We’ve covered the two different types of debt (recourse and non-recourse) in part one of this series. Theo talked about the two most popular forms of financing and the most popular agency debt available. Today, we’ll hear about the other loans that are available to finance your apartment syndication deals. If you enjoyed today’s episode remember to subscribe in iTunes and leave us a review!
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Joe Fairless: There needed to be a resource on apartment syndication that not only talked about each aspect of the syndication process, but how to actually do each of the things, and go into it in detail… And we thought “Hey, why not make it free, too?” That’s why we launched Syndication School.
Theo Hicks will go through a particular aspect of apartment syndication on today’s episode, and get into the details of how to do that particular thing. Enjoy this episode, and for more on apartment syndication and how to do things, go to apartmentsyndication.com, or to learn more about the Apartment Syndication School, go to syndicationschool.com, so you can listen to all the previous episodes.
Theo Hicks: Hi, Best Ever listeners. Welcome back to another episode of the Syndication School series, a free resource focused on the how-to’s of apartment syndication. As always, I’m your host, Theo Hicks.
As you know, each week we air two podcast episodes that are typically a part of a larger podcast series that’s focused on a specific aspect of the apartment syndication investment strategy. For the majority of these series, we will be offering a document, spreadsheet, some sort of resource for you to download for free, that accompanies that podcast series.
All of these free documents, as well as the free Syndication School podcast episodes can be found at SyndicationSchool.com.
This episode is going to be a continuation of last week’s series. This is going to be part three. That series is entitled “How to secure financing for an apartment syndication deal.” Just for a refresher, if you haven’t done so already, I recommend listening to parts one and two. In part one we first discussed the two different types of debt – the recourse and the non-recourse. We described those, and the pros and cons of each.
We also discussed the loan guarantor or the key principal – the person who signs on the loan. We talked about the requirements of the loan guarantor to qualify for the loan, as well as how to compensate that person or group of people if you yourself are not able to fulfill that loan guarantor role. Then we introduced the two main categories of financing, which are the bridge loans and the permanent loans, with the bridge loan being the shorter-term loans, and the permanent loans being the set-it-and-forget-it loans.
Then in part two we began to discuss some of the top loan programs out there that apartment syndicators use on their apartment deals. The first two that we talked about – or I guess the only two we talked about – in part two was the Freddie Mac loan programs and the Fannie Mae loan programs. Those are the two agency loans; those are permanent loans, but they also offer some renovations loans as well… Technically, it could be considered a bridge loan. But if you want the characteristics of those loans, I recommend listening to part two.
We are also giving away a free document for this episode, which is going to be the Top Loans Program Matrix. It’s a spreadsheet that has the top loan programs, and it describes the loans and goes through some of the loan terms, as well as the pros and cons.
Now, in this episode, part three, we are going to finish up discussing some of the top loan programs that apartment syndicators use on their deals, and then we are also going to discuss what types of information you’re going to need to provide to the lender in order to secure financing for your deal.
Now, keep in mind thus far in the Syndication School series we’ve essentially gone in chronological order of how to complete a syndication, so at this point you should have a deal under contract. This is when you are now going to work three different things. Number one is securing the loan, number two is performing due diligence, and number three is securing commitments from your investors. This series, as I’ve mentioned, is focusing on number one, securing the loan, and then in the next two podcast series we’ll talk about due diligence, as well as how to secure the money from your investors.
Continuing with the top loan programs… Another top loan program – or common loan program – that you might come across is HUD. Those are government loans, and there are really two loans that you will secure, that we’re gonna discuss in this episode, and then we’re also gonna talk about the loans that they have for refinances, as well as the supplemental loans.
The first loan, which is the permanent loan, would be the 223(f). It’s gonna be very similar to the agency loans, except for one major difference, which is the processing time. Plus, the loan terms are actually a little bit longer.
