Multifamily Financing Starter Kit

3 Ways to invest in Multifamily

By: James Eng

Senior Director Old Capital Lending

Frisco, TX

[email protected]

214-300-5035

mailto:[email protected]

Summary of Investment OptionsIndependent RentalOwner (IRO)

Lead Investor (General Partner)

Limited Partner

Sign as guarantor on loan Yes Yes No

Management Control Yes Yes No

Control investment decision timing (sale/refinance)

Yes Yes No

Find, negotiate, close transaction

Yes Yes No

Receive acquisition fee or sponsorship equity

No Yes No

Receive tax advantages of real estate ownership

Yes Yes Yes

1031 Exchange Yes Typically No Typically No

Independent Rental Owner (IRO)Disadvantages

• Depending on amount of capital, might not be able to acquire enough units to leverage full economies of scale

• Must sign as guarantor on loan

• Must find, negotiate, close, and manage the property

• Concentrated risk in a small number of properties

• Must spend time learning to be asset manager/property manager

Advantages

• Ability to control investment and make decisions based on your personal situation

• No general partners or limited partners to answer to

• Ability to roll capital gains from one investment to the next utilizing a 1031 exchange

Independent rental owners are individuals with strong balance sheets looking to own their own properties without partners.

Example:

• Doctor purchases 25 unit property for $1MM. He invests $250K as a down payment and takes out a recourse bank loan for $750K. He must personally sign recourse for the loan. Due to the small number of units, he either self manages the property or pays a high management fee of 7%-10% of income.

Lead InvestorDisadvantages

• Must sign on loan as guarantor

• Must spend the time to find the deal, negotiate the deal, raise the equity, and be asset manager of the property

Advantages

• Earn acquisition fees, sponsorship equity, and/or larger return compared to cash invested in deal

• Control over property investment decisions

• Ability to leverage other people’s money to buy larger apartment properties

• No limit to the size of properties you can buy

• Leverage 3rd party property management

Lead Investors put deals together by leveraging other people’s money and 3rd party property management to buy larger multifamily properties.

Example:

• Lead investor acquires a 100 unit multifamily property for $5MM. Lead investor signs a non-recourse note for $4MM and raises the down payment of $1MM from limited partners. Lead investor might earn a 1% acquisition fee and/or 10% sponsorship equity for putting the deal together.

Limited PartnerDisadvantages

• Must spend time identifying and meeting lead investors

• No management control of property. Must rely on general partner to make day to day decisions

• Limited liquidity as general partner will make decisions about when to sell or refinance the property

• Lower return due to payment on sponsorship fee and/or sponsorship equity for general partner putting deal together

• Difficult to utilize 1031 tax deferred exchange as all members of the LLC must go to next transaction

Advantages

• Do not have to sign as guarantor on loan

• Do not have to find, negotiate, close transactions

• No day to day responsibilities of managing the property

• Receive monthly or quarterly distributions of cash flow with limited investment of time after initial due diligence at acquisition

• Receive same tax benefits in terms of depreciation as independent rental owner and lead investors

• Ability to receive benefits of economies of scale of larger properties

• Ability to invest across thousands of units with multiple general partners in multiple submarkets for diversification of risk

Example:

• Retired corporate executive has $1MM to invest in real estate. He invests $50K across 20 separate deals with 5 general partners in 4 different markets: Dallas, Houston, Austin and San Antonio.

• Experienced borrower (at least 12 months of multifamily ownership experience)Limited partners can achieve truly passive income at a slightly lower return with diversification across multiple properties, general partners and markets.

Multifamily Finance 101By: James Eng


Plano, TX

[email protected]

214-300-5035


3 Questions

1. Is the property stabilized (yield play) or distressed (value play)?

2. What is your experience with multifamily (5 units and above) real estate?

3. What is your net worth and liquidity?

1: Is the property stabilized?

Stabilized Properties (Yield):

• 90% occupancy for 90 Days

• No major rehab needed

• Clean historical financials

Non-Stabilized (Value Play):

• Distressed assets performing below market

• Physical updates or operations need to be updated

• Low occupancy and low NOI

2: What is your multifamily experience?

