Financing Multifamily Property in an Uncertain Era

Multifamily residential commercial real estate (CRE) is classified as any housing where multiple separate units are grouped together. The most common example of this is an apartment building, although multifamily also covers separate units located side by side within a complex.

Traditionally, multifamily real estate has a lower barrier to entry than other property types, such as retail or office spaces. This makes it a popular classification of CRE investments for newer or junior borrowers. 

The recent turmoil caused by the COVID-19 has seen upheaval across virtually all aspects of commercial real estate. Let’s take a look at how investing in multifamily residential can be a smart choice for investors and developers looking to make sound investment decisions on the heels of unprecedented disruption.

As outlined in a recent Forbes article, 2022 forecasts indicate a strong growth year for commercial real estate ventures. CRE funding topped over $152 billion by October of last year, with much of the capital waiting to be deployed on growth opportunities. 

With the market predicting a pre-pandemic level of appreciation, now is the time to consider investing in a CRE venture – and multifamily residential provides plenty of potential upsides. With inflation rising rate and looming unemployment investors must proceed with caution.

Making sense of the nuances of multifamily real estate loans can be tricky. There are generally three types of multifamily properties that investors will consider:

• Value-add multifamily properties
• Ground-up multifamily construction
• Stabilized multifamily apartment buildings

Aside from the certain permits that are needed to obtain multifamily real estate development, it is important to note that this type of construction utilizes unique financing tools like short-term debt that is released in tranches upon reaching pre-determined project stages.

Affordable housing builds and other multifamily developments also have considerations regarding sole ownership and the possible need to hire a project manager for the build. If you’re looking to own one of the units and rent the others, a Federal Housing Administration (FHA) multifamily loan is yet another viable option to aid your CRE financing.

To qualify for a Federal Housing Administration loan, you typically need an investment property with five or more units. At least one of the units must be owner-occupied in order to take advantage of the terms of this loan. Qualifications are based on your creditworthiness, income and existing debts in addition to the appraised value of the proposed property. 

A unique feature of FHA loans is that rental income is used in determining your qualification. To account for the higher cost of additional property units, loan limits are higher with each subsequent build added to the development.

Whether you’re looking to qualify for an FHA loan, or gathering partners for your CRE project, it’s important to understand the requirements and risks associated with obtaining multifamily residential property financing.

Multifamily loan requirements include many unique and flexible terms that simply don’t exist with other forms of commercial real estate deals. 

The loan-to-value ratio for a multifamily property is typically lower for these types of developments, with many borrowers able to put down less than 20%. Some lenders will even allow a 0% down payment, thus enacting a 100% loan-to-value ratio for the development of the proposed property. (*These situations, while rare, are not impossible.)

Many lenders will seek an 80/20 loan-to-value ratio, while higher-risk deals may require higher equity, of up to 65% loan-to-value. These terms are largely designated upon the specifics of the deal, as well as the quality of the borrower and the specific lending institution.

Additional requirements for your multifamily financing terms include:

• Income: Your 1099s, tax returns and W2s will have significance when being considered for a loan. Additionally, you’ll need to qualify for a 1025, a special requirement designated for rental income. An appraiser will make a fair market value evaluation of the units attributed to your property.
• Credit Score: Typically you’ll need a median Fair Isaac Corporation (FICO) score of at least 580 to qualify for an FHA loan. It is worth noting that, in addition to your credit score, lenders will look at your credit history as well. In the event of a previous foreclosure, you’ll need to wait at least three years before attempting to qualify for a new FHA loan.
• Debt-to-Income (DTI) ratio: This ratio is determined by the amount of pre-tax income that you put into your debts every month. Front-end DTI is also known as the housing expense ratio and looks at how much of your monthly income is allocated to your mortgage. In order to qualify for a FICO score of 580, you need a housing expense ratio no higher than 38% and a DTI of 45% or lower.
• Debt Service Cover Ratio (DSCR): A formula that is calculated by dividing your property’s income by your total debt service, DSCR determines the viability of your project by evaluating income against any current debt obligations, including interest, principal and sinking funds. Properties with a DSCR of more than 1 are considered to be profitable, while those with a lower score are losing money.

These terms are all important to understand before seeking financing for your multifamily commercial real estate project. Speaking of the viability of a healthy DSCR, many lenders will not issue a loan if your proposal contains an abnormally low score. The majority of lenders will look for a DSCR of at least 1.15-1.25X.

Cash reserves are a valuable asset when looking to secure financing for your multifamily CRE development. Coming off of the uncertainty of the pandemic, many lenders and investors are seeking projects with some form of built-in cash in order to add security to the deal. Here are some of the options available to bolster your proposal.

• One Month’s Operating Reserve and Debt Service: By keeping one month’s operating expenses and amortized debt service in reserve at the time of initial investment, sponsors may refund the reserve in full at the time of sale. (For example, after five years.)
• Zero Reserve: Although this scenario may seem appealing, it affects the initial rate of return (IRR) and cash on cash performance of your deal.
• Three Month’s Operating Reserve and Debt Service: Similar to the one-month scenario, the large reserve may offer some assurances. Larger reserves should be considered for a higher execution risk deal with bridge debt than for a newer investment.

It stands to reason that the specific terms of your CRE loan are going to be deal-specific. Term length will often depend on whether or not your deal is new construction or value-add (usually short to mid-term) or a fully stabilized property that typically requires long-term debt funding. 

Conventional multifamily financing terms will amortize over a 15 to 30-year period, while some short-term loans can qualify with terms of six months to three years. While there are no loan amount limits associated with CRE deals, a banking institution may have specific max allowances.

To fully understand the qualifications, nuances and best practices associated with acquiring a multifamily construction loan, it may be worth seeking professional consultation.

At Black Collie Capital, we specialize in working with our clients to create multifamily financing applications that highlight the information borrowers and lenders are looking for.

BCC is a commercial real estate finance and advisory firm that specializes in arranging and structuring debt, equity, mezzanine and C-PACE financing for multifamily and hotel real estate on behalf of developers, investors and owners.

By right-sizing the information given to the quoting process, you’re guaranteed to have your funding application considered by direct lenders who will recognize the precision and professionalism of your hotel construction financing terms. 

After the deal is done, Black Collie Capital stays onboard your multifamily property project to ensure the process remains smooth. We’re with you all the way, from the proposal phase to the acquisition, construction and right up until a property manager is selected. 

Black Collie Capital provides effortless access to real estate debt & equity financing and facilitates prudent investment decision-making. 

Visit us today to start a conversation about your multifamily residential project, and enjoy the certainty Black Collie Capital solutions provide.