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   ARTICLE   |   From Scotsman Guide Residential Edition   |   July 2017

Dive Into Multifamily Lending

What you need to know about small-balance commercial loans

Dive Into Multifamily Lending

At some point in their careers, all residential mortgage originators undoubtedly get requests to handle multifamily lending. Many people, including commercial property owners and investors, simply do not understand that residential and commercial lending are different specialties, each with their own unique complexities.

As their mortgage-loan adviser, these prospective clients will expect you to know the intricacies of commercial loan programs and provide them with general recommendations at the very least. If you have ever considered diving into multifamily lending — or even just wading into the shallow end — you will need to be prepared to respond to these requests.

Many current and past clients of residential originators probably own commercial property or know somebody who does. Learning to navigate the waters of multifamily financing will keep your reputation intact as a mortgage expert, and can provide business opportunities that may be overlooked by colleagues and competitors.

The biggest difference between residential and multifamily commercial lending is the lack of uniformity among commercial lenders.

Before getting your toes wet, however, you will need to know the primary differences between residential and multifamily lending. You also will need to understand the basics of commercial lending so you can help prospective clients who are looking to invest in multifamily properties.

Residential versus multifamily

The biggest difference between residential and multifamily commercial lending is the lack of uniformity among commercial lenders. Rather than standardization, there is more specialization. Plus, multifamily lending has a lot more factors and questions to consider during qualification, and additional parties often get involved — including attorneys, property managers and accountants.

Most new multifamily investors also are surprised to learn that 30-year fixed loans are not typically available for commercial properties. And, geography can play an important part. Eligibility and loan terms for multifamily properties can change drastically from one market to the next, unlike residential loans. Loan structure and availability also can be different for every unique transaction.

In addition, commercial appraisals and other loan costs can be comparatively higher than the residential equivalents. Although lenders will do a full review of the borrower, as in a residential deal, a major focus of the qualification criteria is on the investment property. Besides standard appraisals, there will be property-condition and environmental inspections, a market review, detailed cash-flow analyses, tenant-lease assessment and other due-diligence items to help the lender determine any potential risk.

The entire process for a permanent loan usually takes 45 to 60 days from application to close, and the process can change from one transaction to the next. Commercial loans do not have the same process conformity as residential loans. Purchases that need to close quickly can be arranged through short-term bridge loans, however, which can close in as little as 5 days.

Other significant differences between residential and commercial lenders include the sources of their capital, their lending parameters and their underwriting. Many commercial lenders don’t publicly advertise their programs, and their loan appetite and underwriting guidelines can change frequently as the market changes.

Developing strong relationships with these lenders and tracking changes to their parameters and underwriting guidelines is a valuable asset on the commercial side. There is much more gray area in multifamily lending, which allows you to use mitigating factors and reasonable negotiation to benefit your clients with respect to their loan requests.

Loan structure

The most competitive multifamily loans have a fully-amortized 30-year structure. Many will be hybrid adjustable rate mortgages (ARMs), however, that have fixed rates for the first part of the loan term, and then either roll into an adjustable period or have a reset at the end of the fixed period.

Interest rates will be higher the longer that rate remains fixed, and some lenders will offer interest-only periods during the first part of the loan to help investors maximize cash flow. Select multifamily properties can qualify for a 20 percent minimum downpayment, but most programs have a 25 percent minimum floor.

Even a small uncovered error or change to cash flow can kill a deal.

Multifamily loans can be made to individuals, but sometimes it is recommended or even required to vest the loan with a borrowing or single-purpose entity such as an LLC, partnership or corporation. Loan amounts and amortizations can be reduced based on any perceived lender risk (e.g., property and/or market concerns, borrower financial issues, etc.) or at the request of the borrower to minimize total interest paid.

Almost all multifamily loans will have a prepayment penalty, which is either determined by a stepdown structure or yield maintenance. This penalty can be mitigated by defeasance. Many loans are full recourse, meaning each sponsor will personally guarantee the loan, but they can be non-recourse with certain borrower and property qualifications.

Multifamily lenders

Commercial lenders come in all shapes and sizes. Your relationship with these institutions is the most important piece of the puzzle. Learning how multifamily loans are structured will open up new conversations and opportunities, but having the experience to confidently navigate the commercial lending world and solve the issues that arise during the process will actually close those transactions.

Many banks and credit unions have specialized commercial lending programs, but some of the most competitive capital sources come from life insurance providers, commercial mortgage-backed securities (CMBS) conduit lenders and select agency-lending institutions. In today’s lending market, debt funds and private investors are becoming increasingly more popular because they provide flexibility in a time when bank regulations and underwriting guidelines are becoming stricter and more unpredictable.

Many commercial lenders will only work through approved correspondent brokerage companies. This helps to minimize the number of unqualified loan requests and provides lenders with loan-servicing assistance, including inspections, payments and annual reporting.

Loan qualifications

A detailed cash-flow analysis of the property is the primary focus of most commercial lenders when evaluating a multifamily deal. These are investment properties, so a review of historical and anticipated net income is crucial. All lenders have their own guidelines and stress-test parameters, but each will need an accurate picture of the property’s income and expenses.

As the originator, you will be responsible for collecting this information. Many sellers and their listing agents may present pro forma numbers as actuals, submit reports riddled with expense-accounting issues or simply not have any property information to provide. This is where you will earn your commission.

Lenders will expect a prescreened broker audit and investigation of any cash-flow line items that appear to be irregular or affect the qualification. Determining the property’s actual and underwritten NOI (net operating income) is important for calculating the borrower’s qualified loan-to-value ratio and debt-service coverage ratio, which tells the lender the amount of cash flow the borrower has available to pay current debts. Even a small uncovered error or change to cash flow can kill a deal, so you will need to do your full due diligence on this to help your client.

Eventually, an appraisal and property inspection will be required for loan approval. On a first-layer review, however, you will want to provide lenders with details to help evaluate the subject property’s rental market, local economics, zoning and code compliance, deferred maintenance, tenancy and stabilization, and anything else that would help assess potential loan risk or anticipate issues.

In addition, lenders will want to review the credit, personal financials and real estate experience of the borrower, and they will complete a global cash-flow analysis. You don’t need to be an accountant to handle these requests, but you should be able to recognize and anticipate tax-return and balance-sheet problems. You also will want to gather accurate documentation from the borrower, audit the package to check for potential lender concerns, and conduct your own cash-flow analyses.

Required documentation

Every lender is different regarding what they need to see to evaluate a loan request. In general, however, there are some common documents you will want to request from clients every time that likely will need to be reviewed.

For the property, you will want to collect a current and complete rent roll, historical cash-flow documents, and a related list of applicable capital expenditures. From the borrowers, you will need a personal financial or 1003 application, copies of tax returns and, if possible, a recent credit report. If a borrowing entity is involved, lenders will need to understand the entity structure, agreements and powers.

In addition, be prepared to answer follow-up questions regarding the investment property and local market, your borrowers and any risk-related items you anticipate could be a potential problem during escrow. Having these documents and answers together will help make the process go swimmingly, and prove to any commercial real estate professional that you are a knowledgeable multifamily originator and reliable referral source.


 


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