Experienced Operator:

• At least 24 months of multifamily ownership

New Investor:

• No Experience, but a lot of enthusiasm

3: What is your net worth and liquidity?

Net Worth

• Must be equal to or greater than the loan amount

Liquidity

• Minimum of 10% of loan amount in cash or marketable securities not in retirement accounts

Loan ScenariosAssuming you meet the net worth and liquidity requirements:

Stabilized Property + Experienced Operator= Non-recourse loan (Agency or CMBS)

Stabilized Property + New Investor= Recourse loan (bank)

Non-stabilized Property + Experienced Operator= Recourse loan (bank)

Non-stabilized Property + New Investor= Recourse loan (bank)

Typical Non-Recourse Loans terms:

• 75-80% Loan to Cost

• 5 or 10 year term

• 30 year amortization

• No personal guarantee of loan shortfalls

Typical Recourse Loans terms:


• 5 year term

• 20 or 25 year amortization

• Personally guarantee any loan shortfalls

Commercial Real Estate Loan Options:How to choose the best loan

By: James Eng


Frisco, TX

[email protected]

214-300-5035


Summary of Loan TypesType of Loan Bank Loan Fannie Mae Freddie Mac CMBS

Non-recourse No Yes Yes Yes

Typical Loan Term 3-5 Years 5 or 10 Years 5 or 10 Years 5 or 10 Years

Amortization 20-25 Years 30 Year 30 Year 30 Year

Max LTV (Acquisition/Refinance)

75%/75% 80%/75% 80%/75% 75%/75%

Interest Rates based on Cost of funds of deposits 10 year treasury 10 year treasury 10 year treasury

Property Occupancy Flexible Minimum 90% for past 90 days

Minimum 90% for past 90 days

Stabilized (80% or up)

Rehab Budget Included in loan Included in loan Not included in loan Not included in loan

Escrows (RE Taxes, Insurance, Replacement reserve)

Yes Yes Yes on Real Estate taxes Yes

Prepayment Limited to none Yield Maintenance Step Down Yield Maintenance or Defeasance

Supplemental Loans or Earnout

Yes Yes Yes None

Borrower Experience New investor Experienced Experienced Experienced

Property Types All Multifamily Multifamily All

Types of Loans OverviewStabilized Property + Experienced Operator= Non-recourse loan (Fannie Mae, Freddie Mac, or CMBS)

Stabilized Property + New Investor= Recourse loan (bank)

Non-stabilized Property + Experienced Operator= Recourse loan (bank)

Non-stabilized Property + New Investor= Recourse loan (bank)

Typical Non-Recourse Loans terms:





Typical Recourse Loans terms:


• 5 year term



Recourse Bank LoanDisadvantages

• Signing personal guarantee for any loan shortfalls


• Shorter fixed rate loan term (3 or 5 years) typically

Advantages

• Lower interest rate (based on cost of funds of deposits) and will typically not change during loan underwriting process

• Limited prepayment penalty (step down or none)

• Receive loan commitment before spending money on 3rd party reports and application fee

• Quicker underwriting and closing process as decision maker closer to asset

• Rehab can be rolled into the loan

• Available to first time investor

• All property types

Typical Transaction:

• Occupancy below 90% for last 3 months

• Rehab greater than $5,000/unit

• Investor wanting to sell property in less than 5 years

• First time investor

Example of Closed Transaction

Wilshire Manor Apartments (58 units) was acquired with a bank loan by a local first time investor group. The property was a 90% occupied Class C property in Arlington, TX. Old Capital arranged a 5 year, 25 year amortization loan with 12 months interest only on a fixed interest rate of 4.75% with no prepayment penalty.

Recourse bank loans work well for first time investors looking for low interest rates, flexible prepayment, and are comfortable signing a personal guarantee for loan shortfalls.

