A Complete Guide to Financing Multifamily Real Estate

June 17, 2021

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

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


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


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


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


What Is Multifamily Commercial Real Estate?

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

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

Apartment Buildings
Apartment buildings are a specific type of multifamily housing. Typically,most people refer to buildings with 5+ units as “apartment buildings”. (Thesmaller 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, theattractive 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.) aretypically not available when financing apartment buildings. Apartmentbuildings, even if owner-occupied, will usually require at least 20% or 25%down.  

Thereare generally three categories of multifamily property that investors willconsider: (1) stabilized multifamily apartments; (2) value-add multifamilyproperties; and (3) ground-up multifamily construction. The latter refers to adevelopment opportunity in which a sponsor either buys land or otherwisepermits a property for multifamily construction. Multifamily construction isone of the more challenging types of multifamily investing, and carries certainrisks associated with permitting the project. Multifamily construction alsoutilizes distinct financing tools, such as short-term debt that is released intranches as construction milestones are achieved.


Multifamilyvs. Single Family Real Estate
Themultifamily real estate market includes both “residential” rental property (1-4units) and “commercial” rental property (buildings with 5+ units). Residentialmultifamily is the easiest to finance and has the lowest barriers to entry.This is how most multifamily investors typically get started. Some will evenowner-occupy one of the units in their first rental property as a way ofsecuring the most attractive multifamily financing.

Residential real estate also includes single-family rental properties, thoughsingle-family rentals are notconsidered “multifamily” property. There are some investors, however, who haveachieved great success by investing in one single-family rental property at atime. This investment strategy appeals to some, particularly in lower costmarkets where property values are low but rents are high.


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

Multifamilyvs. Commercial Real Estate
Peopleoften confuse the terms “multifamily” and “commercial real estate,” as thoughthese 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 includesmultifamily, office, retail, industrial, hospitality and land development.

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


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


·      TraditionalBank Loans
Whenbuying multifamily real estate, most borrowers will seek out a traditional bankloan (also called “conventional financing”) first before considering othertypes of apartment loans. A traditional bank loan is generally morecustomizable than other sources of CRE debt, which in turn, provides moreflexibility to borrowers as they underwrite their deals.

Typically, smaller banks will have hyper-local decision-making, meaning theycan 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 largerbanks 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 thansmaller, 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 byshopping deals around a bit. That’s not the case in every market.


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


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


·      AgencyLoans
Government-sponsoredenterprises (GSEs), collectively referred to as “agency lenders,” includeFannie Mae and Freddie Mac. GSE loan programs were specifically created to makemultifamily loans in an attempt to ensure the American population has abundantand affordable rental housing.

One thing to understand about agency loans is that Fannie and Freddie aren’tactually making these loans themselves. Instead, the loans are made throughprivate lenders (i.e., traditional banks) and once the loan is made, the GSEswill purchase those loans to be pooled with others that are then packaged andsold as bonds on a secondary market to other investors. Agency loans carrywhat’s known as an “implied guarantee,” meaning that if the underlyingcollateral goes bad or if the borrower defaults, the U.S. government will stepin and pay the debt on the bonds.

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


·      CMBS Loans

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


CMBS loans can be used for allproperty types, not just multifamily as is the case with agency loans. Theprimary difference between CMBS loans and those offered by banks or lifecompanies is that CMBS loans tend to be longer-term loans on properties withstable 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, theborrower has little flexibility to negotiate repayment options with the bank. Theborrower will often have trouble tracking down a decision-maker who can modifythe loan to better address their needs.


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

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

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

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

·       HardMoney Loans
Hard money lenders arethird-party financiers that generally offer loans at above-market rates. Forexample, a hard money lender might charge 12% interest on a deal that atraditional lender might charge just 5.5%.

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


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


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


·      OnlineMarketplaces
Inrecent years, there has been an explosion of online crowdfunding platforms thatcan 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 multifamilyloan through a more traditional avenue.


Asyou can see, there are many different types and sources of multifamily loans.Any investor will want to understand the breadth of financing options availableas they source debt for their deals. It is always worth shopping around, as thecost of capital is one of the biggest costs associated with multifamilyapartment deals. Multifamily loans can be structured very differently, and eachloan 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 yourspecific deal.