For the 223(f) the loan term is going to be lesser of either 35 years or 75% of the remaining economic life. So if the property’s economic life is greater than 35 years, then your loan term is actually going to be 35 years, and it’ll be fully amortized over that time period. So whatever the loan term is is what the amortization rate will be.
Loan size – the minimum is going to be one million, so if you’re dealing with a smaller apartment community under the one million dollar purchase price, then this is not going to be the loan for you.
In regards to the loan-to-value (LTVs), they will lend up to 83.3% for a market rate property, and they will also lend up to 87% for affordable. That’s another distinction of the Housing and Urban Development loans, which is they are also used for affordable housing.
There’s going to be an occupancy requirement, like most of these loans. They define it as stable occupancy for six months. The assumption is that’s around 80% to 90%.
The interest rate will be fixed for this loan, and then you will have the ability to include some repair costs using this loan program. For the 223(f) loan you can include up to 15% of the value of the property in repair costs, or $6,500/unit. If you’re doing not necessarily a minor renovation, but if you’re spending about $6,500/unit – overall, so that’s not just for the interiors, but overall – then you can include those in the loan.
For the pros and cons based on what I’ve just mentioned, the pros for this loan is that they have the highest LTV. Again, you can get a loan where you don’t have to put down 20%. You can actually put down less than 20%. It also eliminates the refinance, as well as the interest rate risk, because it is a fixed rate loan, and the term can be up to 35 years in length. So you don’t have to worry about refinancing, or the interest rate going up, if something were to happen in the market.
Like most of the loans we’ve discussed, these loans are non-recourse, as well as assumable, which helps with the exit strategy.
Number four, another pro is that there’s no defined financial capability requirements, no geographic restrictions and no minimum population. So there’s no limitation on them providing you a loan for a deal if the market doesn’t have a lot of people living in it, or the income is very low, things like that.
Also, supplemental loans are available, and we’ll discuss that here, later on in the episode. Then as I mentioned, funds are available for renovations.
Now, the list of cons/drawbacks or things to think about when you’re considering a HUD loan is… Number one, as I mentioned, the longer processing times. The time from contract to close is at minimum 120 days, and 6 to 9 months is actually common… Whereas if you remember for the Fannie and Freddie debt, those processing times are between 60 and 90 days.
So these loans take a little bit longer to process. They also come with higher fees. You’ll also be required to pay mortgage insurance premiums, and they are also going to be annual operating statement audits. That is the most common HUD loan, the 223(f).
The other one is the 221(d)(4). These are for properties that you either want to build, so these loans can be secured for development… Or if you wanted to substantially renovate an apartment building, then this would be an ideal loan for you. Similar to the 223(f) loan, these do have very long terms. The length of the loan will be however long the construction period is, plus an additional 40 years, and that is fully amortized.
Now, this isn’t for smaller deals, because the minimum loan size is going to be five million dollars. If you have a deal that you want to renovate and it’s got a one million dollar purchase price, you’re going to have to look at some other options.
Similarly, this is for market rate properties, as well as affordable properties; the same LTVs of 83.3% and 87% respectively. These loans are also assumable and non-recourse, as well as fixed interest rate, with interest-only payments during the construction period.
Now, the cap ex requirements are essentially the opposite of the 223(f). For the 223(f) it was up to 15% or up to $6,500/unit, whereas for the 221(d)(4) loan it actually needs to be greater than 15% of the property value, or greater than $6,500/unit. Again, these are for — not necessarily heavy renovations, but these are for properties that you need to invest a good amount of money into to stabilize.
Now, some of the pros and cons – again, they’re pretty similar to the 223(f) pros and cons. You’ve got that elimination of the refinance and interest rate risk because of that fixed rate and a term of up to 40 years. They’re also higher-leveraged than you traditional sources. Again, you can put down less than 20% in order to secure this loan. And they are non-recourse and assumable, which will help you on the exit.
The cons are, again, those longer processing time and closing times. There’s gonna be higher fees, and you also have those annual operating audits and inspections.
