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The Ultimate Guide to Multifamily Loans

Overview

Multifamily loans are used to finance apartment buildings with 5 or more units. These apartments or multifamily properties include garden style apartment buildings, townhouses, loft style apartment buildings, brownstone apartment buildings as well as low-rise, mid-rise and high-rise apartment buildings.

In this guide we will cover the different types of multifamily lenders, a typical multifamily loan process, how to qualify for a multifamily loan, standard multifamily loan terms, the third party reports needed for a multifamily loan and some items to monitor after your loan has funded.


Multifamily Lenders

There are 4 major lender types that account for the majority of multifamily lending. These include agency lenders, banks & thrifts, insurance companies and conduits. Together they hold approximately 92% of outstanding multifamily mortgage debt totaling more than $1.5 trillion. Below is a breakdown of the major lender types, their market share and the characteristics of their multifamily lending products.

Agency Lenders

This group, which includes Fannie Mae / Freddie Mac / HUD lenders, are by far the most active multifamily lenders. Outstanding multifamily debt originated by agency lenders is approximately $838 billion, close to 50% of all outstanding multifamily mortgages. In 2020, Freddie Mac alone funded $83 billion in multifamily loans, accounting for approximately 27% of total multifamily lending that year. The "agencies" were created by Congress to provide liquidity and affordability in the U.S. housing market and are considered government sponsored entities. While the agencies do not lend directly, they purchase mortgages from approved lenders who underwrite multifamily loans according to their guidelines.

49.68% of multifamily debt outstanding was originated by agency lenders.

Agency lenders will lend in all states and regions, and are particularly focused on affordable housing. Loan amounts start at $750,000 with the Fannie Mae small loan program, but generally range between $1 million to $100 million. Borrowers can receive up to 80% leverage in some markets depending on property operating metrics. Other benefits to agency loans include; long term fixed rates (up to 30 year fixed loan options), rate discounts for affordable housing, non-recourse loan structure and interest only payment options. In addition to standard stabilized multifamily loan products, agency lenders have specialized programs that can meet the needs of a variety of multifamily property types and situations.

Banks

This group includes commercial banks, savings and loans, thrifts and credit unions. These lenders account for $480 billion in outstanding multifamily mortgages. Holding 28% of total multifamily debt outstanding, these lenders are the second most active lender group in multifamily lending. These lenders range from national mega banks to small regional financial institutions. Banks and thrifts lend on other investment property types and their multifamily lending only accounts for just under 20% of their total commercial mortgages outstanding.

28.45% of multifamily debt outstanding was originated by banks.

Each of these lenders have their own specific lending guidelines and lend in specific regions or "footprints". Multifamily loan amounts from these lenders can range from $500,000 to over $100 million. Fixed rate terms are usually 3 to 7 years with some offering 10+ year fixed rate products. A benefit of their multifamily lending programs is their familiarity with their lending markets. These lenders generally maintain their loans in their own portfolios and can sometimes be more flexible with loan terms.

Insurance Companies

This group includes insurance companies that invest in loans secured by commercial and multifamily real estate. While not well known as mortgage lenders, insurance companies hold almost 10% of all multifamily mortgages outstanding, totaling $167.5 billion. These lenders have a lower risk threshold than other lender types. Accordingly, they are usually active on lower leverage multifamily loan requests in defensible markets. They primarily focus on larger loan amounts, with a handful of insurers originating smaller loans. The major benefits to insurance company multifamily debt are low rates and long term fixed rates.

9.94% of multifamily debt outstanding was originated by insurance companies.

Conduits

This group includes financial institutions that originate and fund loans that are ultimately structured for sale in the capital markets as commercial backed securities, collateralized debt obligations or asset backed securities. These lenders are generally investment banks or other firms with extensive knowledge and expertise in the capital markets. These lenders account for $50 billion in outstanding multifamily mortgages, or just over 3% of total outstanding.

3.02% of multifamily debt outstanding was originated by conduits.

These lenders focus on larger dollar loan amounts as these transactions are more costly to execute due to additional third party reports and legal fees. Loans through conduits generally make sense on loans greater than $10 million. Some benefits to conduit loans are interest only payment options, maximum leverage and larger (>$100 million) loan amounts.

Other

Non-traditional lenders account for the remaining 8.91% (or approximately $150 billion) in outstanding multifamily mortgages. The largest share, 6.26% or $105 billion, is held by state and local governments. The remaining is held by the federal government, real estate investment trusts, government retirement funds and other various entities.

