Securing a supplemental loan. That is how we will be wrapping up this series of the syndication school episodes.. Without further ado, hit play and learn the next step of the apartment syndication process. 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 am your host, Theo Hicks.
Each week we air two podcast episodes – now video episodes as well on YouTube – every Wednesday and Thursday, that are part of a larger series that’s focused on a specific aspect of the apartment syndication investment strategy. For all of these series we offer some sort of document or resource – whether it be a Microsoft Word document, an Excel template, a PowerPoint presentation template, a PDF – something for you to download for free that accompanies that series. All of these free documents, as well as the Syndication School series can be found at SyndicationSchool.com.
This episode is finally here – it’s part ten of the ten-part series entitled “How to asset-manage a newly-acquired apartment syndication deal.” If you haven’t done so already, I recommend listening to parts one through nine. At the very least, listen to parts one through three; in parts one, two and three we introduced the top ten asset management duties. These are the ten things that you as the asset manager need to do in order to ensure that you are successfully implementing your business plan after closing on the deal.
You’ve put a lot of work into getting to this point, so you wanna make sure that you are implementing the best practices to make sure that you’re actually able to bring the deal full-cycle and sell it at the end, and send a large distribution to your investors, as well as their capital back. That’s parts one, two and three.
Then in parts four through nine we went into more detail on some of those ten asset management duties. In part four you learned how to maintain economic occupancy; in parts five and six we’ve talked about property management companies – in part five how to manage your property management company, and then in part six how to fire them if they aren’t doing what they’re supposed to be doing. In part seven we learned some strategies on how to attract high-quality residents; in part eight we learned some strategies to keep those high-quality residents and retain them at the property. Then in the last Syndication School episode (episode #9) we talked about some of the questions that you might have surrounding sending out the distributions to your investors. We answered eight questions that you might have about sending distributions to your investors.
Now, one of the last things that you might do, that we haven’t talked about already, during the time that you’ve owned the property, is to get another loan on the property. That’s gonna be the focus of this episode.
We’re not gonna talk in extreme detail about refinances, just because the process of getting a refinance is very similar to the process of securing a new loan. So if you wanna learn about that, check out the series on how to secure financing for your apartment syndication deal. But essentially, you’re going to want to refinance your deal if you either did a bridge loan on the deal, so you did a shorter-term, maybe a three-year loan with two one-year extensions, just because you wanted to include the renovations in the loan, and then you knew since you’d be adding value to the property and forcing appreciation you could pull out a large chunk of equity by doing a refinance and then returning that equity to your investors, so giving them their money back sooner… Which increases the internal rate of return based on the time value of money.
Generally, if you do a bridge loan, you’re most likely going to refinance; but of course, if you are doing a bridge loan, you wanna make sure that you’re not forced to refinance, which is where those extensions come into handy. So you wanna make sure that you’ve got a bridge loan that is as close in length to your projected hold period as possible. If you’re planning on holding on to the property for five years, you’re gonna want to get a bridge loan that you could potentially hold on to for five years, which is where that three-year plus one plus one comes in handy… But of course, you also wanna have the ability to refinance if you’ve forced that appreciation because of the fact that you can pull that equity out.
So refinance is one, but the other type of loan you can get on the property instead is a supplemental loan. So the supplemental loan is not something that you’ll get on a bridge loan. Generally, for bridge loans – they’re gonna expire, and once it expires, you’re gonna go ahead and refinance into a permanent loan, like a Fannie Mae or a Freddie Mac loan. But let’s say that you decided that it made more sense to secure a Fannie Mae or a Freddie Mac (agency) loan. Maybe they did or didn’t include some or all the renovations, but you wanted to secure long-term financing so you didn’t have to worry about a refinance, but you still wanna have the benefits of being able to pull out some of that hard-earned equity that you’ve received by adding value to the property. That’s where the supplemental loan comes into play.
A supplemental loan is a multifamily loan – this is the textbook definition – that is subordinate to the senior indebtedness. Essentially, what that means is that it is a loan on top of the existing loan, and it is in second position to that loan. You’ve got your initial Fannie Mae, Freddie Mac debt on the property, and then you get a supplemental loan on top of that; essentially, a second loan on top of the first loan, that is in second position behind that first loan. So you have to pay that first loan first, and then you pay the second loan.
Generally, these are secured 12 months or later after the origination of the first loan, or if you are getting multiple supplemental loans after the supplemental loan. So if you close on the debt January 1st, 2019, then your first supplemental loan is available at January 1st, 2020. Then if you’ve got a second one, and if you actually take it on January 1st, 2020, and you have the option to get a second one, you can get that one January 1st, 2021.
Now, as I mentioned, a supplemental loan is not the same as a refinance. A refinance is a brand new loan. So you’re closing out the previous loan and you’re starting a brand new loan. A supplemental loan is a second loan on top of the existing loan. So you’re keeping the existing loan, you’re still paying that existing person, and then you’re also paying the second loan, which is on top of that first loan… And I guess technically you’re not paying two different parties, because the supplemental loan is going to be serviced through whatever lender you used initially. If you used Fannie Mae, then Fannie Mae will do the supplemental loan. If you did Freddie Mac, then Freddie Mac will do the supplemental loan.
Now, the benefits of a supplemental loan compared to a refinance is going to be lower closing costs. The costs of closing the smaller, second loan with the same company is going to be a lot less than the costs of underwriting a brand new loan for the property.
Also, there is certainty of execution. So you might not necessarily know if you can refinance, you can get that new loan. Obviously, it happens all the time, but there’s not 100% certainty that you’re going to close on this new refinance loan at the exact terms that you want… Whereas for the supplemental loan, there are terms, obviously, but as long as you meet the requirements and as long as it’s 12 months, then you know that you can get that supplemental loan.
