Multi-Family Financing with Maximum Leverage and Minimum Risk
As a real estate investor, knowing which tool to pull out of the toolbox is a big part of your success. And to know which tool you need, you have to know what tools are available.
Commercial loans generally have shorter terms than residential loans … and that isn’t always good. What if the market doesn’t agree with your personal timeline?
Keeping in mind that times have and will again change, we took a look at the best commercial financing options out there to keep your risk low and your leverage high.
In our latest episode, we visit with an FHA multi-family lending expert to find out how to finance apartments with maximum leverage and minimum risk. In this informative episode of The Real Estate Guys™ show you’ll hear from:
- Your multi-passionate investor host, Robert Helms
- His multi-problems co-host, Russell Gray
- Multi-family financing expert Paul Winterowd
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Multi-family financing basics
To get you the basics on multi-family loans, we did a Q&A with Paul Winterowd, a long-time member of the lending team at Bonneville Multifamily Capital.
If you’re a multi-family investor or interested in becoming one, “It’s a great time to be in the business,” Paul told us.
That’s due to two things … flowing capital markets and stable rates that have held over the years.
Paul told us that multi-family properties are the No. 1 asset class in commercial real estate because of their broad risk profile.
So what are the primary things to know before getting a loan?
To start, there are some significant differences between the loans offered by the banking system and loans offered by government agencies.
Among them is the balloon payment. Most bank loans for multi-family property investors have five- to ten-year amortization schedules that force investors to pay the full amount or refinance once time’s up.
And that can pose problems, especially considering how much the market can change in five or ten years.
Paul shared with us a story of a friend who bought a multi-family property in Las Vegas in 2004. With his co-investors, he put a total of three to four million dollars into the property. Their five-year term came due in 2009—right after the housing bubble collapsed. Even though Paul’s friend made every payment on time, no banks would work with him. The bank sold the property to a loan shark, who foreclosed.
Paul’s friend didn’t do anything wrong, but he fell hard because of timing.
We asked Paul what options investors have if they want to be less beholden to the ebbs and flows of capital markets.
He told us that there is ONE loan program in the commercial real estate world with a fully amortizing term and no balloon payment … an FHA loan.
Everything you need to know about FHA loans
An FHA loan is a mortgage insured by the Federal Housing Authority, which is under the jurisdiction of the Housing and Urban Development (HUD) Department.
FHA provides a conduit for financing. The great thing about the FHA’s commercial loan program is that terms can stretch up to 35 years … 42 years for construction loans.
Essentially, this loan is the closest to a single-family loan that exists in the commercial lending world.
And there’s more … although it’s easy for people to make a decision based solely on the lending rate, Paul told us that FHA rates are “bottom of the barrel.”
In addition, FHA loans provide a very attractive loan-to-value ratio: between 75% and 85%. Traditional bank loans will get you between 65% and 70%.
A necessary disclaimer: Paul doesn’t work for the federal government. He’s just really good at helping people figure out which loans are right for them.
Gearing up to get a loan
The FHA loan sounded like a REALLY great option to us … so we asked Paul what it takes for an investor to get involved with the FHA program.
Paul told us that in general, the key litmus tests to get a loan are adequate experience and sufficient net worth.
Because lenders want to know that this isn’t your first rodeo, they’ll want to see more than just a single-family property on your résumé … meaning it may be necessary for you to bring in a partner.
Lenders will also want to see at least a 1:1 ratio of net worth to loan amount to make sure that buyers have cash assets on hand in case anything gets wrong. The FHA program offers a boost here, accepting ratios as low as 1:4.
And yes, you can go into the FHA program with a partner, or partners. The FHA will look at your combined assets and experience, although in a classic syndication scenario, they will need a lead sponsor or sponsorship group.
Because Paul is intimately involved in the lending process, we asked him what he looks for when he underwrites loans.
He told us in order to mitigate risk, he needs buyers to hit several important numbers in regard to their asset:
- A debt-coverage ratio of, at minimum, 1.25. That’s the net operating income of a property divided by the annual debt service. Paul and other underwriters want to see that there’s plenty of net income to cover the debt service.
- Records of at least 90 days of occupancy at 90% or above.
- A trailing twelve months (aka a profit and loss statement for the last year).
Paul emphasized the importance of keeping good records … in fact, he could not emphasize it enough!
In terms of buyers’ personal records, he told us he’d also need the following:
- A list of all assets and outstanding debt.
- A personal financial statement that shows the buyers’ experience.
Obviously, there’s a lot of preparation that goes into qualifying for the FHA loan. But are there any downsides?
The only real downsides are the paperwork and waiting time, Paul told us.
Typical HUD loans take about 60-90 days, but permanent financing for FHA loans takes even longer … about 4-6 months.
Because HUD is insuring these loans, more underwriting has to take place to minimize risk for the federal government.
As Paul reminded us, “Good things come to those who wait.” If you’re willing to be patient and deal with a little more paperwork, you could find yourself with a killer solution.
Is there anything Paul wishes borrowers knew before seeking out an FHA loan? Paul told us that people think timing is everything and rate is everything … but they’re not.
If buyers took a step back and looked at the bigger picture, they’d be able to find other benefits that are very compelling. We think a fully amortized loan is worth the wait.
Debt isn’t always dangerous
We see Paul as a wealth of knowledge.
In any new situation, it’s helpful to have a sort of “safari guide” … someone to lead the way in places you haven’t gone before.
We hope that Paul’s knowledge has given you some things to think about.
In particular, we want you to keep in mind that debt can be an asset. Taking advantage of opportunities like the FHA loan can force value and create more equity from the equity you don’t have to spend up front, leading to a cycle of success.
We also hope that if anything, Paul got you thinking of some good real estate practices.
This week, we encourage you to go out and make some equity happen!
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