JF2269: Multifamily Lending 101 Part 1 | Syndication School with Theo Hicks
In today’s Syndication School episode, Theo Hicks shares some knowledge and experience about choosing a lender. Just because agencies tend to have the best terms on their loans, it doesn’t mean that you shouldn’t consider other options.
Theo also talked about the most well-known agencies and their process of transforming your loan into MBS (mortgage-based securities), and how it works on the borrower side of dealing with DUS Lenders.
To listen to other Syndication School series about the “How To’s” of apartment syndications and download your FREE document, visit SyndicationSchool.com. Thank you for listening, and I will talk to you tomorrow.
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Joe Fairless: There needed to be a resource on apartment syndication that not only talked about each aspect of the syndication process, but how to actually do each of the things, and go into it in detail… And we thought “Hey, why not make it free, too?” That’s why we launched Syndication School.
Theo Hicks will go through a particular aspect of apartment syndication on today’s episode, and get into the details of how to do that particular thing. Enjoy this episode, and for more on apartment syndication and how to do things, go to apartmentsyndication.com, or to learn more about the Apartment Syndication School, go to syndicationschool.com, so you can listen to all the previous episodes.
Theo Hicks: Hello, Best Ever listeners and welcome to another episode of The Syndication School series, a free resource focused on the how-to’s of apartment syndication. As always, I’m your host, Theo Hicks. Each week, we air a podcast episode that focuses on a specific aspect of the apartment syndication investment strategy. For a lot of these episodes, including this episode today, we offer some free resources. So there are going to be free documents, PowerPoints, PDFs, Excel template calculators, things like that’ll help you along your apartment syndication journey.
All of the previous episodes and previously given away free documents are available for free at syndicationschool.com/. And this is going to be most likely a two-part series, depending on how long I talk today, about multifamily lending. This is going to be a multifamily 101 course talking about these specific topics.
So today, we’re going to talk about how you determine which lender to actually use. We’re going to talk about agency lenders versus private loans, and which ones you should use, should you always go with agencies. We’re going to talk about using mortgage brokers versus working directly with a lender. We’re going to talk about at what point of the process you’re supposed to engage the mortgage broker and the lender. And that’ll probably be about as far as we get to in today’s episode.
And then next week, or if you’re listening to this in the future, the syndication school episode that is seven episodes after this, as we release daily episodes, we’re going to talk about how to know if you qualify for an agency loan, and then we’re going to talk about things like upfront reserves, can you have renovations costs, including the loan, and then what you need to look at when you are reviewing options. And then for both of these episodes – because we’re not going to get into super specifics on the different types of loans that you can get through the agencies and through the bridge lenders… So in a separate document, we’re going to provide the top loans program, which will be an Excel template that will have the most popular agency loans, bridge loans and other types of loans that you can get on multifamily properties. So to kick things off – well, how do you know what lender you should use?
Now, most of the time, the best terms you’re going to get on a loan is going to be the agency loan. Now, just because agency loan has the best terms, it doesn’t necessarily mean that you should always use an agency loan, because of the fact that, for example, there’s a prepayment penalty, which we’ll talk about a little bit later. But that is something that is on the agency loan. So if you are doing a deal that you plan on refinancing or selling after a few years, well, it might not be best to get an agency loan because of the extra fee you’ll have to pay. In that case, a non-agency loan would be ideal. But most of the time, I would say that if you can qualify for an agency loan and the plan is to hold the deal for, say, 5 to 10 years, then you’re going to want to get an agency loan.
So with an agency loan, a lender is going to provide you with the debt to purchase the apartment, but rather than actually holding that mortgage on their books, they’re going to sell that mortgage to an agency. So that’s why it’s actually called an agency loan. And then the agencies are then going to pull together thousands of these different types of loans they bought, and they’re going to sell them to private investors or investment firms on the open market as Mortgage Backed Securities (MBSes).
So the two agencies that everyone knows about that will actually purchase these loans from lenders and then resell them as these mortgage backed securities or MBSs are Fannie Mae and Freddie Mac. And both of these agencies guarantee the MBSes that they sell to investors, because they are government-sponsored entities, GSE’s, which means that not only is the agency guaranteeing these loans, but the United States government explicitly say it, but they’re implicitly, as a sponsor of these agencies, also backing these loans. So in order to provide that guarantee, these agencies are only going to buy certain types of mortgages from approved providers.
