If you are looking at investing in multifamily syndications (or any other type of commercial real estate deal), part of your due diligence should include assessing the type of loan being used.
There are many different types of loan products that serve different business plans, there is not a one-size fits all approach.
Because of this I want to breakdown the different types of loans.
From a 30,000 ft view to determine the appropriate loan one must consider the length of the expected hold period (1-4 years or 5-10+ years), current cash flow, and occupancy.
If you are planning on doing a quick “flip” such as a value-add project that involves buying, renovating, and selling, then a bridge loan might be the most appropriate.
Bridge loans offer the ability to buy properties that may either not be stabilized (occupancy lower than 90% for commercial real estate), and/or that the cash flow is substantially low and needs a lot of work to be able to cover the typical loan requirements (1.20 – 1.25x DSCR [Debt Service Coverage Ratio]).
Another benefit or reason to use a bridge loan is if you are expecting to own the property for less than 3 years.
If you try to use a Conventional or Fannie/Freddie loan with a fixed interest rate and want to sell prior to 5 years you might need to pay some hefty penalty fees in the form of step down or yield maintenance fees. These fees can be so high that all of the appreciation/value you created for the property could be wiped out by paying them in order to sell.
Some people may say “but isn’t it risky having a bridge loan with variable interest rate?”
Yes although there are methods you can use to eliminate some of the risk with these loans. More on that explained at the end.
For many of these loans much, the criteria to be eligible include that the General Partnership team have a networth equivalent of the loan amount plus at least 10% of the loan amount liquid in the bank. The 10% liquid must never be moved from that bank account and the lender may require from time to time bank account statements to confirm this.
Types of loans:
1. Conventional Commercial Real Estate Loans
Overview
Conventional commercial real estate loans are traditional loans offered by banks and financial institutions. They are not insured or guaranteed by any government agency, which generally means they have stricter underwriting criteria.
Loan Terms
- Term Length: Typically ranges from 5 to 20 years.
- Amortization: Often extended up to 25 or 30 years.
- Interest Rates: Can be fixed or variable, depending on the lender and market conditions.
Requirements
- Down Payment: Usually 20-30% of the property’s value.
- Credit: Strong credit history and financials are required.
- Property Cash Flow: Lenders assess the property’s income and cash flow to ensure it can cover the mortgage payments.
- Personal Guarantee: Often required, which means the borrower personally guarantees the loan in case of default.
Advantages
- Competitive Rates: Generally offers competitive interest rates.
- Flexibility: Can be used for a wide range of commercial property types, including office buildings, retail centers, and industrial properties.
Disadvantages
- Stricter Criteria: More stringent underwriting criteria compared to government-backed loans.
- Down Payment: Requires a substantial down payment.
2. Fannie Mae Multifamily Loans
Overview
Fannie Mae provides financing for multifamily properties through its Multifamily Mortgage Business. These loans are designed to support the acquisition, refinance, or improvement of apartment buildings and other multifamily properties.
Loan Terms
- Term Length: Typically ranges from 5 to 30 years.
- Amortization: Can extend up to 30 years.
- Interest Rates: Competitive and can be fixed or variable.
Requirements
- Property: Must be a rental property with at least 5 units.
- Credit: The borrower must meet Fannie Mae’s credit and financial criteria.
- Income: The property must have a strong income history or potential.
Advantages
- Longer Terms: Offers long-term financing options.
- Competitive Rates: Generally provides lower rates compared to conventional loans due to the government backing.
Disadvantages
- Property Requirements: Limited to multifamily rental properties.
- Application Process: The application process can be complex and time-consuming.
3. Freddie Mac Multifamily Loans
Overview
Freddie Mac offers multifamily loans through its Multifamily Lending Business. These loans are similar to those offered by Fannie Mae but may have different criteria and benefits.
Loan Terms
- Term Length: Typically ranges from 5 to 30 years.
- Amortization: Can extend up to 30 years.
- Interest Rates: Competitive rates, fixed or variable, depending on the loan program.
Requirements
- Property: Must be a rental property with at least 5 units.
- Credit: The borrower needs to meet Freddie Mac’s credit and financial standards.
- Income: The property should demonstrate stable income or strong income potential.
Advantages
- Flexible Terms: Offers flexible loan terms and conditions.
- Competitive Rates: Competitive rates, often comparable to or better than Fannie Mae.
Disadvantages
- Property Requirements: Limited to multifamily properties.
- Complex Application: The application process can be complex and requires detailed documentation.
4. Bridge Loans
Overview
Bridge loans are short-term loans designed to provide temporary financing until a more permanent solution is obtained. They are used to “bridge” the gap between immediate financing needs and long-term funding solutions.
Loan Terms
- Term Length: Typically short-term, from 6 months to 3 years.
- Amortization: Often interest-only payments with a balloon payment at the end of the term.
- Interest Rates: Generally higher than conventional loans due to the short-term nature and higher risk.
Requirements
- Property Type: Can be used for a variety of property types, including commercial and multifamily.
- Exit Strategy: Requires a clear exit strategy, such as securing permanent financing or selling the property.
Advantages
- Fast Access: Provides quick access to capital, which is useful for time-sensitive opportunities.
- Flexible Terms: Flexible loan terms and requirements compared to traditional financing.
Disadvantages
- Higher Costs: Higher interest rates and fees compared to long-term loans.
- Short-Term: Short-term nature requires a solid plan for refinancing or repayment.
What is a non-recourse loan?
Non-recourse is common for many large commercial real estate loans. Simply means the borrowers are not guaranteeing the loan, and in the even of default, the lender can only take back the property it lent on but not go after any of the borrower’s assets.
There is however what’s called the “bad boy” carve outs. If the borrower commits any of the items included in the carve out clause, then it immedaitely turns the loan into a recourse loan which allows the lender to go after the borrower’s assets and file a lawsuit against him.
Some of these carve outs include:
- Fraudulently preparing financial statements or tax returns
- Failing to pay taxes or make insurance payments on time
- Misrepresenting the property
- Voluntarily destroying real estate
- Raising subordinate financing without the lender’s approval
- Intentionally declaring bankruptcy
- Falsifying their financial strength or ability to repay the loan
What is a step-down prepayment penalty?
This is the schedule of fees that shall be paid if the property is sold by a certain timeline with the fees decreasing or “stepping down” the longer the owner owns the property. A typical step-down might be 5% of the outstanding balance in the first year, 4% in the second year, 3% in the third year, and so on. Most lenders will not charge a step-down penalty in the last 90 days of the loan term.
Since we mostly use bridge loans for our deals, how can we eliminate as much risk as possible?
1. Having a rate cap in place for 3 years.
Rate caps serve as an insurance against the interest rates rising above a certain level. This is almost like fabricating your own fixed rate loan with all the benefits of a bridge loan.
As of our latest deal purchased on June of 2024 a rate cap on a $24M loan cost $2.5M that will secure that our interest rate will not go higher than 4.75%.
2. Having different exit strategies.
By the time we are approaching the 3 year mark, per our conservative projections we will have sufficient cash flow to refinance into a fixed rate loan if necessary at even a 7% interest rate which is much higher than what the market is now.
3. Purchasing the property at a low-basis.
Buying a property for a low price relative to comparable properties in the area can help with being in a strong position to be able to sell and return investor capital back and potentially profit if necessary by the 3 year mark.
Hope this deep insight into commercial real estate loans helps you on your next investment due dilifence!
Satch Bernhardt
CEO | V1 Capital
