Multifamily Financing: An Overview

Multifamily financing offers solutions for real estate investors looking to expand their portfolios beyond single-family properties. These loans are available through banks, credit unions, commercial lenders, and private investors. 

Multifamily financing allows real estate investors to purchase or refinance 2 – 4 small multifamily homes and 5 or more large condominiums. Suitable for beginners and experienced investors alike, multifamily loans offer interest rates as low as 2.625% and terms of up to 35 years. So, what is multifamily financing and how do you qualify for it? Let’s get right into it. 

What Is Multifamily Financing? 

Multifamily financing is similar to commercial lending where borrowers are mainly commercial entities like property developers and not individual homeowners. It means multifamily housing is a general term for rental properties with two or more units. They can be as small as a duplex or triplex or as huge as sprawling residential neighborhoods. What is important to note here is that buildings with five or more dwellings fall under the ‘commercial’ financing category. Such multifamily commercial real estate properties do not enjoy attractive loan options as compared to smaller units. 

Types Of Multifamily Financing 

There are various types of multifamily loans available, each suited for different purposes. Depending on your needs, some of the financing options listed below might be perfect for you. It is essential to understand these options because as your real estate investment strategy evolves, your loan requirements might change: 

Multifamily Financing by Term Length 

1. Permanent Loans 

Permanent loans are commonly used for buying or refinancing multifamily properties. They usually last 20 to 30 years and can have either fixed or floating interest rates. Agency loans like those from Fannie Mae and Freddie Mac, along with CMBS loans, HUD financing, and long-term loans from banks, credit unions, or life insurance companies, are examples of permanent financing options. 

2. Short-Term Financing 

There are several short-term financing choices for multifamily properties and developments. These loans are usually more costly, with higher interest rates and fees, yet they serve a crucial role in acquiring or developing a property. Most of these loans last between six months to two years. 

Multifamily Financing by Purpose 

Regardless of the loan’s duration, grouping multifamily loans by their purpose is a useful way to categorize financing types.  

1.  Acquisition Loans 

Acquisition loans are used when buying a multifamily property. These loans can either be long-term and permanent, or short-term bridge loans, which are common for property purchases. 

2. Refinancing Loans 

Refinancing loans replace existing debt on multifamily properties for various benefits. These include securing better interest rates, negotiating improved terms post-occupancy growth, and avoiding balloon payments at loan maturity. Refinancing enhances financial stability and adjusts to market shifts for continued investment success. 

3. Construction Loans 

Construction loans finance the building of multifamily properties. They often last six months to two years and are usually interest-only payments. 

However, not all construction loans are short-term. For example, HUD 221(d)(4) multifamily construction financing from the Department of Housing and Urban Development offers up to 43 years with a fixed interest rate, making it highly favored among apartment developers. 

4. Bridge Loans 

Bridge loans are short-term loans that serve as a temporary solution between purchasing a property and securing a permanent loan. They usually last six to 12 months and often require interest-only payments. 

Bridge financing typically provides rapid funding, making it ideal when waiting for more favorable financing options, such as an HUD multifamily loan. Although bridge loans can be costlier than other types of financing, they are highly beneficial tools in multifamily finance strategies. 

5. CMBS Loans 

A CMBS loan, also called a conduit loan, pools similar loans into securities sold on the secondary market. It is beneficial for borrowers with less-than-perfect credit but a strong property, as lenders focus more on the property’s income potential than on the borrower’s credit history. 

6. Rehabilitation Loans 

If you own a property that needs upgrades, a rehabilitation loan could be the solution you’re looking for. This type of loan gives investors the funds to renovate existing apartment buildings or communities. While some have terms like construction loans, they are often more affordable. 

7. Mezzanine Loans 

Mezzanine loans are utilized to increase financing for a multifamily property beyond what a traditional loan allows. They complement existing loans by providing additional funds, enabling higher leverage on the property. 