Non-Recourse Fannie Mae LoanDisadvantages

• Limited flexibility on loan structure (No changes to loan documents)

• Large prepayment penalty (Yield Maintenance or Defeasance) early in loan term

• Interest rate not fixed until week before closing

• Must submit application fee and 3rd party fees upfront

• Only for Multifamily properties

Advantages

• Do not sign personal guarantee for any loan shortfalls

• Max 80% LTC for Acquisition and Max 75% LTV for Refinance

• 5, 7, 10, 12, 15, 30 year loan term and 30 year amortization

• Rehab up to $5,000/unit rolled into the loan

• Can be approved by Delegated underwriter without having to go to Fannie Mae

• Fixed interest rate

• Interest only available

• Low legal and closing costs

• Supplemental loan available

• Minimum loan amount of $750,000


• Stabilized property (90% occupancy or higher for last 90 days)

• Limited rehab or deferred maintenance

• Investor wanting to hold property long-term (5 or 10 years)

• Experienced borrower (at least 12 months of multifamily ownership experience)


Woods of Haltom (88 units) was acquired with a $2.750MM Fannie Mae loan by a experienced investor. The property was a 95% occupied Class C property in DFW. Old Capital arranged a non-recourse fixed rate loan with 30 year amortization.

Fannie Mae loans work well for experienced investors acquiring stabilized multifamilyproperties with limited rehab needed wanting to hold the property long-term.

Non-Recourse Freddie Mac LoanDisadvantages

• Limited flexibility on loan structure (No changes to loan documents)

• No rehab rolled into the loan



• Must be approved by Freddie Mac (1-2 weeks longer approval process than Fannie delegated underwriters)

• Only for Multifamily properties

Advantages


• Max 80% LTC for Acquisition and Max 75% LTV for Refinance

• 5, 7, 10, 12, 15, 30 year loan term and 30 year amortization

• Step down prepayment penalty available



• Low legal and closing costs

• Supplemental loan available (not available on small balance loans under $5MM)

• Minimum loan amount of $1,000,000


• Stabilized property (90% occupancy or higher for last 90 days)

• No rehab or deferred maintenance


• Experienced borrower (at least 12 months of multifamily ownership experience)


Magnum Oaks (38 units) was refinanced with a $1.350MM Freddie Mac loan by a experienced investor. The property was a 100% occupied Class C property in Houston, TX. Old Capital arranged a non-recourse fixed rate loan with 30 year amortization, 3 years interest only with a 4.75% interest rate.

Freddie Mac loans work well for experienced investors refinancing stabilized multifamilyproperties with no rehab needed wanting to hold the property long-term.

Non-Recourse CMBS LoanDisadvantages

• No rehab rolled into the loan

• Limited flexibility on loan structure

• Prepayment penalty (Yield Maintenance or Defeasance) very expensive early in loan term



• Legal costs higher than other loan programs due to being securitized to investors

• Minimum loan size of $3,000,000 typically due to higher transaction costs

Advantages


• 5 or 10 year loan term and 30 year amortization



• Large cash out available on refinances

• Available for secondary/tertiary markets

• All major property types (Apartment, Office, Retail, Industrial, Self-storage, etc..)


• Stabilized property (80% occupancy or higher)

• Limited rehab or deferred maintenance


• Over $3MM loan amount


Experienced investor group utilized a CMBS loan for the refinance of a bank loan. The property was a 92% occupied Class C property in Dallas, TX. Old Capital arranged a non-recourse 10 year fixed rate loan allowing the borrower to cash out over $1MM at close.

CMBS loans work well for investors looking to lock in long term fixed interest rates with 30 year amortization on a non-recourse loan.

How to create your sponsorship group for Agency Loans (Fannie/Freddie)

By: James Eng


Frisco, TX

[email protected]

214-300-5035


Pieces of the Puzzle

Multifamily Ownership Experience

Net Worth and

Liquidity

Finding the

Property

Raising the Equity

Net Worth and LiquidityRequirements:

• Net Worth of the sponsorship group must be equal to or greater than the loan amount. Net worth includes the value of your personal residence.

