Some Commercial borrowers, especially in multifamily real estate, make some mistakes when estimating the size of a loan for their property. They are light on several areas when underwriting the expenses for a loan. Unfortunately, these mistakes can lead to frustration and potentially kill deals if trying to sell the property. The good news is that most of the time, the mistakes people make fall into one of the following three categories. Learn about them now and you will have an easy time avoiding them later. Management Fees:Just because you self manage doesn’t mean we forget about them. A lot of proforma’s we see with “family” operators that self manage, do not list a management fee on the expense side of the ledger. While, these operators do not charge a management fee to themselves (IMHO, they should) they need to account for it in the numbers for financing. Depending on the market, management fees typically range from 3-5% of collected rents. This 3-5% may not seem like much, but it could be the difference in getting the Loan Proceeds the operator wants. For example: Rents are $400,000 and the market management fee is 4%. That is $16,000 added to the expense side of your pro forma. At a cap rate of 7% that is $228K value haircut. Underestimating the Tax impact on Acquisitions:The Tax Man Always Gets His Cut In this hot market of multifamily transactions, we are seeing many operators selling their properties at very attractive cap rates. One of the main issues we see as we are running the numbers on an acquisition is the underestimating of the new tax liability. In fact, the most of the tax appraisers are on high alert on due to the high volume multifamily transactions considering the market. Lenders will always underwrite to the appropriate tax levels which in a lot of cases cuts loan proceeds. It doesn't matter if the current owner has been getting waivers and suppressing a higher valuation. Once that transaction is in place, the new owner will have a tough time justifying an old value that doesn't exist. Remember, "The Tax Man Always Gets his Cut." Repairs and Maintenance This is a category that some borrowers and “family” operators tend to undervalue on the expense side of things when looking at financing a multifamily loan. When reviewing these operating statements, especially on smaller transactions with "self managed smaller properties", we will often see very light numbers under “Repair and Maintenance.” Most of the time they are under reported because their “Uncle Joe” takes care of all the property repair. From a financing perspective, we typically see lenders underwrite a minimum of $700-$750 a unit in Repairs and Maintenance. For Illustration, a 100 unit property with $750 in underwritten R/M equals 75K in expenses added to the bottom underwritten NOI. If the borrower budget comes in with extremely light R/M numbers, it could spell disaster from a loan sizing perspective. These are just a few scenarios that we see that could potentially cut loan proceeds which can frustrate a borrower. The financing available for an asset can kill a deal if the asset is running light on these expenses. Be sure to check these expenses when determining value of your Multifamily asset. If you would like us to review your proforma, feel free to reach out to us. 1-800-770-9849.
The Benefit of Freddie Mac Small Balance Loan Program If you’re looking to finance an investment into a multifamily property, you should know that back in 2014, Freddie Mac threw its hat in the ring and began offering loans for smaller properties. Whether you’ve been using Banks or other lending options in the past, or you’re new to multifamily home investment altogether, the following will help you understand why Freddie Mac’s SBL Program is such a great option. The Basics of Freddie Mac Small Balance Multifamily Loans This loan was designed to compete head-to-head with Fannie Mae’s small apartment loan program and similar versions offered by large national banks. In the past, Freddie Mac was a go-to option for those who needed more than $10 million, but over the past 3 years the Freddie Mac Small Balance Loan Program has taken off with tremendous success. The Freddie Mac Small Balance Loan will finance multifamily properties investments of between $1 million and $7 million and a minimum of 5 Units.
Who Is the Freddie Mac Small Balance Multifamily Loan For? While anyone is welcomed to apply for the Small Balance Multifamily Loan, it was clearly created for borrowers who were demanding more competitively priced options in their loans. The borrower requirement are: Minimum Credit Score of 640, Net Worth of equal the Loan amount and minimum liquidity of 9 Months debt service payments.
Non-Recourse This is a non-recourse loan. This means that your loan will be secured by the multifamily property as collateral, which is typical. Freddie Mac requires the property to be set up within a “SAE” (single asset entity) such as an LLC. This is a huge advantage to the bank lending which almost certainly require a “personal guarantee” of the mortgage. In other words, with a non-recourse loan, you will have no personal liability except for traditional “bad boy carve-outs” such as; fraudulent acts by the members of the LLC. Flexible Prepayment Options Traditional Agency loans have limited prepayment options and almost certainly will use Yield Maintenance Prepayment Penalty. Yield Maintenance basically means that if you pay it off before the date of maturity the lender is entitled to the same amount of money they would have received had you kept making payments until maturity. The idea behind this loan term is to ensure that a lender doesn’t take a financial hit because of a borrower paying the loan off early. Fortunately for you, this won’t be an issue if you want flexibility on your loan exit. With the Freddie Mac Small Balance Multifamily Loan from you have ability to choose different prepay options, including soft and hard step-down options.
Up to 80% Loan-to-Value Your LTV ratio is the amount your mortgage is for divided by the appraised value of the property. For example, if you were to purchase a property for $2,000,000. The maximum loan amount you could qualify for would be $1,600,000 (2,000,000 X .80). Thus requiring only 20% or $400,000 in Equity to purchase the property. As you can see, with their Small Balance Multifamily Loans, Freddie Mac is willing to take on a substantial amount of risk. The ability to maximize your loan proceeds to 80% will also depend on other factors such as Debt Service Coverage and size of market.
30-Year Amortization Though you probably know this one, the 30-year amortization feature of these loans represents the amount of time your loan payment schedule is set. There will be a balloon payment at the end of your term, but having 30 Year Amortization schedule reduces your monthly payment, thus potentially increasing your cash flow and your IRR. This is serious upside to traditional bank financing who typically run a 20 or 25 Year amortization schedule.
No Replacement Reserves Escrow Most multifamily loans require a replacement reserve escrow which are funds that will be used to pay for periodic building maintenance, like the replacement of certain components that wear out long before the building itself. Typical escrow amounts are $250-$350 per unit annually. While Freddie Mac does not require a Repair Reserve Escrow, the escrow amounts will be underwritten for loan sizing purposes. It is however “deferred” to the borrower. The good news is that you’re not required to set any amount aside for Freddie Mac Small Balance Multifamily loan, but it is wise to set aside reserve amounts to fund for future replacement costs.
Assumable If, for whatever reason, you decide at some point that you want to sell the multifamily property you used this loan to buy, the fact that it’s assumable will help. This simply means that a new buyer could take over the loan from you with little-to-no changes being made to the initial loan including to the interest rate. With interest rates potentially rising in the next few years, this feature should make it much easier to sell the property with “today’s” lower rates. The assumption of the loan is subject to a 1% fee and new borrower approval from the lender.
Cash-Out Refinance Finally, one last reason to consider the Freddie Mac Small Balance Multifamily loan is that you have the ability to do a cash-out refinance. Freddie Mac will not cap the cash out proceeds on a refinance if the property has been owned for 2 or more years. So if you are in an underleveraged loan, you can maximize the loan proceeds and take cash out of your property. These are just a handful of the many reasons Freddie Mac Small Balance Multifamily Loans deserve your attention if you’re looking to purchase or refinance your multifamily property. With the help of a qualified commercial mortgage broker, you could end up with an incredible deal.