Then there’s also going to be a faster processing time, which goes hand in hand with the lower costs, because the process of underwriting a supplemental loan is not as in depth as a new refinance loan, plus it’s the exact same lender.
Now, I guess I should have mentioned this earlier – I’ve kind of already hit on this, but the purpose of getting a supplemental loan is twofold. One, most likely it’ll be to return some capital to your investors without having to refinance, so you can pull out some equity and return that to your investors.
Secondly would be to cover any expense that you need to cover. Maybe you underestimated the amount of money that it’ll cost to fix up the property, or for some reason you need some money to invest back into the property and a supplemental loan is a great way to get that capital without having to do a capital call.
As I mentioned, the supplemental loan will be secured through the same provider as the original loan. So if you went through Fannie Mae for your first loan, well, your supplemental loan will be through Fannie Mae; same for Freddie Mac.
Now, Freddie Mac and Fannie Mae are the main two ones we’ll talk about. They have some specific terms for their supplemental loans that I’m going to go over relatively quickly. I’ll differentiate between the two when there are differences, because they’re pretty similar.
So the terms can be between 5 and 30 years. For Fannie Mae, the loan size minimum is $750,000, and the minimum for Freddie Mac is a million dollars, so these are pretty big supplemental loans that you’re doing on larger properties. If your property is only worth $750,000, then you’re most likely not going to be getting a supplemental loan, or a Fannie Mae loan in general.
Both can be amortized up to 30 years. Both expect to have an interest rate on that loan that’s around 100 to 125 basis points above whatever the going market interest rate is. So 100 to 125 would be 1% to 1.25% higher.
The LTV for Fannie Mae is up to 75%, and the LTV for Freddie Mac is up to 80%. What that means is you’ve got a property that’s worth – let’s use easy numbers – 100 million dollars; then Freddie Mac is going to loan up to 80 million dollars on that property. And Fannie Mae is willing to lend up to 75 million dollars on that property. But that includes the original loan. So if you’ve got a Fannie Mae debt, and let’s say you still owe 70 million dollars, so you still hold debt worth of 70 million dollars, then your supplemental loan can be up to 5 million dollars. Or for Freddie Mac it could be up to 10 million dollars, to equal that 80 million or that 75 million dollars.
So it’s not like they’re gonna give you 75% of the property value; I guess technically they’ve already given you some money, it’s just they’ll give you more up to a certain percentage of the cost, which means that you need to have at least a certain amount of equity in that property at all times.
Debt service coverage ratio for the Fannie Mae will be a minimum of 1.3%, and 1.25% for Freddie Mac. So if you’re getting multiple supplemental loans, then it will include the previous supplemental loan as well, when they’re doing that debt service coverage ratio calculation. Both Fannie and Freddie Mac are offering non-recourse with the standard carve-outs. The timing is 45 to 60 days within the application. Then the cost for Fannie Mae is about $10,000 application fee, 1% origination fee, and then between 8k to 12k in legal fees.
The difference between Fannie Mae and Freddie Mac is that the application for Freddie Mac is a little bit higher – 15k. And then they actually have another application fee, which is the greater of 2k or 0.1% of the loan amount. Plus, you’ve got the 1% origination fee and then the same 8k to 12k in legal fees. As I mentioned, typically you’re going to take this capital and return it to your investors, or use it to reinvest into the property.
The last thing I wanted to talk about when it comes to supplemental loans is how you actually secure the thing, logistically… So what specifically do you do once it’s time to go out and secure that loan. As I mentioned, you can request it after 12 months. Once the loan has seasoned for 12 months, you can start the process of applying for a supplemental loan.
So you’re gonna reach out to whoever provided you with the original loan, whether the mortgage broker or you work directly with Fannie Mae or Freddie Mac… And you wanna ask them what they need in order to size out a supplemental loan, that is to determine how much money you can get from the supplemental loan. Typically, the four things that they’re gonna wanna see is a trailing 12-month operating statement, so your profit and loss statement for the last 12 months, they’re gonna want the year-end operating statement for the most recent full year, they’re gonna want a copy of a current rent roll, and they’re gonna want a list of all of the capital expenditures that you invested into the property since you bought it.
Once they have that information, the process is essentially similar to a regular loan, except not as in-depth. So they’re gonna do an appraisal, and then they’re gonna do what they call a physical needs assessment, which is effectively a property condition assessment – a detailed inspection of the property. They’re gonna use that to essentially determine the value of the property, and then based off of whatever their loan requirements are, they can determine the size of the supplemental loan. At that point, you’ll get the money.
One last thing is that you’re gonna wanna also ask your mortgage broker or lender, whoever provided you with the original loan, if you can get supplemental loans, and if you do, how many you can get… Because sometimes you can get more than one. Every 12 months you can just continuously pull out equity and get another supplemental loan and continuously distribute capital back to your investors, which again, helps with that internal rate of return.
And that’s it for the supplemental loan, and we also talked about the refinance as well… And that is it for this ten-part series, which is how to asset-manage a newly-acquired apartment syndication deal.
Now, next week we’re going to, in a sense, conclude the apartment syndication cycle with the sale of your property. Then from there, as I mentioned yesterday, we’re going to kind of go back through the process and talk about some of these steps in a little bit more detail, and cover really anything else that we missed and anything else that you needed to know in order to learn the how-to’s of apartment syndication.
Until then, I recommend listening to parts one through nine of this series; listen to one of the other 19 syndication school series we’ve done thus far. Check out the free document for this series, which is that weekly performance review template that you will send your management company to make sure that you’re hitting your KPIs at the property. All that can be found at SyndicationSchool.com.
Thank you for listening, and I will talk to you next week, when we will conclude the cycle with the sale of your property.