By Melissa Jahnke, Associate Director of Operations, Walker & Dunlop
The Federal Reserve raised interest rates by 75 basis points in June and then by 75 basis points in July, sending shockwaves through the commercial real estate industry. Fortunately, there are options and solutions to circumvent these potential obstacles. Specifically, investors in a segment of multifamily housing known as small balance sheet lending (SBL), which includes properties from five to 150 units, have several options to realize their multifamily portfolio financing aspirations. View a higher resolution version of the timeline above here.
During a recent webcast “Financing Amid Rising Rates: The Best Approaches for Multifamily Loans $1M to $15M,” Walker & Dunlop market experts Allison Williams, senior vice president and chief product officer ; Allison Herrera, senior director of SBL; and Tim Cotter, director of capital markets, talked about navigating today’s funding landscape.
These seasoned professionals have found ways to do deals in a wide range of financing environments and shared their perspectives and guidance. If you’re a five- to 150-unit property owner seeking $1 million to $15 million in loans, the following will help you navigate today’s financial environment and build your momentum.
Step 1: Consider the full range of capital sources
During the webcast, Walker & Dunlop surveyed audience members about the sources of capital they have used. Bank and credit union financing was the most prevalent, with 70 percent of respondents reporting that they had worked with a bank or credit union recently.
This form of capital suits many purposes, such as conventional and construction financing not large enough to interest debt funds. But loans from these highly regulated institutions can come with some disadvantages, such as recourse for part or all of the loan, stricter underwriting requirements and potentially tight availability of capital in the months ahead.
For these reasons, participants in the $1-15 million sector of the multifamily market must expand their options beyond banks and credit unions. The full range of financing sources includes Fannie Mae and Freddie Mac, the Department of Housing and Urban Development (HUD), life insurance companies, and commercial mortgage-backed securities (CMBS).
Here is a brief summary:
Funding of the agency: The United States government created Fannie Mae and Freddie Mac with a mission to provide financing for affordable housing, in good times and bad. This makes their programs less vulnerable to market volatility.
Agency financing is non-recourse, an advantage over many banking options, and execution can be faster if you are familiar with the intricacies and requirements of the program.
Other benefits for SBL multifamily borrowers include:
- Up to 80% loan to value (LTV)
- A relatively low debt service coverage ratio (DSCR)
- Holding interest rates and early locking of interest rates
- A very flexible prepayment structure with cash-out options compared to other government financing programs
HUD Funding: For SBL borrowers with the time for a longer foreclosure process and the resources for extensive post-closing reporting and documentation, HUD financing may be a good fit. HUD programs are known for their attractive interest rates and leverage, which can be higher than the leverage available from Fannie Mae and Freddie Mac. Borrowers can get longer terms, up to 30 years, full amortization and a lower debt service coverage ratio.
HUD finances market-rate properties as well as affordable and rent-restricted housing and has construction programs available as well.
Life insurance companies: While these equity providers are typically known for low-leverage, institutional-quality deals involving leased properties in major metropolitan areas, don’t let that perception limit your thinking. There are loan options of all sizes, including those in the $1 million to $15 million range, and some life companies are open to financing older assets that need upgrades. Additionally, life insurance companies offer many of the advantages of agency financing, such as non-recourse terms and relatively faster and more efficient execution.
CMBS: While these are often considered “financing of last resort” and spreads are currently widening, CMBS can be a good option for:
- Transactions not suitable for agencies or life companies
- A sponsor with a bad credit
- An agreement with a unique attribute
Finally, remember that not all financing needs to be long-term or permanent. Bridging loans of 2-5 years can be a good option for:
- Properties that require additional stabilization
- Rehabilitation of a property after purchase
- Acquiring a property that is not stabilized due to a recent event, such as damage to several units
- Transition to a refinance, permanent loan transaction or a sale
While these loans often have variable interest rates, they may include an interest rate cap for protection. Such loans can be underwritten for pro-forma operating income — the projected cash flow after the property is stabilized and occupied versus where it is today — for more loan dollars for purposes like rehab work.
Step 2: Check what you can
While you can’t control inflation, the Fed, or geopolitical events, there are many elements within an SBL borrower’s power as interest rate volatility continues.
This starts with your existing portfolio. Do you have a loan that you weren’t ready to refinance a few years ago, or a loan with a prepayment penalty on the horizon? Now may be the time to review these scenarios and explore refinancing options.
To get the best leverage and highest possible LTV, consider your net operating income:
- Are your operating expenses as tight as you can make them?
- Are there any unnecessary fees you can eliminate?
- Are you performing maintenance as effectively as possible?
Finally, fix your documentation. Since your goal is to lock in an interest rate as quickly as possible, having the necessary documents on hand speeds up the process.
Throughout the process, consider the maximum rates. For now, these are still at historic lows and not moving in step with the Treasury rate. But today’s strong rent growth is likely to change that situation. As one of the most important drivers for operating income, continued rental growth will help determine where capital rates go. This means that you can close a loan at a much lower rate now than what you end up with at the end of the year.
At the end
Whatever next steps you take, work with an expert. As the market evolves, they will have an updated view of who is lending, how much and under what terms and conditions in the $1 million to $15 million space. Find out more about your options by downloading Walker & Dunlop’s funding guide.
It’s never too early to start. Even if your property is only in the planning stages, an expert partner can track the market, evaluate potential lenders and even help you close on a rate early that is based on your cash flow or anticipated stabilization.
With a comprehensive view of equity options, proactive actions and expert guidance, you can ensure you don’t have to put your multifamily plans on hold. An expert will be able to make sure that 2022 is a year of progress, not a holiday, no matter what interest rates do in the coming months.
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Look at everyone Financing Amid Rising Rates: The Best Approaches for Multifamily Loans $1M – $15M Stream online here and learn more about Walker & Dunlop’s small balance lending capabilities here.