Multifamily Mortgage Loan Requirements: Everything You Need to Know
If you want to get a multifamily loan, you’ll have to meet certain requirements first. These requirements include certain standards that both the property in question and the individual borrower must meet in order to quality. In terms of a property, a lender will look at aspects like the property’s condition and location. In contrast, for the borrower, a lender will consider things such as the borrower’s net worth and overall financial condition, their previous real estate experience, and the financial condition of any other properties they may own.
Different lenders will have different underwriting standards for multifamily loans; for example, life companies, HUD, Fannie Mae, and Freddie Mac will have the strictest guidelines, followed by banks/credit unions and CMBS/conduit lenders. Hard money or private money lenders will often have the most lenient guidelines, often lending to borrowers with poorer credit or outstanding legal issues, as well as potentially financing distressed properties or other special situations.
In general, properties and borrowers considered a high risk to a lender will either be disqualified or charged a particularly high interest rate (as well as potentially high origination fees). Each lender is different, however, and what may seem like a deadly risk to one lender may be a walk in the park for another. This is why it’s often important to use a qualified commercial or multifamily mortgage broker in order to consult with multiple lenders to find the best deal.
General Requirements for Multifamily Loans
Some of the general requirements for multifamily mortgage loans include:
LTV: LTV, or loan-to-value ratio, is perhaps the most important consideration for a multifamily lender. LTV looks at the requested loan amount and divides it by the current market value of the property. Most banks, credit unions, and CMBS lenders will not go above 75% LTV, though HUD multifamily, Fannie Mae Multifamily, and Freddie Mac Multifamily will go as high as 80% (with LTVs even higher for HUD multifamily loans for affordable properties). Some hard money and private money lenders will also go to 80%, with a select few going up to 90% for cross-collateralized properties (i.e., when a borrower uses another piece of real estate as collateral for their loan).
DSCR: DSCR, or debt service coverage ratio, is the amount of net income a property produces divided by the property’s debt service (their prospective monthly loan payment of principal and interest). Most lenders require a DSCR of at least 1.25 or above for multifamily properties, with higher DSCRs considered safer (at least from the lender’s perspective). Retail and hospitality properties are generally required to have higher DSCRs due to their increased risk.
Credit Score/Credit History: Credit score is another important component in the multifamily and commercial loan qualification process. Most lenders prefer borrowers with credit scores of at least 620, with Fannie Mae and Freddie Mac generally requiring borrowers to have credit scores of at least 660. Some hard money lenders may allow credit scores as low as 500-550 or may not check credit at all.
Debt Yield: Debt yield takes a property’s net operating income (NOI) and divides it by the entire loan amount. Lenders use this metric to determine how long it would take for them to recoup their investment if they needed to repossess a property should a borrower default on their loan. Debt yield is primarily used by CMBS or conduit lenders but may occasionally be used by other lenders. Lenders looking at this metric typically require a debt yield of at least 10%.
Occupancy: Occupancy is an important yet indirect measure of a property’s financial health. Most lenders prefer an occupancy rate of 85-90%+, though exceptions may be made if the property has a particularly high DSCR or the LTV of the prospective loan is quite low.
Borrower/Sponsor Net Worth: A borrower’s overall net worth is also an important qualification factor, with some bank lenders and many Fannie Mae, Freddie Mac, and HUD multifamily lenders requiring a net worth of 100% of the loan amount. This net worth can come in the form of stocks, bonds, and other tradeable securities, cash/cash equivalents (like CDs or money market accounts), or other real estate investments, though the more liquid (i.e., the closer to cash), the better. Most lenders will also require a borrower to present an SREO (Schedule of Real Estate Owned). In many cases, when the primary borrower does not have a high net worth, they will recruit a separate sponsor, who will, in essence, co-sign the loan for them, typically in exchange for a fee and a certain amount of equity in the property.
Real Estate Investing Experience: Real estate investing experience is another factor lenders look for. Lenders, in general, want to work with a principal borrower (either an individual or entity( who has successfully invested in similar types of real estate before, as this presents less of a risk than brand-new investors. Less experienced investors may choose to team up with a more experienced partner or sponsor that can give them additional credibility in the eyes of a lender.
Replacement Reserves: Replacement reserves are funds set aside to cover ordinary expenses, like plumbing, replacing flooring, HVAC upgrades or replacement, and parking lot, sidewalk, and driveway repaving. A lender will often require that a certain amount of funds are placed in an escrow account to ensure that the borrower has the funds necessary to maintain the property in good condition. In addition to upfront, one-time replacement reserve payment, the borrower will often have to contribute a certain amount of money each year for reserves. For instance, many Freddie Mac multifamily loans require the borrower to put between $200-$300 per unit per year in a replacement reserve fund.
Multifamily Loan Requirements By Loan Type
Below, we review the general application requirements various types of multifamily mortgages, including bank loans, HUD/FHA multifamily loans, Fannie Mae and Freddie Mac multifamily loans, CMBS loans, and hard money/private money loans.