• Post close liquidity of the sponsorship group must be greater than 10% of the loan amount. These funds must be in cash or marketable securities outside of retirement accounts. Bank statements will be required to show proof of these funds.

Example:

• Sponsorship group is purchasing 100 unit multifamily in Dallas, TX for $5MM. The loan amount requested is $4MM. The sponsorship group in total must have a minimum net worth of $4MM and post close liquidity of $400,000.

Multifamily Ownership ExperienceRequirements:

2 ways of qualifying for this experience:1) Have at least 12 months of previous multifamily ownership experience

2) Sign as a key principal on a Fannie Mae or Freddie Mac Loan

Example:

• A key principal (KP) purchased a 75 unit in Jan 2015 with a recourse bank loan and is now looking to purchase 100 units in April 2016. This key principal would qualify for Fannie Mae since they have owned a multifamily of similar size for over a year.

• A key principal purchases a 75 unit and signs on a Fannie Mae loan in December 2015 and is now looking to purchase 100 units in April 2016. The key principal would qualify for Fannie Mae since they have already signed on a Fannie Mae loan even though they have owned for less than 1 year.

Finding the PropertyRequirements:

• Stabilized occupancy (90% occupied for the last 90 days)

• Limited deferred maintenance

• Under $5,000/unit in rehab

Example:

• Sponsorship group is purchasing 100 unit multifamily in Dallas, TX for $5MM. The occupancy is 93% and has been above 90% for the last 6 months. The property needs $450,000 in rehab, which falls below the $5,000/unit threshold. There is limited deferred maintenance of $50,000 for access gates and parking lots.

Raising the EquityRequirements:

• Sponsorship Group needs to have a minimum of 10% of the equity in the transaction

• Limited partners typically do not have more than 20% equity in the transaction or they will sign as a principal on the loan

Example:

• Sponsorship group is purchasing 100 unit multifamily in Dallas, TX for $5MM. The loan is expected to be 80% LTV, so the group needs to raise $1MM. The sponsorship group will need to own at least 10% of the borrowing entity and no one limited investor can own more than 20%.

Other Agency Loan Considerations• 3rd Party Property Management: If the sponsorship group has full-

time jobs outside of real estate or does not live close to the property, it typically makes sense to hire a 3rd party property manager experienced in the local market. Lenders are more comfortable with a 3rd party property manager on your first couple of property acquisitions.

• US Citizenship: Fannie and Freddie Loans are for Key principals that are US Citizens. There are exceptions to this rule, but they require a waiver from the agency and cannot be approved at the delegated underwriter level.

• Tenant Concentrations: Any tenant concentrations must be disclosed up front. Items such as student, military, or employer concentrations.

How Apartments get Financed: How to get your equity out

By: James Eng


Plano, TX

[email protected]

214-300-5035


How to get your Equity out:

1. Refinancing out of recourse debt into non-recourse

2. Agency Supplemental Financing

3. Earnouts

1: Recourse to Non-RecourseNon-Recourse Loans terms:

• 75% Loan to Cost (Refinance); 80% Loan to Cost (Acquisition)




Recourse Loan Terms:


• 5 year term



New Investor: 1st Apartment purchased in 2013

• NOI of $100K

• Purchase Price $1M (Purchased at 10% cap rate)

• Financed with recourse bank debt of $750K

• Equity down payment of $250K

2015 ( Raised rents, improved occupancy, reduced expenses)

• NOI of $140K

• Updated value of $1.4M

• Financed with non-recourse agency debt of $1.050M

• Payoff recourse bank debt of $750K

• Equity recaptured of $300K

By increasing the value of the property, you have pulled out all of your initial equity, moved to non-recourse debt, and still own the property.