Advantages and Disadvantages of Multifamily Loans 

Multifamily loans offer unique benefits and considerations for real estate investors. Understanding these can help navigate the complexities of property financing effectively: 

Pros 

1. Better Interest Rates: Multifamily properties generally secure lower interest rates compared to similar properties in other commercial real estate sectors, reflecting their lower risk profile. 
2. Extended Loan Terms: While many multifamily loans span five to ten years, options like HUD loans offer fully amortizing, long-term solutions. 
3. Customizable Terms: Borrowers enjoy flexibility with multifamily loans, thanks to a wide array of available options that cater to specific needs. 
4. Increased Financing Potential: Multifamily financing often allows for higher Loan-to-Value (LTV) ratios compared to loans for office and industrial buildings, enabling greater leverage for investors. 

Cons 

1. Prepayment Penalties: If your multifamily loan includes a prepayment penalty, it can be substantial. 
2. Required Reserves: Certain apartment loans mandate that borrowers maintain a specific amount of cash reserved for essential property repairs. While this is standard practice for any apartment investor, required reserves can restrict an investor’s flexibility. It’s important to note that HUD loans require reserves by default. 

Qualifying for a Multifamily Loan 

Most multifamily loan applications require borrowers to meet specific criteria. Although some loan types like CMBS and hard money loans may be less stringent, most lenders typically expect borrowers to demonstrate the following items: 

1. Credit History 

Most lenders prefer borrowers with a good credit score. A strong credit history shows you are dependable and likely to make timely loan payments throughout the loan period. 

2. Income 

Lenders typically consider both property income and other sources of income when evaluating borrowers. If your income doesn’t comfortably cover the debt servicing costs, you may face higher fees and rates to account for the increased risk to the lender. 

3. Collateral 

Most first-time multifamily borrowers typically need substantial collateral to secure the loan. This could involve using personal property or other assets as security in case of a default. 

Multifamily Financing Terminology You Need to Know 

Here are a few terms you need to know to thoroughly understand the concept of multifamily financing: 

Hard Money Loan 

“Hard money” loans refer to money from government agencies and other organizations. Under this, borrowers receive money secured by existing property. 

Bridge Loan 

Bridge loans provide quick and easy cash flow obtained by a company or person. 

Non-Recourse Loan 

This is a type of secured loan that does not hold the borrowers and principals accountable and liable beyond the pledged loan collateral. 

Affordability 

Refers to the percentage of a multifamily property’s rent that qualify as “affordable” according to the definitions set by the Federal Housing Finance Agency. 

Funding Time 

The time in which the money for your loan will be capitalized. 

Cap Rate 

Percentage ratio that is used as an estimation for an investor’s possible return on investment. 

Debt Service Coverage Ratio (DSCR) 

It is the ratio of net cash flow to the total debt service payment every year or over any specified period. 

Debt Service Reserve (DSR) 

This is a reserve account created to fund monthly debt service in the event a borrower is unable to make payments due to unforeseen circumstances. 

Thinking of Constructing a Multifamily Property? 

As cities become denser, the need for multifamily housing has never been greater. Finding innovative ways to compress living spaces while creating the sense of a ‘home’ requires an intricate combination of state-of-the-art design and engineering. Multifamily construction is one of the most difficult types of multifamily investments, and getting project approvals and multifamily construction loans carry a certain amount of risk. In general, there are three categories of multifamily properties that investors consider: 

1. Stabilized multifamily apartments 
2. Value-add multifamily properties 
3. Ground-up multifamily construction 

Financing for the construction of a multifamily property comes in several forms such as HUD, bank loans, and lenders like CMBS, Fannie Mae and Freddie Mac. 

The Bottom Line 

Multifamily loans offer appealing benefits for investors aiming to buy, refinance, or renovate multifamily properties. These loans often feature lower interest rates and longer repayment periods compared to other loan types. Additionally, they are secured by the property’s value, ensuring borrowers feel more confident in their investment’s security. 

Looking for further assistance? Reach our experts at Beach Front Property Management.