8.91% of multifamily debt outstanding was originated by other institutions.


Multifamily Loan Process

While each multifamily loan will have some variance in process, the general flow of the process is as follows.

1. Get Quote - The first step is to get indicative pricing and terms from the lender for your loan request. This usually includes loan amount, general terms and rate. To do this they will need to review some items pertaining to the property and borrower/ sponsor. The standard items needed are; property address, a current detailed rent roll, historical operating statements (i.e. last 1-2 years and a year-to-date) and a personal financial statement for the borrower or sponsor.

2. Letter of Intent (or Interest) LOI - When you decide to move forward with a proposed loan, you will request a Letter of Intent (or Interest) that lists the relevant loan terms, requirements and costs. Both you and the lender will execute this document indicating their intent to lend to you and your intent to move forward with their loan proposal. Some lenders will require a deposit to cover third party report fees, others require this with the Application Package.

3. Submit Application Package - Once the LOI has been executed, you are expected to submit to the lender all items needed for them to start their underwriting process. These items usually include; additional operating history, information on capital expenditures over the last few years, tax returns (if required), lender specific forms and disclosures, leases or sample lease and contact info for third party inspections. Some lenders will allow you to lock a rate at this point. If that is an option, usually a refundable deposit is required to lock your rate.

4. Ordering Third Party Reports - As part of the lenders underwriting process, they will require third party reports (property specific reports from outside vendors). Usually, the lenders will request bids from approved vendors, which they then share with you for approval. Once approved, these reports are engaged. It is important to get this process started as soon as possible because the finished reports are required by the lender to complete their underwriting.

5. Open Escrow or Engage Attorney - Depending on the state where your property is located, you will need to either open escrow and/or engage an attorney to start the process for title insurance and loan payoffs (if a refinance). The lender will want a preliminary title report for your property. Your title officer or attorney will provide this as part of their services.

6. Additional Underwriting Items - It is common for the lender to request additional items or information after you have submitted the loan application package. These are additional items that the lender will need to complete their underwriting of your loan. Some lenders will also require you to obtain estoppels from your tenants.

7. Receipt of 3rd Party Reports - After about 3-5 weeks of being ordered, your third party reports will be completed and sent back to the lender for review and will be included as part of their final underwriting. If the third party reports come back without issue (i.e. valuation issues on the appraisal or recognized environmental concerns on Phase 1), your loan is on its was to final approval or commitment.

8. Insurance Requirements - At least several weeks before the estimated funding date, you will want to coordinate with your insurer and your escrow officer or attorney to make sure that the insurance policies required by the lender are lined up and ready to go into effect.

9. Loan Approval - Once the lender has completed their underwriting they will issue a loan approval and/or issue a loan commitment with the final loan terms. If your loan rate was not locked earlier in the process it can locked at this point or at funding depending on the lender.

10. Funding and Closing - The lender will then send loan documents to escrow or your attorney for signing preparation. Your escrow officer or attorney will have also made sure all final title items are complete, loan payoffs are coordinated (if you are refinancing) and ensure insurance items are set up. At this point your loan documents should be ready for signing and when the lender’s instructions have been followed and your executed loan documents have been sent back to the lender, your loan will fund.


Qualifying for a Multifamily Loan

Unlike a home mortgage that uses a borrower's income to qualify, 5+ unit multifamily loan qualification is based primarily on the financials and operating condition of the property itself and then secondarily on metrics related to the sponsors (individuals who own the borrowing entity). Property specific loan analysis includes occupancy, loan-to-value and debt service coverage ratio. Sponsor specific metrics include liquidity, net worth, experience and credit history.

Property Specific Loan Metrics

  • Occupancy is the percentage of units occupied. Different lenders will vary in their occupancy requirements, but generally most lenders on stabilized multifamily properties will require a minimum of 85-90% occupancy. Some lenders will even have a timeframe in which they require a specific level of occupancy. For example, agency lenders usually require 90% occupancy for the last 90 days.
  • Loan-To-Value (LTV) is the percentage of debt in relation to the property's value or purchase price (whichever is less).

    For example, a loan request for $700,000 on a property with a market value of $1,000,000 would have a loan-to-value of 70%. Lenders generally have upper limits on the maximum loan-to-value they will allow.