Now, HUD also offers refinance loans, as well as supplemental loans for their loan programs. Their refinance loan is called the 223(a)(7). Essentially, once you secured the either 223(f) loan or you secured a 221(d)(4) loan, you’re able to secure this refinance loan. So it has to be one of those two; it can’t be going from a private bridge loan to this refinance loan. That’s now how it works.
So the loan term for the refinance loan is up to 12 years beyond the remaining term, but not to exceed the term. That means if your initial term was 40 years and you refinanced at 30 years, then this refinance loan will only be ten years, because it can’t be greater than 40 years. For the loan size, it’s either the lesser of the original principal amount from your first loan, or a debt service coverage ratio of 1.11, or 100% of the eligible transaction costs.
These loans are also fully amortized, and the occupancy requirements are going to be the same as the existing terms for the previous loan. These are also going to be assumable and non-recourse, with that fixed interest rate.
Now, they also have the supplemental loan program available, which is the 241(a). Again, these are if you already have a HUD loan, so that 221(d)(4) or that 223(f). I wanted to take a step back and talk about what a supplemental loan is… First, let me discuss the actual terms of this loan, and then we’re gonna discuss overall what a supplemental loan is and how you actually secure a supplemental loan.
The loan term is coterminous with the first loan. Whenever you acquire it, it’s just going to be the length of the remaining loan, so you’re essentially just adding a million dollars to five million dollars to your existing loan.
The loan size can be up to 90% of the cost of the property, so essentially a 90% LTV. So you need to have at least 10% of equity in the property at all times. It’s gonna be fully-amortized, again… They’re also gonna base the loan size on a debt-service-coverage ratio, so it needs to be 1.45. Again, that’s the ratio of the net operating income to the debt service. And then the minimum occupancy requirements are going to be the same as whatever the terms are for the existing loan. Like all the loans, they’re assumable, they are non-recourse, and the interest rate is fixed.
Now, what is a supplemental loan? If you don’t know what that is – it is a multifamily loan that is subordinate to the senior indebtedness. So that means that it is positioned behind the original loan. Typically, the supplemental loan can be secured after 12 months from the origination of the original loan, or sometimes you can get multiple supplemental loans. If that’s the case, then it must be 12 months after the origination of the first or the most recent supplemental loan.
A supplemental loan is not the same as a refinance, because for refinance you’re getting a brand new loan, whereas for a supplemental loan you’re effectively getting just a second loan in addition to your existing loan.
The benefits of getting a supplemental loan compared to simply refinancing is there’s going to be a lower cost associated with it. Going through the process of getting a brand new loan is more costly than the cost of going through the process of securing a supplemental loan. There’s also the certainty of execution. You might not necessarily know if you’re gonna be able to actually secure the refinance once you actually buy the property, because you don’t necessarily know what the market is gonna be like, whereas you’re gonna know upfront when you can secure a supplemental loan, and how much you’re gonna be able to get with a supplemental loan.
Then the processing time is a lot faster, because again, you’re not going through the process of being qualified by a new lender or the same lender for a new loan.
Generally, I guess this is a requirement – the supplemental loan must be secured from the same debt provider as the original loan. So if the original loan was Fannie Mae, the supplemental loan comes from Fannie Mae. Same with Freddie Mac, same with HUD.
I believe in the first two episodes — I believe in the previous episode we discussed the top loan programs. When I discussed the top loan programs and we talked about Fannie and Freddie Mac, I believe I discussed the terms of the supplemental loans.
Now, how do you actually secure a supplemental loan? I know we’re kind of getting ahead of ourselves, because at this point we just have a deal under contract, and you’re not necessarily securing a supplemental loan until after the deal is purchased… But essentially, you’re able to request the supplemental loan any time after your original loan has been seasoned for 12 months. So 12 months and one day is when you’re able to secure that first supplemental loan. And in order to do so, you reach out to your mortgage broker or the lender, whoever provided that original loan, and ask them what they need from you in order to underwrite and size out a supplemental loan.