So Fannie Mae was actually created first, and then Freddie Mac was created later to generate some competition to drive down the rates even more for both the borrowers, the lenders and the MBS investors.
So why am I going through this entire history? Well, the question is, what lender do you use? So if you want to get an agency loan, then you can only use the lenders that are allowed to sell their products to these agencies. So you’re not going to be working directly with Fannie Mae or Freddie Mac; they’re the ones that are buying the mortgages. You’re going to want to work with an approved lending institution.
So both Fannie Mae and Freddie Mac have a list of these approval lenders on their websites. So for Fannie Mae, they only buy loans that are originated from what are called delegated underwriting and servicing lenders (DUS lenders). So what this basically means is that Fannie Mae is delegating the underwriting process and the servicing of the loans to a third-party lender that must meet their strict qualifications.
So in order to obtain a Fannie Mae loan, you must go through one of these delegated underwriting servicing lenders or DUS lenders, and there’s 25 at the time of this recording; you can go to Fannie Mae’s website, if you just Google Fannie Mae DUS lenders, then you’ll see that list.
And then Freddie Mac also has an approved list of lenders and they’re actually called the Optigo® conventional lenders. And similarly, if you just Google Freddie Mac Optigo® lenders, then the list of Freddie Mac approved lenders will come up, and a lot of them are the same as the DUS lenders.
So if you are able to qualify, which we’ll talk about, I guess next week, if you are able to qualify for agency, then you’re going to want to go through one of these DUS or Optigo® lenders in order to get the agency debt.
Now, the next question is, should you always use these agency approved lenders?
As I mentioned before, one of the major benefits of the agency loan are going to be the loan terms. So when you compare the agency loans to the non-agency bridge loans, you’re going to see usually lower down payments, and then you’re definitely going to see lower debt service because of the lower interest rates, which means that of course, you’re going to have a higher cash-on-cash return. But as I mentioned already, not every deal is going to be best served by an agency loan, using an example of a shorter hold period, but also not every deal or borrower is even going to qualify for an agency loan.
Obviously, if you don’t qualify for an agency loan or the deal doesn’t qualify for an agency loan, then there really isn’t that great of an advantage of using that lender; it’s probably better to use a mortgage broker to help you find the best loan that you qualify for or that the deal qualifies for… Although, obviously, that lender will probably still provide financing, this won’t be an agency loan and the terms won’t be as good. Which kind of brings us to the next point, do you use a lender or do you use a mortgage broker?
So the mortgage broker is a firm or a person who acts as an intermediary between a lender and then the borrower. And then the major benefit of using a mortgage broker is that they are going to have a higher level of expertise and a larger breadth of relationships than you, because that’s their main focus, is working with lenders.
So since there are countless different multifamily loan programs offered at any given time, when you work with a mortgage broker and you send them information on you, your team and the deal, then they will come back to you with the ideal loan program, or a lot of options to choose from. So that’s kind of their expertise; they can use their expertise and find the best loan program, whereas you might not be able to do that on your own. Although working with a lending institution, they should do the same thing. So in a sense, they both have expertise, so really, the major benefit is more the breadth of relationships. So the mortgage broker is not going to be limited to the loan programs offered by single institutions.
So if I go and work with Wells Fargo, Wells Fargo has their list of loans, and if you want a loan that’s not on their list, well, they really can’t make up a loan for you. Whereas a mortgage broker is working with Wells Fargo and then all these other lending institutions, and so they have access to all of Wells Fargo loans, as well as all loans at other lending institutions, which means that they can offer you may be a better loan program in general, plus, they can negotiate with multiple lenders to get you the best terms for a particular loan program.
So overall, your options are a little bit more limited when you’re working with a lender than with a mortgage broker. And then I guess one of the downsides of a mortgage broker is that since they are an intermediary, they’re going to charge a fee for their service, a certain percentage of the loan that you pay to the mortgage broker as a fee.