  • Debt Service Coverage Ratio (DSCR) is the ratio of net operating income (NOI) to annual debt service (yearly mortgage expense).

    For example, if a property has $125,000 in net operating income and loan payments that total $100,000 annually, the DSCR would be 1.25x.

    The DSCR shows the cash flow available to the borrower once their loan payments have been made. In the example above, the investor would have $0.25 remaining for every $1.00 paid in mortgage expense. From the lenders perspective, the greater the DSCR the better, as it helps the sponsor absorb changes in vacancy or a decline in rents.

    DSCR is arguably the most important metric when qualifying for a multifamily loan because it is the metric that most often limits the maximum loan amount available on a multifamily property and can effect the loan’s interest rate.

    As this is a primary qualifying metric, its critical to ensure an accurate DSCR for your loan request. To achieve this, the net operating income (NOI) must be calculated correctly. For more on this, see our calculating NOI guide.

Sponsor Specific Metrics

Sponsors are the individual or individuals with significant ownership and control of the borrowing entity. The borrower on multifamily loan transactions refers to the borrowing entity (usually an LLC or corporation set up to hold the property). If the property is held under the individual, the sponsor and borrower are the same. Below are some metrics used to qualify the sponsor of a multifamily loan.

  • Liquidity & Net Worth of the sponsor is examined to ensure that the individuals responsible for the property have the financial wherewithal to manage economic cycles and fluctuations in the property's operating performance (i.e. increases in vacancies or decreases in rental rates).
  • Experience in real estate is analyzed to determine a sponsor's competence and knowledge pertaining to effectively managing a multifamily property.
  • Credit History will demonstrate a sponsors historical payment record along with other issues like law suits or judgements.

Submission Requirements

Each lender will have their own requirements for a complete application package, with specific forms for a loan application, questionnaires and disclosures. However, the items you will generally be responsible to provide will include the following:

  • Historical Operating Statements (usually the 2 prior years and a year-to-date)
  • Current Rent Roll
  • Financial Statement (for sponsor and borrower)
  • Schedule of Real Estate (for sponsor and borrower)
  • Historical Tax Returns (for sponsor and borrower)

Multifamily Loan Terms

There are various components that make up the terms on a multifamily loan. These terms determine the structure of the loan and how a loan behaves once it has been funded. Below are some of the major multifamily loan terms and descriptions of each.

Loan Term

The loan term is the duration of the loan. At the end of the loan term, the remaining principal balance is due. The principal balance due at the end of a loan term is considered the balloon payment.

Fixed Rate Term

The fixed rate term is the length of time the loan rate is fixed and will not adjust. These fixed rate terms generally vary from 3 to 30 years, based on your loan. A less common option is a "floating" rate term that adjust periodically based on an underlying index and a margin. A loan's fixed rate term does not always match its loan term, and in those cases, the rate can adjust after the fixed rate period.

Amortization

The amortization of a loan is the schedule over which the loan is paid down to zero. The most common amortization on a multifamily loan is 30 years. The amortization schedule calculates the principal and interest payments on a loan amount, at a given interest rate, so that there is no remaining principal balance at the end of the amortization period. Most lenders will allow shorter amortizations for borrowers who want to pay off their principal balance sooner.

Interest Only Options

Some multifamily loans offer an interest only payment option (either partial and full term). During the interest only payment period, no principal is paid down. If the interest only payment option is partial term, once that interest only partial term is over, the borrower is required to pay full principal and interest payments amortized over a shorter time frame. For example, a 10 year fixed rate term with a 10 year loan term and a 30 year amortization with a 3 year interest only option would have interest only payments for the first 3 years. At the end of those 3 years, the loan payments would recalculate based on a 27 year amortization period. This would determine the loan payments for the remaining 7 years of the term.

Prepayment Penalty

Most multifamily loans have some form of prepayment penalty during their fixed rate terms. These penalties are fees that a borrower would incur if they paid off their loan before the end of the prepayment penalty period. There are several different types of prepayment penalties. These include defeasance, yield maintenance and step down prepayment penalties. It is important to understand the prepayment penalty structure of your loan to make sure it fits with your business plan for the property.

