By Melissa Jahnke, Associate Director of Operations, Walker & Dunlop
The Federal Reserve raised interest rates by 75 basis points in June and then another 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), covering properties from five to 150 units, have several options to realize their multifamily portfolio financing aspirations. See a higher resolution version of the timeline above here.
During a recent webcast, “Financing Against Rising Interest Rates: Best Approaches for $1M-$15M Multifamily Loans,” Walker & Dunlop market experts Allison Williams, senior vice president and chief product officer; Alison Herrera, SBL Senior Director; and Tim Cotter, Director of Capital Markets, talks about navigating today’s financial landscape.
These seasoned professionals have found ways to execute trades in a wide variety of financial environments and shared their perspectives and guidance. If you are a property owner of five to 150 units that require loans between $1 million and $15 million, 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 polled audience members about the sources of capital they use. Bank and credit union financing was the most common, with 70 percent of respondents reporting that they had recently worked with a bank or credit union.
This form of capital is suitable for many purposes, such as conventional and construction financing, which is not large enough to interest debt funds. But loans from these highly regulated institutions can come with some drawbacks, such as recourse for part or all of the loan, stricter underwriting requirements and potentially tighter capital availability in the coming months.
For these reasons, players in the $1 million to $15 million multifamily market need to expand their options beyond banks and credit unions. The full range of funding 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’s a quick overview:
Agency funding: The United States government created Fannie Mae and Freddie Mac with the mission of providing 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 implementation can be faster if you are familiar with the ins and outs and requirements of the program.
Other benefits for SBL multifamily borrowers include:
- Up to 80% loan to value (LTV)
- Relatively low debt service coverage ratio (DSCR)
- Interest rate retention and early interest rate lock-in
- Fairly flexible prepayment structure with withdrawal options compared to other government funding programs
HUD Funding: For SBL borrowers with a longer turnaround time and resources for extensive reporting and documentation after closing, HUD financing may be appropriate. 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.
Life insurance companies: While these capital providers are typically known for low-leverage, institutional-quality deals involving well-rented 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 insurance companies are open to financing older assets that need improvements. In addition, life insurance companies offer many of the advantages of agency financing, such as non-recourse terms and relatively faster and more streamlined execution.
CMBS: Although they 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 insurance companies
- Credit Impaired Sponsor
- A transaction with a unique attribute
Finally, remember that not all funding needs to be long-term or permanent. Bridging loans of 2-5 years can be a good option for:
- Properties requiring additional stabilization
- Rehabilitation of property after acquisition
- Acquiring a property that is not stabilized due to a recent event such as damage to some of the units
- Transition to refinancing, permanent loan deal or sale
Although these loans often have floating interest rates, they may include an interest rate cap for protection. Such loans can be guaranteed for pro forma operating income — the projected cash flow after the property is stabilized and occupied compared to where it is today — for more loan dollars for purposes such as rehab work.
Step 2: Control what you can
While you can’t control inflation, the Federal Reserve, or geopolitical events, there are many elements within the SBL borrower’s power as interest rate volatility continues.
This starts with your existing portfolio. Do you have a loan that you weren’t quite ready to refinance a few years ago, or one with a prepayment penalty on the horizon? Now may be the time to revisit these scenarios and explore refinancing options.
To get the best leverage and highest possible LTV, review your net operating income:
- Are your operating costs as low as you can make them?
- Are there any unnecessary fees you can eliminate?
- Are you performing maintenance as efficiently as possible?
Finally get your paperwork right. Since your goal is to lock in an interest rate as quickly as possible, having the necessary documents on hand speeds up the process.
During the process, take into account the limits. They are currently still at historic lows and out of step with the Treasury’s interest rate. But today’s strong rent growth is likely to change that situation. As one of the most significant bottom line boosters for operating income, continued rent growth will help determine where the top lines go. That means you could close on a loan at a much lower cap rate now than you’ll get at the end of the year.
Whatever next steps you take, work with an expert. As the market evolves, they will have an up-to-date view of who is lending, how much and on what terms in the $1 million to $15 million space. Find out more about your options by downloading the Walker & Dunlop 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 lock in an early rate that is based on your cash flow or projected stabilization.
With a complete overview of capital options, proactive actions and guidance from experts, you can be sure you won’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 pauses, regardless of what interest rates do in the coming months.
Walker & Dunlop is a content partner of REBusinessOnline. For more articles and news about Walker & Dunlop, click here.
Watch the whole thing Financing Amid Rising Interest Rates: Best Approaches for $1M-$15M Multifamily Loans webcast here and learn more about Walker & Dunlop’s small balance lending options here.