This piece by Rob Beardsley was originally published on Lone Star Capital.
Secret #1: You can get an agency loan for your first multifamily deal.
Although agency lenders are typically looking for 2 years of multifamily ownership experience in the market you’re looking to acquire the property, they are often more flexible on this requirement in practice. With the right narrative and financial wherewithal, a first-time borrower would have no problem in getting an agency loan. The loan signers must have combined net worth equal to the loan balance and combined liquidity (cash, stocks, bonds) between nine months of debt service and 10% of the loan balance.
What’s more, a first-time borrower can use a guarantor on the loan to satisfy the lender’s experience, net worth, and liquidity requirements. With a guarantor, a borrower could have no prior real estate experience, $0 net worth, and $0 liquidity and still close the deal. As long as the loan is non-recourse and the deal underwrites well, there are groups, including Lone Star, who can and will cosign loans for emerging sponsors.
Secret #2: Agency lenders all originate loans on behalf of Fannie Mae and Freddie Mac, but loan terms differ between them, even when comparing the same agency programs.
When I started out in multifamily, I mistakenly assumed that all delegated underwriting and serving (DUS) lenders offer the same loan terms, since they originate loans for Fannie Mae and Freddie Mac, and those government sponsored enterprises (GSEs) ultimately approve the loan.
In reality, however, individual lenders have quite a bit of leeway in how they underwrite deals and so one lender often beats another on proceeds even when both use the same LTV and DSCR thresholds within the same agency lending program. This realization pushed me to build relationships with many different agency lenders so as to find the ones most willing to work with me to deliver the terms I desired.
Building these relationships has been critical because it lets us confidently underwrite and put deals under contract, knowing that our lender relationships would come through for us and not re-trade the deal last minute.
Similarly, Fannie Mae and Freddie Mac are both mandated to provide liquidity to the housing market and support affordable housing. Despite this, loan terms often differ between the two GSEs and can even differ substantially between loan products within Fannie or Freddie individually. It’s critical not only to get feedback from multiple DUS lenders, but also from both Fannie and Freddie, to encourage competition for your business.
Secret #3: Only one agency lender can formally submit a given deal to Fannie Mae or Freddie Mac.
Take care in your communications with lenders – don’t let them formally submit a deal package to Fannie or Freddie without your approval. Lenders may push you to submit to the agencies, which effectively marries you to them for that deal if you want to move forward with an agency loan.
Instead, have agency lenders offer soft quotes, then review your quote matrix and your experiences with different lenders to settle on a final choice.
Secret #4: Agency lenders vary, but their legal documents are mostly the same. For bridge loans, loan terms and legal documents are all over the place.
It’s essential to comb through every point in a bridge loan term sheet since so much can vary in terms of what lenders may throw at you. With agency loans, the focus is often on leverage, interest rate, and years of interest-only – for bridge loans, there is much more going on.
For example, in addition to the standard bad-boy carve-out guaranties required by all non-recourse lenders, bridge lenders may ask for additional personal guaranties, such as interest reserve replenishment guaranty, construction completion guaranty, and more. Be sure to read the language for these guaranties! Negotiate if they seem worse than market or less than fair.
Another item to watch out for on bridge loans is a lockbox or deposit account control agreement (DACA). A lockbox can be soft, hard or springing and essentially gives control over the property’s bank accounts to the lender. These lockboxes are cumbersome and expensive and should be avoided as much as possible. Rather than agreeing to a lockbox up front, it is better to negotiate a springing lockbox which is only established upon a trigger event as defined in your loan agreement.
It’s also worth checking the term sheet to ensure that interest is not charged on unfunded capital. For example, for a bridge loan with a $2MM holdback for capital expenditures, you want to begin paying interest only as funds are disbursed and the capex budget is funded – avoiding interest on the full $2MM. Similarly, it’s possible to negotiate replacement reserves out of a bridge loan either entirely or at least for the initial 12-month renovation period.
Lastly, it is important to negotiate the index floor (typically LIBOR). Lenders will often seek a floor on the index rate that keeps you paying more even when interest rates fall. This is unfair since a borrower shouldn’t have to subsidize a lender’s borrowing costs.
Secret #5: Historically, borrowers pay less using floating rate debt rather than fixed rate loans and they provide more flexibility.
Floating rate debt takes the guess work out of interest rates and exposes you to the risks and rewards of interest rate changes. While a fixed rate may help you sleep better at night, it limits your upside and flexibility should rates move lower. From a numbers standpoint, the research shows you actually pay the least amount of interest when you float rather than fix over almost any period of time.
Even more importantly than saving money on cash flow are the prepayment penalties associated with each type of loan. Fixed rate loans often have a yield maintenance/defeasance prepayment penalty. These complex calculations can be extremely costly to the borrower depending on prevailing market interest rates and the term remaining on the loan.
In strong markets, these penalties limit sales early in the loan term, since the property will have to be sold subject to an assumption of the existing financing. Fixed rate loans may also have a “step-down” prepayment structure which is not as bad as yield maintenance, but the lender makes up for this with an increased interest rate.
Meanwhile, floating rate loans typically have a simple, economical prepayment penalty of 1% of the loan amount regardless of remaining loan term. For investors willing to trade interest rate protection for the option to capture gains via an opportunistic sale or refinance with minimal penalties, floating rate loans most likely the best option. Floating rate loans can be further optimized with the sophisticated use of interest rate caps which can have a strike (interest rate ceiling) as close to the in-place rate as needed in order to protect future cash flows.
Secret #6: You do not need a hedge broker in order to get an interest rate cap for your floating rate loan.
If you’re keen on saving your partnership money, it is very doable to arrange your own interest rate cap without the help of a hedge broker. Today, rate caps are very inexpensive and therefore the broker fee is small, so it doesn’t save you a ton of money.
Nevertheless, of the agency approved rate cap providers, SMBC Capital Markets is really the only counterparty that is competitively providing caps in the multifamily loan space, so a broker isn’t really necessary from a market making perspective. SMBC’s rate cap transaction process is standardized and streamlined. This means you can work with them directly and be confident that you’re getting a fair execution with an approved hedge provider.
Secret #7: The payment date on your loan is more important than you think.
Since rent payments begin around the 1st, become late around the 4th, and are often not fully collected until well into the month, optimize cashflow by arranging mortgage payment dates as late in the month as possible.
For agency loans, this is achieved by simply filling out a form that lets you choose to pay your mortgage on the 9th of the month. Bridge lenders are stricter about payment date: most are only willing to push it back to the 6th of the month, which is mostly due to the securitization process which these loans go into.
Secret #8: Involve your whole team to get the best loan possible.
For example, your insurance broker can scrutinize lender-proposed insurance requirements and negotiate out unneeded coverage, bringing the premium down as much as possible. This not only saves you money on expenses, but also lets the lender underwrite lower expenses, and thus derive a higher valuation and greater loan amount.
Your debt broker should identify the best lender candidates that fit the deal profile and then create competition between them to deliver the most competitive loan terms.
Your property management company should put together a budget showing the leanest possible expenses for the lender. While agency lenders can only underwrite revenue to in-place numbers, they can underwrite expenses to a budget. It is thus critical that your property management budget lets the lender to arrive at the strongest underwritten net cash flow.
Even your lender is on your side here, so it is worth asking what they need to get the best possible deal done. If you don’t feel that your lender is doing everything they can to see you succeed, then it’s worth finding a new lender or mortgage broker who will go the extra mile.