discrepancy in what a hard money lender can offer compared to more traditional lenders, you might wonder why anyone would utilize a hard money lender. There are actually several circumstances in which a hard money lender is necessary.

Hard money lenders can generally move much faster than traditional lenders. In a multi-offer situation, if a borrower needs to acquire a down payment or is seeking to make an all-cash offer, a hard money lender can provide cash quickly. This allows the borrower to put up the cash in the short term while they figure out a longer-term financing solution. 

Someone might seek a hard money loan depending on the nature of a deal, too. High-risk deals (and/or high-risk borrowers) might struggle to obtain traditional commercial real estate financing; they may have no other option than to pursue a hard money loan. Upon project stabilization, they can then refinance the deal to repay the hard money lender and put lower cost, long-term debt on the property.

7. Online Marketplaces

In recent years, there has been an explosion of online crowdfunding platforms that can help borrowers secure both debt and equity for their multifamily deals. Crowdfunding platforms tend to have less oversight than traditional lenders, and as such, are typically only used by borrowers in “last resort” situations – i.e., if the nature of their deal makes it difficult to source a multifamily loan through a more traditional avenue. 

Conclusion

As you can see, there are many different types and sources of multifamily loans. Any investor will want to understand the breadth of financing options available as they source debt for their deals. It is always worth shopping around, as the cost of capital is one of the biggest costs associated with multifamily apartment deals. Multifamily loans can be structured very differently, and each loan should be tailored with unique terms to meet a customer’s needs.

Interested in finding a multifamily loan that meets your needs? Contact us today to discuss the most appropriate type of financing for your specific deal.

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