Typically, they’re gonna want a trailing 12 months operating statement (T12), they’re gonna want the year-end operating statement of the most recent full year, they’re gonna want a current rent roll, and they’re gonna want a list of the capital expenditures that you invested into the property since acquisition.
At that point, they are going to perform an appraisal, as well as what they call a physical needs assessment, which is essentially a property condition assessment, which – you don’t know what that is yet, because we haven’t talked about that yet, but essentially it’s an in-depth inspection of the property, with recommendations for what you need to do, as well as the costs. That’s what they use in order to determine the size of the supplemental loan.
You’re also gonna want to ask your broker or your lender upfront how many supplemental loans you’re able to actually get, and then how long you need to wait between those two loans. For some deals you can just get one supplemental loan, others you can get two, others you can get more than two. So that’s essentially all you need to know about the supplemental loan.
Something else I wanted to go over as well, because I kept mentioning assumable loan… I just wanted to discuss what that means, as well as the pros and cons of the assumable loan.
An assumable loan – I guess it’s kind of self-explanatory, but if you’re buying a property and the loan is assumable, that means that you can just take over the loan at those existing terms. And if you’re selling the property, then a buyer can take over the property with the same loan, at the existing terms.
Again, for most things there’s not really any absolute pros and cons, or benefits and drawbacks; it really is based on the buyer’s financials, their experience, the terms of the existing loan, the type of the existing loan, the market conditions, the person’s business plan… So there’s a lot that goes into it, but just high level, these are some of the potential pros and cons of assuming a loan.
Some pros – obviously, time-saving. An assumable loan can be approved in as little as 30 days, maybe even sooner, whereas some of these loans can take up to 9 months (HUD loans) to finish and be secured.
Next is money savings. Since the loan process for the assumable loan is shorter and requires less documentation, the costs are also going to be lower. There’s the opportunity for better terms, because if you’re buying a property and the current terms in the property are better than the market terms, then your debt service is going to be lower, and therefore your cash-on-cash return is going to be higher.
Maybe there’s a lower interest rate, maybe it’s a fixed interest rate, whereas you can only qualify for a floating interest rate… Maybe the term is longer than you can qualify for, maybe it’s non-recourse and you can only qualify for recourse… There’s lots of different ways that the terms can be better. We’ll talk about the opposite side of that in the potential cons.
Next, it could be a lower down payment. When a buyer assumes the loan, the down payment is equal to the difference between the amount owned in debt and the sales price, so essentially the equity. So if the owner doesn’t have a lot of equity in the deal, the down payment may be lower than the down payment of a new loan.
And then five, you can just make the deal more attractive. If you yourself are selling your property and you have an assumable loan, because of those potential pros that I just went over, your deal might be more attractive to other people… Whereas if they had to secure a brand new loan and the interest rates are really high, then they might not be able to buy your property at the price that you want.
Now, for the potential cons — and in reality, the reason why I call these “potential” is because all of those pros can be cons as well. The approval process might actually be longer if the current loan is overly complicated. So it could take longer to secure this assumable loan than it would be to get a brand new loan.
Also, there’s another potential con – you’re only dealing with one lender. The buyer – either you, or a buyer of your property – who’s assuming the loan is really forced to work with that one lender that holds the debt, so that could be a potential con.
The pro could be a lower down payment, but it could also be a higher down payment if the owner has a lot of equity in the deal. There could also be worse terms, if the market was worse when the current owner or you secured the loan, than it is in the current time.
And then lastly, you might not even qualify for the assumption, or the buyer might not qualify for the assumption. Lenders have pretty broad discretion when qualifying a buyer for an assumable loan. For example, they are gonna want the buyer’s financials and experience to be similar to those of the owner. If that’s not the case, if the owner is very experienced and the buyer isn’t, then they might not be able to qualify for that loan assumption.
