Begin with the end in mind. How are you going to exit your investment? What challenges will your buyer encounter when you sell the property?
This article will look at three investment strategies and the ideal debt for each strategy.
1. Value Add- Fix, Lease Up, Sale/Refinance. Investment horizon: 2-3 Years
Property needs a capital infusion to cure deferred maintenance, change the tenant profile, and bring down units to market. These will not qualify for conventional agency financing due to low occupancy and large amount of rehab needed.
A bridge loan will work well with this type of acquisition, as the lender will give you rehab dollars to bring the property up to market. Typical terms are: 75% Loan-to-cost, 5 year fixed, 4.50-5.00%, 20-25 year amortization, and recourse under $5MM in loan amount. Benefits of this loan are you can roll a large amount of rehab into the loan and have no or a small prepayment penalty once the asset is stabilized. Disadvantage of a bridge loan is that at the end of your loan term, there is balloon payment where the entire principal balance is due. If the financing market is not as liquid as it is in today’s market, it might be difficult for you to sale or refinance the property. In order to avoid the balloon, some bridge lenders allow you to have a fully amortizing loan by allowing you to float the interest rate after the initial fixed rate of the loan.
2. Yield Play- Limited deferred maintenance, improve operations. Investment horizon: 7-10 Years
Property is above 90% occupancy, no large capital projects are needed, and tenant profile is where you want it.
Agency loan (Fannie Mae or Freddie Mac) works well with this type of acquisition, as you can fix the interest rate for 5, 7, 10, or 12 years with 30 year amortization and the loan is non-recourse at interest rates of 4.25%-4.75%. In addition to very favorable terms upfront, if the value improves significantly in the first 2-3 years of your ownership there is an opportunity to take additional debt through a supplemental loan. Disadvantage of these long term loans are if you decide to sale the property, the new buyer will have to assume your loan or you will have to pay a very large prepayment penalty called Yield Maintenance.
3. Hybrid- Well occupied, but upside available through light capital improvements (under $5,000/unit). Investment horizon 5-10 years.
In this scenario, you have 2 options: Bridge loan or agency loan.
Bridge loan brings more risk as it is recourse (under $5MM loan amount) and has a fixed interest rate loan term of only 5 years, but there is no limited prepayment penalty when you exit or refinance.
Agency loan is less risky as it is non-recourse ($1MM or above), locks in the interest rate for up to 12 years, and gives you the option of a supplemental loan, but there is a large prepayment penalty if you sale the property early in the loan term. If you do not want to pay the prepayment penalty, the buyer can assume the loan, but they will be capped at 75% LTC and typically not get as much interest only. Due to the challenges of an assumption you have to sale the property at a discount compared to offering it free and clear.
As you can see there are many things to consider when matching your debt with your investment strategy on your next multifamily acquisition, If you have any questions about your next refinance or acquisition, please contact James Eng at 214-300-5035 or firstname.lastname@example.org.