THE MORTGAGE BANKERS ROLE IN MULTIFAMILY FINANCING
BY DAVID FAGAN,
LEGG MASON REAL ESTATE SERVICES
Until the 1990's, most multifamily borrowers were limited to conventional lending institutions like insurance companies, thrift institutions and commercial banks. Although some Federal programs (HUD) existed, the time to process a loan made most borrowers reluctant to pursue that source during the 1980's. With the evolution of a secondary mortgage market, the Commercial Mortgage Backed Security (CMBS) for income properties in the early 1990's and the streamlining of the government programs, all this has changed.
Today, there are more sources of financing apartments than for any other type of investment real estate. Conventional lenders and the newly formed Conduits provide good avenues of short term to medium term debt. The Federal Home Loan Mortgage Corporation (Freddie Mac) and the Federal National Mortgage Association (Fannie Mae) offer medium to long term loans. Long term programs are also available through the HUD administered FHA Section 221 (d)(4), new construction, and Section 223(f), refinancing and moderate rehab projects.
Before deciding on which financing avenue to pursue, the borrower should determine which loan features are most important in meeting their needs. When determining a loan strategy and comparing different loan programs a borrower should consider the following:
Loan Amount - is restricted by the lender's Loan to Value Ratio, generally 75 to 80%.
Interest Rates - are generally set based on a spread over the comparable US Treasuries. The final rates are locked anywhere from application to three days before closing. The critical factors on determining a spread are Loan Term, Debt Service Coverage Ratio and Loan to Value. The more conservative the loan the better the spread will be.
Loan Term - generally run from three to ten years with some lenders going out to 25 years.
Amortization Schedule - run from 15 to 30 years depending on the property age.
Prepayment Terms - because of the advent of the Commercial Mortgage Backed Security most lenders tie their prepayment penalties to a Loss of Yield formula.
Borrower Liability - most multifamily lenders require no recourse for the debt but have standard carve provisions for fraud and environmental liability.
Assumability - a one-time assumption is generally allowed with the approval of the buyers credit worthiness.
Loan Costs - in addition to the cost of an appraisal, environment and engineering report, some lenders do charge processing fees or charge a commitment fee.
Once the borrower determines what features are most important for their investment strategy they then can pursue a lender with the type of loan policies that meet their goals. One of the primary roles of a mortgage banking firm is to work with the borrower to determine his financing strategy and then secure that type of financing with different sources of lenders that they represent. The pros and cons of the various sources of multifamily financing are:
Banks (Commercial & Thrifts)
Generally, these types of lenders offer shorter loan terms and conservative loan dollars. They can be more flexible in negotiating loan terms and documents than most lenders but have a tendency to look for full recourse for repayment of the debt. These lenders are a good source for a construction loan with a mini-perm after construction, which enables a borrower to build a project, stabilize the income then allowing them to place a permanent loan on the project at maximum dollars. Most banks also charge a one-percent commitment fee.
Conduits
Conduits are Wall Street firms mortgage subsidiaries that issue pools of mortgage loans secured by a Commercial Mortgage Back Security. The conduits tend to be more aggressive on loan dollars but are also on the higher side of the interest rate scale. Most conduits loan close with rates set just prior to the closing, although they do offer Rate Lock Options with additional Good Faith Fees posted with the lender to insure that the borrower does not walk away from the closing. A risk factor in processing a loan through a conduit is timing in that the market can fluctuate daily and the terms of the deal can be changed prior to commitment if market conditions swing too drastically, which have happened recently.
Fannie Mae
Fannie Mae's multifamily program operates through a select number of firms that co-insure the loans with Fannie Mae under a program know as Delegated Underwriter and Servicer (DUS). With a limited number of DUS Lenders these lenders operate on a national level rather than a regional level like the mortgage banker.
FHA Section 223 (f)
This section of the HUD program is used for refinancing of existing multifamily properties. The program also covers refinancing of complexes that need moderate rehabilitation. The advantage of this program is that the loan amount can reach 85% of value as determined by FHA as long as no equity is extracted. If there is an equity extraction the loan is limited to 70% of value. Loan terms and amortization can reach 35 years with favorable interest rates due to the FHA insurance on the loan. The draw back is that there is a 1/2 of 1% mortgage insurance premium that brings the constant more in line with other long term lenders.
FHA Section 221 (d) (4)
This section of the HUD program is for new construction of multifamily projects. The program offers up to 40-year self-amortizing loans. As with the 223 (f) program there is a 1/2 of 1% mortgage insurance premium but the 40 year amortization is a distinct advantage in today's high cost of construction where a borrower is trying to minimize equity into new projects. The program offers the highest leverage of any program in the market today with the maximum loan being determined by the lesser of a loan determined by 90% of total cost, 90% of value as determined by FHA or a 1.15 debt service coverage ratio. The FHA loans are the only true non-recourse loan including environmental indemnification. The FHA cost does have a .3 of 1% processing fee and an inspection fee that makes the cost of processing a HUD loan higher but this is offset by the long loan terms that is offered.
Freddie Mac
The Freddie Mac financing program offers one of the best multifamily financing options available in the market today. In addition to 5, 7 and 10 year terms amortized over 20 to 30 year schedules, Freddie Mac offers 15, 20 and 25 fully amortized loans. Loan amounts can reach 80% of value but a conservative borrower will be rewarded with some of the lowest rates in the industry if a borrower's request is limited to 65% to 70% of value. One of the other major advantages of the Freddie Mac program is their Early Rate Lock in which a borrower can lock rate within 10 days of Freddie Mac issuing a quotation on the property. Total processing time from acceptance of an application to closing is generally 90 days.
Insurance Companies
Along the spectrum of lenders, insurance companies tend to be more conservative with loan dollars. Loan sizes are generally in the $3 million and up range with property age of 10 years and newer. Interest rates tend to be in the middle of the spectrum for multifamily but can get very competitive for new "A" type properties. Most loans mature between five and ten years, although some longer-term debt is available in limited amounts. Some insurance companies will quote a fixed prepayment penalty and most fixed rate at either accepted application or at issuance of the commitment. Insurance companies that operate through mortgage bankers in a correspondent relationship are par lenders and do not charge commitment fees but may have small processing fees.
Summary
It is evident that a wide variety of financing options are available to borrowers who wish to purchase or refinance multifamily projects. The complexities of some of these programs warrant the use of an experienced mortgage banker. With their knowledge of the local market and understanding of the various programs, mortgage bankers offer "one stop shopping" for owners of multifamily complexes.
David Fagan is Senior Vice President for Legg Mason Real Estate Services. He can be reached at the Rochester office at 716-262-2100.