So who do you use? It really kind of depends on different things. If you’re just planning on always using agency loans, it maybe makes sense just to work with an agency-approved lender. But if you plan on using some bridge loans and agency loans or you want to have a mortgage broker who works on your behalf, goes out there and maybe one DUS lender is offering better terms today, and then a month from now a different DUS lender is offering the best term, but they can kind of figure all that out for you, as opposed to going out and talking to all of them…
So if you want to get the best terms, working with a mortgage broker is probably the ideal strategy, and it’s definitely the ideal strategy if you plan on pursuing a private loan, a bridge loan, because they’re going to find you the best terms for that as well.
So the last thing we’ll talk about in this part one will be when do you engage with this mortgage broker or the lender. So you decide that you’re going to go with a lender or decide you’re going to go with a mortgage broker – at what point in the process do you actually reach out to them?
So let’s just assume that you’re just getting started and you haven’t done a deal before – you should not be reaching out to a mortgage broker or a lender once the deal is under contract. In reality, you really shouldn’t be looking at deals until you’ve spoken and engaged with a lender or a mortgage broker… Because when you have a conversation with them, they’re going to ask you information about your background, and the type of deals you’re looking at and the amount of money you can raise, what markets you are investing in… And then based off of that, they can tell you what loan program you’re going to qualify for. But more importantly, they can tell you how much debt you can qualify for.
So if you assume that you’re going to qualify for, let’s say, $10 million in debt, and you’re going out there looking at deals that are in the 12 plus million dollar range, and you find a rock solid deal, get it under contract and then you engage your mortgage broker and say, “Hey, I’ve got this $12 million deal. Here’s the information on it. Here’s my background”, and they say, “Oh, well, hey, Theo, you can actually qualify for $5 million in debt.” Well, there are obviously solutions like finding a loan guarantor, which we’ll talk about next week, but it’s better to know upfront how much money you can qualify for, and then you can either pursue those types of deals or pursue partnerships to qualify for more money.
So ideally, before you even start engaging real estate brokers to find deals, you should really get your property management company and your mortgage broker on board first, and then you can start looking at deals, and then the mortgage broker will tell you what you should send them if you find a deal you’re interested in. And then before you submit an offer, your mortgage broker or your lender will ideally give you kind of an estimate quote on how much they can loan, what the interest rates are going to be, so that you can calculate an accurate debt service so that you can actually determine a good offer, right?
Because not only do you have your traditional operating expenses, but you’re going to have to pay your debt service as well, which is going to really impact the cash-on-cash return, especially when you’re talking about getting interest-only or you’ve got higher LTVs or lower LTVs. All that’s going to affect how much money you’re paying to the lender each month. And the more you’re paying to the lender each month, all other things being equal, the lower the cash flow is ultimately going to be, which means the lower the return is going to be to your investors, which means the lower the offer has to be.
So again, you don’t want to submit an offer and then realize that the debt service is so high on that type of loan that you’re not going to be able to meet the cash-on-cash return requirements of your investors, and then you have to lose that deal, and you lose credibility in the eyes of the brokers, and even the owners… It’s not a good situation at all.
So overall, engage your lender or your mortgage broker upfront before you start pursuing deals. Again, have that general conversation to determine how much you can qualify for, and then before you submit an offer on a deal, make sure you’re getting a quote from your mortgage broker or your lender so you can get that estimated, the debt service amount and the estimated loan amounts, which in turn determines the down payment, so you can get a better credit representation of the cash-on-cash return, so that you know if it’s actually worth submitting an offer on or not.
So that’s the first half of the multifamily lending one-on-one a course. Next week, we’re going to most likely finish it off by going over in detail some more of the process, like how do you qualify for these things, what are the reserve requirements or renovation costs including the loan, and the other things to look for when reviewing the option. Now that I think about it, it might have to be a three-part series, because I think I might make the what to look at when reviewing loan options into its own episode, but we’ll see; at least two parts, potentially three parts. So that concludes this episode. Thanks for tuning in.
Make sure you check out some of the other episodes we have about the how-to’s of apartments syndications, as well as free documents, at syndicationschool.com/. And also, as I mentioned in the beginning of this episode, make sure you click on that free top loan program document and download that, so you can get more specifics on the different terms for each of the different types of loans available.
Thank you for listening. As always, Best Ever listeners, have a best every day and we will talk to you tomorrow.
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