Overall, because of these potential cons, make sure that if you’re a buyer and you are under contract with the financing being the assumable loan, make sure you have a financing contingency in place in your contract, as well as a few lenders on back-up just in case you don’t qualify for that assumption.
I should have covered the assumable loan, as well as the supplemental loan in the last episode, but I covered them now, so we got that out of the way and you know generally how to approach supplemental as well as assumable loans.
Now, the last three top loan programs I wanted to discuss quickly are the CMBS (commercial mortgage-backed securities), the traditional bank loans, as well as loans from life insurance companies.
For the CMBS loans – these are essentially for loans that don’t fit into that agency box, that Fannie or Freddie box, or that require maybe faster closing times, or maybe you don’t wanna have a lot of red tape, or things that are more focused on the property income than the borrower, or the current condition of the property, then the CMBS financing might be the ideal loan for you.
Loan terms are 5, 7 or 10 years. Loan sizes are a minimum of 3 million dollars. The pros and the cons of the CMBS loan… Pros – it’s non-recourse. There are attractive fixed rates for the relatively longer-term loans. The loan size – there’s a wide range of loan sizes, so there’s no maximum loan size. And then you also have the ability to do a cash-out refinance with the CMBS loan.
The cons – there’s less autonomy in the operation of the property, and limited flexibility to deviate from the terms of the loan documents. These loans have lots of structural requirements for what you do with the property than other loans. There’s also difficulty in releasing collateral. They are expensive to exit (high pre-payment penalty), and taxes, insurance, replacement reserves and leasing costs reserves are required for those loans.
Next is the traditional bank loan, like getting a loan from PNC for your property. If you wanna know the loan terms for those, check out that top loan program document. The pros will be that they will do smaller loan amounts. The minimum for this is 2 million dollars, and there really is no ceiling. They can finance distressed assets, so again, more flexibility on the entrance, and the closing time is faster than that of agency debt.
The cons – occasionally more rigid down payments, income verification and credit score requirements. The max LTV for a traditional bank is 75%. Sometimes the loans are going to be recourse, so they’re not necessarily going to always be non-recourse. The amortization period may be shorter, and the fixed interest rate times might be shorter than CMBS, than agency loans. They’re also stricter with cash-out refinances. For traditional banks, it can really be all over the place. It really just depends on the bank.
And then lastly, our life companies. Life companies offer an interesting alternative to Fannie and Freddie Mac financing. They have longer loan term options, and as they say, “exceptionally competitive rates.” Loan terms are 10 to 25 years or longer than agency. Loan size is a minimum of two million dollars.
Some of the other pros for the life company loans – they will consider loan modifications or special requests during the loan term. So you can kind of go back and negotiate the terms of your loan throughout your hold period, rather than being something that doesn’t change from day one. And then they’re also non-recourse.
The cons – they tend to be less aggressive on max dollar deals. These are better for relatively smaller deals. They tend to focus on just higher asset classes, so not necessarily good for C or D class properties… And they’re less likely to do cash-out refinances.
That’s the conclusion of the top loan programs. As I mentioned, you can download that free top loan program document and you can review all of the pros and cons, as well as the terms that I discussed in part three, this episode, as well as part two, the previous episode.
Now, we’re gonna stop there for today. I know I said at the beginning of this episode that we were going to talk about the documents and information you need to provide to the lender in order to qualify for your loan. We are going to discuss that in the beginning of tomorrow’s episode, as well as also talk about how to select your ideal loan based off of our discussions in parts one through three.
In the meantime, I recommend listening to some of the other Syndication School series, where we focus on the how-to’s of apartment syndications. Make sure you download that free Top Loan Programs document at SyndicationSchool.com. Or for the Top Loan Programs document – you can also download that in the show notes of this podcast episode.
Until next time, thank you for listening, and I will talk to you tomorrow