2: Agency Supplemental LoansTypical Supplemental Loans terms:

• 75% Loan to Value

• Co terminus maturity with first mortgage

• At least 12 months after first mortgage origination and with at least 7 years remaining on loan term

• Lender looking for NOI growth not just cap rate compression

Experienced Investor: Apartment purchased in 2013

• NOI of $500K


• Financed with non-recourse agency debt of $4M

• Equity down payment of $1M

2015 ( Raised rents due to interior rehabs and reduced expenses)

• NOI of $700K


• 75% LTV qualifies loan of $5.250M, which allows investor to receive $1.250M supplemental loan in addition to $4M in existing debt.

• 125% of Equity recaptured

By increasing the value of the property, you have pulled out all of your initial equity and still have low interest rate fixed debt on cash flowing asset.

3: EarnoutsTypical Earnout Loans terms:

• 75% Loan to Value

• Co terminus maturity with first mortgage

• Lender looking for NOI growth

• Based on Debt Yield (NOI/Loan Amount), typically at least 10%.

Experienced Investor: Apartment purchased in 2013 needed significant rehab over 2 years

• NOI of $500K


• Financed with bank debt of $3.750M

• Equity down payment of $1.250M

2015 ( Raised rents due to interior rehabs and reduced expenses)

• NOI of $700K


• 75% LTV of new value reaches a total loan of $5.250M, which allows investor to receive $1.250M in a earnout in addition to $4M in existing debt.

• 100% of Equity recaptured

By increasing the value of the property, you have pulled out all of your initial equity and still own a cash flowing asset.

How to get your Equity out:

1. Refinancing out of recourse debt into non-recourse

2. Agency Supplemental Financing

3. Earnouts

Multifamily Underwriting REVENUESRental Income:

Gross Potential RentIf all units were leased at market rent. Based on current Rent Roll (# of Units X Rent X 12). 2 ways of calculating: Either In place rents + vacant at market (conservative) or all units at market rent (more aggressive).

VacancyPhysically vacant units. Based on current rent roll vacancy and competing properties. Minimum of 5% of gross potential rent.

Rental Concessions, delinquencies, etc

What specials are the subject property giving? What about other properties? Is the property collecting rent from all tenants, how much usually is written off in bad debt? Any non-revenue units for manager or model? Trailing 12 and competing properties in submarket.

NET RENTAL REVENUE (Gross Potential - vacancy-rental concessions- delinquencies)

Actual Rental income collected. Conservative is trailing 12 net rental income. Lenders will use Trailing 3 months annualized. Some brokers will proforma trailing 1 annualized.

Other Income Good News income (Laundry, parking, utility reimbursement): 100% of trailing 12Bad News income (late fees, security deposit forfeit) 80% of trailing 12EFFECTIVE GROSS INCOME: Net Rental + Other IncomeEXPENSESReal Estate Taxes:

(Greater of 80% of purchase price or current assessed value) X current tax rate. Compare to other properties in area to determine tax comparables.

Insurance: Trailing 12 or insurance estimate quote; Average of $300-$350/unit

Utilities:Trailing 12; Electric, gas, water (Approximately $1000/unit). Determine what utilities tenants currently pay for directly or through a reimbursement system (RUBS).

Repairs and Maintenance:Trailing 12; Building maintenance and repairs, unit turns; Not CAPEX; ($1,000/unit). Remove any items that are full replacement as these are capital items.

Property Management Fee:Typical property management fees: 5% for 50-75 units ; 4% on units under 75-150 units, 3% on units above 150 units

Payroll:Trailing 12; includes leasing agent and maintenance person along with benefits; contract services for items on-site staff cannot complete ($1200/unit; $100K-125K)

General and Admin:Trailing 12; includes marketing, leasing office expenses, licenses. (Approximately $200-$300/unit)

Capital reserve or replacement reserveReplacement reserve either held by lender or owner to replace large capital items over time. $300/unit for Class C, $275/unit for Class B, $250/unit for class A.

Total Expenses: Total expenses typically range from $4,500/unit-$6,000/unit. Expense ratio 55%-65% of total revenue on Class C deals NET OPERATING INCOME Total Revenue- Total Expenses

Multifamily Financing Starter Kit

Real Estate

Transcript of Multifamily Financing Starter Kit