Welcome to Everything About Wealth podcast 4, Financing Options for Multifamily Real Estate.
On this podcast, we have a commercial mortgage broker with us to discuss several finance options to buy multifamily property. This episode is great for syndicators buying multifamily properties and of course, capital / passive investors who want to have a better idea of how loan programs may affect your return on investment. I have seen investors get excited when they see $100,000 of profit but, quickly become disappointed when the mortgage payments eat up most of the cash flow. Depending on the terms, an annual mortgage payment can be $60,000-$100,000 or more. Remember, you must analyze the returns after the mortgage payment has been accounted for to really understand the true cash-flow of a property.
Now let’s get to the good part which is our guest Paul Winderowd. Paul is a commercial mortgage broker with Bonneville Multifamily Capital. Although the company focuses on loan programs for a variety of commercial properties, Paul’s primary focus is multifamily financing. Paul Winderowd specializes in three areas of financing which include HUD/FHA, Fannie Mae, and Freddie Mac. Additionally, he works with bridge capital financing which we will discuss on a future call. Paul has helped me in the past with refinancing a multifamily property in our portfolio and it was a pleasant experience working with him. That is why I asked him to come on the podcast today to help educate all of us a little more about the financing process.
As an active investor, I know there are a lot of lending options in the marketplace which can be confusing when deciding the best lending options for your investment. So, we hope today’s podcast with Paul will help put the pieces of the puzzle together.
One of the first loan programs we will discuss is the HUD program, which essentially are FHA programs administered by government. There are a dozen of different programs to choose from, but the two common ones are 221D4 for new construction and 223F program for existing property.
Many developers prefer the 221D4 program when building multifamily properties. This type of loan works well due to the terms associated with the loan. The program is a construction to permanent loan, meaning you obtain one loan and your done. Unlike other construction loans that require you to get a separate loan after the construction is completed. The HUD loan is 42-year loan with 2 years for construction and then it rolls into a 40-year term and amortization loan. The loan terms and amortization stay fixed for the entire duration of loan. New development investors benefit from these loans because the developer and investor know exactly what they're getting into and don’t have to worry about the refinancing the loan and/or interest rates going up for the life of the loan. It eliminates a lot of risk in development.
The second common HUD loan is the 223F. This program is primarily used for the acquisition of multifamily. This program is a fixed thirty-five year term and amortization with no balloon. This loan is very secure and safe because there is no refinance risk during a downturn or unfavorable turn in the market. The only factor to keep in mind for this loan is that it can be a little tricky when it comes to the loan closing process. It takes much longer than your typical loan programs which can typically take around 45-60 days. The permanent HUD loan can take between six months to a year to close. So why is the loan process so long for this program? The short answer is that working with a government agency can take longer due to their own processes. As with many companies, when it comes the government you’re really working on their timelines.
Another factor to keep in mind with the HUD programs are higher capital reserve requirements. The program requirement is higher than Fannie Mae, Freddie Mac, and other conventional banks. Replacement reserves for Freddie is straightforward at $250 per door per year. For HUD properties, the capital reserves can range from $500-$600 per door per year. The reason the requirements are higher is due to length of the loan. They want to be sure owners will be able to maintain the property in good operational and functional standing over the period of the loan.
Lastly, but not least because it deals with the most important factor of owning a piece of real estate; distributions. For any loans, it is essential to understand how often a sponsor or owner can process distributions, which means paying yourself out from the account. Banks have different requirement for each loan. For example, with HUD, the loan only allows distributions every six months. That means you can only pay out funds from operations top yourself and other investors twice a year so, you must plan accordingly. You will want to be sure you are operating the property efficiently because HUD can also stop distributions if it is not. When using Fannie or Freddie, distributions are more flexible ranging from monthly to quarterly.