Recourse

Recourse refers to a sponsor's liability for unpaid mortgage expense (and other related expenses) in the event of a loan default. Loans with full recourse give the lender the right to go after the individual's who are sponsors of a loan. Loans with recourse require the sponsor to personally guarantee the loan. Non-recourse loans are loans who's obligations are limited to the borrowing entity. However, even non-recourse loans present some liability to sponsors. This liability is in the form of "carve outs", which identify certain situations in which the lender may have recourse. These situations include fraud, environmental contamination, and other acts of negligence.

Covenants

Covenants are ongoing borrower requirements, usually in the form of property operating ratios. Some common covenants are debt coverage service ratio (DSCR) minimums, occupancy minimums and other sponsor or borrower requirements. It is important to understand all covenants on a loan and the consequences of breaking those covenants.

Reporting

Most multifamily loans have yearly reporting requirements. This reporting usually includes updated rent rolls and operating statements to be sent to the lender yearly on a prescribed date (i.e. 60 days after calendar year end). Some lenders will also require updated financial statements from the borrower or sponsor.


Third Party Reports

Most lenders will require some reports from "third parties" (outside companies) as part of their lending due diligence process. At minimum, lenders will require an appraisal for a multifamily loan. However, most will require additional third party reports. The following are the most common third party reports potentially required by multifamily lenders.

MAI Appraisal

An Appraisal is a report that develops an opinion of the market value of a property. This market value determination allows the lender to underwrite the loan request according to their loan-to-value guidelines and informs the lender of market rents and expenses so they can accurately model an operating statement and net operating income. Additionally, it will include recent comparable multifamily property sales with details like price per unit and market CAP rates. Appraisals must adhere to the Uniform Standards of Professional Appraisal Practice and be conducted by an appraiser who is a member of the Appraisal Institute, the foremost professional association of real estate appraisers.

Phase 1 ESA

A Phase 1 Environmental Site Assessment (Phase I ESA) is a risk management tool that evaluates the environmental liability associated with a multifamily property. This report assesses the the historical and current uses of the property to determine any potential environmental issues. The scope of this report includes a site visit by an inspector, historical research, geology and hydrogeology information, regulatory research as well as interviews and document review. Phase 1 ESA's are to be conducted according to ASTM E1527-13 standards. The desired outcome of a Phase 1 ESA is: no evidence of recognized environmental conditions and a recommendation of no further investigation. If there are recognized environmental conditions or the potential for contamination, lenders will usually require a Phase 2 ESA, which are actual tests of the soil, soil gas, and/or groundwater for possible environmental contamination.

Property Condition Assessment (PCA)

The Property Condition Assessment is a comprehensive report that assesses major building systems and improvements to determine the condition of a property and identify damaged building systems and safety issues. The scope of this report includes inspector field work, evaluation of building systems, building components and site improvements. Reports should include detailed information on immediate repairs and replacement reserves.

Seismic

Seismic Risk Assessments and/or Probable Maximum Loss estimates are required by some lenders depending on property location (proximity to a seismic zone) and/or loan amount. These reports may assess; seismic ground motion, site stability, building stability and potential building impairment. The objective of this report is to provide a statistical estimate of building damage in the event of an earthquake. Lenders will generally require buildings they lend on to fall below a certain threshold of potential seismic damage.

ALTA Survey

ALTA (American Land Title Association) Surveys show detailed property boundaries, improvements, utilities and other details. They are usually required based on state requirements or lender's title insurance requirements. This survey is made for the purpose of supplying a title company or a lender with the property data necessary for issuing an American Land Title Association extended coverage title insurance policy. This extended coverage policy insures the lender against unforeseen risks not covered by other title policies.


Post Close Items

Once your loan has funded you will still have some obligations to the lender, specifically in respect to managing covenants and annual reporting requirements. It is important to maintain a good working relationship with your lender throughout the term of your loan. The key to maintaining this relationship is communication. Getting them the annual reporting items required in a timely manner is an important first step. Understanding your covenants and communicating with the lender on potential covenant issues is also a good way to maintain a good relationship. If, for example, you’re operating income or occupancy decreases substantially and you believe that it might cause you break a covenant, reaching out to your lender is a good idea. Usually, the lender will work with you on many issues that come up as long as your payments are up to date.

Lastly, understanding the terms of your loan will ensure that there are no post close surprises. This includes knowing your loan terms, specifically the fixed rate term, the term of the loan and your prepayment penalty structure. This knowledge will prepare you for any balloon payments, changes in rate or other items that you will want to be prepared for.