Bank Loans:
Max. LTV: 70-75%
Min. DSCR: 1.25x
Net Worth Requirements: Typically 100% of the loan amount
HUD/FHA Multifamily Loans:
Max. LTV: 90% for HUD 221(d)(4) loans for LIHTC properties
Min. DSCR: 1.15x for HUD 221(d)(4) loans for LIHTC properties
Net Worth Requirements: Typically 100% of the loan amount
Fannie Mae and Freddie Mac Multifamily Loans:
Max. LTV: 80%
Min. DSCR: 1.20x
Net Worth Requirements: Typically 100% of the loan amount
CMBS/Conduit Loans:
Max. LTV: 75%
Min. DSCR: 1.20x
Net Worth Requirements: As low as 25-40% of the loan amount
Min. Debt Yield: 10%
Hard Money/Private Money Loans:
Max. LTV: 90% for some lenders with cross-collateralization
Min. DSCR: Varies, may be less than 1.0 for fix-and-flip scenarios
Net Worth Requirements: Generally, none
Other Requirements for Getting a Multifamily Loan
While we’ve reviewed the main requirements for getting multifamily financing, there are a few other hoops to jump through. While the below list is not exhaustive, as any type of multifamily loan requires a significant amount of due diligence and documentation, these are a few of the most common requirements for potential multifamily borrowers:
Title Search/Lien Search: A lender will nearly always require that a property undergoes a title search and lien search prior to approving a borrower for financing. The title search will determine if any individuals or entities other than the stated owner have a legal claim to the property (including heirs, current or former spouses, business partners, etc.). The lien search will make sure there are no liens on the property, such as those which have been placed by unpaid service providers (i.e., construction companies, roofing companies, electricians, etc.). If issues come up and can be easily dealt with, the deal may move forward, but if they are serious, the borrower may need to exit the deal and look for another property.
Background Check: A background check will typically be performed on the principal borrower(s). Different lenders have different standards, but in general, as long as the primary borrowers have not committed serious crimes (particularly financial crimes), minor legal problems shouldn’t be an issue.
Environmental Assessment: A lender will often require a property to undergo an environmental assessment, usually in the form of a Phase I ESA, which determines if the property is contaminated or presents any form of danger to the residents, the neighbors, and the environment itself. If contamination is present, a Phase II ESA will be required to determine the extent of the issue and if it can be remediated.
Engineering Report: For construction loans or for loans on buildings that will undergo serious rehabilitation, an engineering report from a licensed engineering company will generally be required.
Seismic Report: In certain states with high levels of seismic activity, certain lenders (including HUD multifamily lenders) may require a borrower to get a seismic report, which will detail the property’s potential for being damaged during an earthquake, looking at factors including the history of seismic activity in the area and the sturdiness of the building itself.
Property Management Company: Unless a borrower is also an extremely experienced property manager, a lender will typically want to see a signed agreement with an experienced property management company before deciding to approve a multifamily loan.
2-4 Unit Multifamily Loan Requirements
Generally, multifamily loans are for properties with 5+ units and are underwritten like other commercial real estate loans (i.e., just like loans for retail, industrial, self-storage, or other commercial properties). However, when it comes to 2-4 unit properties, there are additional financing options, including loans from the FHA as well as Fannie Mae and Freddie Mac’s single-family divisions.
Many people decide to purchase 2-4 unit properties using loans backed by these institutions, with some people living in one unit of the property. The FHA only allows 2-4 unit multifamily loans when the owner occupies one of the units, with down payments of as little as 3.5% (96.5% LTV).
In contrast, Fannie Mae and Freddie Mac both permit the purchase of 2-4 unit non-owner-occupied investment properties. Fannie Mae’s conventional loan guidelines allow 85% LTV for 2 units and 75% for 3-4 units. Freddie Mac allows LTVs of 85% for 2-unit properties and LTVs of up to 80% for 3-4 unit properties. Freddie Mac also allows cash-out refinances on 1-4 unit properties up to 75% LTV.
FHA, Fannie Mae, and Freddie Mac loans for 1-4 unit properties generally do not require the borrower to have as much real estate investing experience (no experience is required for owner-occupied properties). Net worth is also less important, though the borrower’s debt-to-income ratio (DTI) will be an important factor in the qualification process.
In Conclusion: Multifamily Loan Requirements Can Be Complex, So Preparation Is Key
For those with little real estate experience, multifamily mortgage requirements can be complex. However, in the end, they simply boil down to a measure of risk. If a lender believes that there is an excellent chance that they will be repaid on time and in full, they are generally likely to approve a multifamily loan. If not, they are likely to reject a borrower or, in some cases, only lend them a smaller amount of money.
The strict requirements for the best multifamily loans mean that potential borrowers/investors should do everything in their power to prepare before approaching lenders, including ensuring their project has adequate sponsorship and that the property in question is financially viable. By doing this legwork in advance, borrowers can save significant time and money when they finally begin to go through the multifamily loan application process.