Fannie, Freddie or Banks: Which Apartment Lender is Best for You?
There’s no shortage of options when it comes to multifamily financing. Here’s five factors to consider when deciding on a commercial lender.
So you’ve decided to buy an apartment building. Diversifying your portfolio with a consolidated source of passive income is a savvy move. Go ahead and pat yourself on the back.
While finding a multifamily property that matches your investment criteria and experience is no cakewalk, you aren’t done with the tough choices just yet. There’s no shortage of products to consider when it comes to financing your multifamily investment. First, the major players involved.
Figure 1. Multifamily Mortgage Debt Outstanding – Q1 2015
(Source: The Federal Reserve)
Apartment investors spend a lot of time weighing the pros and cons of bank and agency loan products. While there is no right or wrong choice, you must arm yourself with the knowledge needed to determine which loan product works best for your investment. So let’s jump into some specific terms.
Non-Recourse vs. Recourse
The biggest differentiator between bank and agency apartment financing is whether the loan is recourse or non-recourse. Fannie Mae and Freddie Mac (agency) loans used to buy or refinance apartment buildings are non-recourse, meaning that the debt is secured only by the loan collateral (e.g. the apartment community). If you default on a non-recourse loan, the lender can only recoup the pledged collateral. They can’t go after your personal assets. One of the biggest benefits of working with non-recourse lenders is that your personal liability is protected.
Apartment financing from a bank usually comes in the form of a recourse loan. This means that you and your partners are personally liable for the full loan amount in the event of a default. If the property sale does not cover the loan amount, the lender can go after assets that were not used as loan collateral. Sometimes banks will offer non-recourse refinancing, but the risk is often reflected in a higher interest rate.
Flexibility and Pricing
While the non-recourse loans offered by Fannie Mae and Freddie Mac might help you sleep better at night, recourse loans tend to offer more flexibility when it comes to loan structure and pricing. Because it is more difficult to recoup on a non-recourse loan, lenders are going to impose more restrictions on what you can do with your apartment building. Their goal (which should align with your goal) is to keep the apartment asset competitive and in good repair. As such, loan provisions might include capital expenditure and maintenance schedules.
Recourse loans from Banks tend to offer a slight advantage on interest rates. That being said, recourse multifamily loans are typically structured with a floating interest rate spread over an index. Fannie Mae and Freddie Mac products can be locked in at a fixed rate, and can offer better long-term fixed-rate loan terms than banks if you are looking to “set it and forget it”.
Agencies also have the benefit of higher leverage, which tops out at 80% loan to value (LTV) in certain markets. Banks usually top out around 75% LTV.
Speed of Execution
Traditional wisdom would steer you towards a Bank loan if you are looking for speed of execution above all else. However, recent developments in online technology (like ALEX) now allow lenders to streamline the documentation process on Agency loans. Fannie Mae and Freddie Mac products are now catching up to the quick loan process Banks have been known for.
While Agency loan products are standardized when it comes to requirements and terms, not all lenders are built equal. Finding an experienced lender and attorney are two ways to ensure the fastest Agency financing possible.
Servicing and Beyond
Banks usually keep your apartment loan on their own balance sheet, so you can expect to work with a single entity over the course of your loan.
Smart investors will find an Agency lender that maintains an in-house point of contact for servicing over the life of their loan. Some Agency lenders hand off your financing to a third-party manager after the loan is sold to a GSE for securitization. This can present some headaches when it comes time to refinance or sell your apartment property.
You are also going to want to consider prepayment penalties. Bank loans typically feature a 1% prepayment penalty, while Agency products have declining prepayment penalties or yield maintenance.