A benefit of HUD programs is that both are non-recourse which helps mitigate personal risk. Non-recourse means there is no personal guarantee because the property acts as the collateral. Of course, there are bad boy carve outs. This means there are exceptions to non-recourse in a case fraud is committed or the property is grossly neglected. If you operate with full transparency and do your best with the operations, the only risk is foreclosure of the property and maybe a hit to your credit. The default rate for this program is almost non-existent. Over the years, there were only 14 out of 11,000 loans foreclosed on.
As of January 2019, the interest rates of each program vary depending on the financing, leverage, location, and structure. For companies such as Paul’s company, Bonneville Multifamily, rates on HUD 223F, permanent financing are around 4.25% and rates for HUD 221DF new construction, are around 4.75%-4.85%. With Fannie and Freddie, the rates can range around 5%, with 30 basis point depending on structure including MIP. Of course, remember the term and amortization range from 35-42 years. Remember interest rates fluctuate with market conditions.
Most conventional bank loans have amortization terms of 5 years, with a 25-year amortization period. After five years there is a reset, also known as a rate adjustment or balloon. This means the interest rate may increase and/or a refinance with new terms is required. Loans with shorter amortizations or terms may work for investors that want to resell or recapitalize the property within a 3-5-year timeframe.
To get approved for one of the programs, there are credit, net worth, and liquidity. In general, HUD has lower requirements than some banks or insurance companies. Fannie and Freddie Mac credit standards are disclosed in advance and a good benchmark to use for the other loan programs. The credit requirements are usually above 680; net worth which includes all your assets and liabilities will usually be equal to the loan amount. So, if you're looking for a $2,000,000 loan, your net worth will need to be around two million dollars. The net worth can be a combined number between multiple sponsors. So, if there are two or three sponsors on the deal, if one of the sponsors has a net worth of a $1,000,000 dollars and another two may have 500,000, together they would qualify for the $2,000,000 net worth requirement.
Lastly, lenders may review the liquidity or cash-on-hand. Fannie and Freddie like to see nine months of principle and interest payments post close after equity contributions. Additionally, lenders will review equity contributions to verify sponsors will have additional funds on the sidelines. They don’t want sponsors using all their funds to purchase real estate and then are not able to maintain the property in the case of an emergency. A safe metric to calculate the liquidity requirement is to have 10% of the loan amount in cash. The liquidity information is usually verified on a personal financial statement and by reviewing tax information.
With any process, we highly recommend shopping different lenders to see what programs will benefit the structure of the investment the best. There are lenders and loan programs that have a certain threshold of value when lending on a program, for example, Fannie and Freddie focus their loan programs with properties valued around $1,000,000 or more. If you are looking to purchase smaller properties, then shopping with other banks may be a better option for you. Also, verify the cost associated with each loan program to find the better fit. As I have seen, HUD programs have higher fees than other loan programs which must be accounted for. For a long-term investment it is worth considering due to the flexibility with renovations and great loan terms. When pursuing shorter investment strategies Fannie, Freddie and smaller banks may be better to finance multifamily properties.
One of the last questions I asked Paul on the phone call was what type of recommendations he would give someone looking for a good lender or terms. You want to find a lender that wants to work with your investment strategies and has your best interests in mind. When comparing lenders understand how their terms may affect the property’s cash flow and returns. Lenders may cost you $1,000 - $5,000 a month in cash flow due to shorter amortization schedules. Or require for you to put additional capital in a deal that you could use to buy another deal which could add another $3,000-5,000 a month or more. Keep in mind, mortgage brokers and banks typically earn 1% of the loan amount and depending on the loan, may have an additional origination fee with construction programs.
Thanks for joining us on this podcast - we appreciate Paul’s insights. If you're in need of a mortgage broker, I highly recommend reaching out to Paul Winderowd. The best way to reach Paul is by email at paul@bmfcapital.com. In case you want to give him a shout, his phone number is 801-323-1050 or 813-231-0504.
Remember to stay tuned on our next episode with Paul that covers how to use bridge capital financing to buy multifamily properties.
Books Mentioned on the Call The Compound Effect Warren Hardy
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