Loan Options for Small Balance Apartment Borrowers Explained
The definition of a small balance apartment loan varies from market to market and lender to lender but is typically defined as a loan between $750,000- $1 million to $5-7 million.
While these loans may seem large to the smaller investor, many multifamily lenders are institutional in nature and rarely provide loans under $10 million.
Getting the correct financing is essential to achieve the optimal ROI for any apartment investment, and “small” apartment deals are no different. For this reason, it’s essential that you understand your options when it comes to smaller apartment loans.
It’s also important to understand that while lenders may offer loans within a certain range, they may not provide the best service or the best terms to smaller borrowers. This is typical because they consider these deals riskier. Plus, lenders make a set percentage of the loan in profit, making it less profitable for them to take the time and energy required to underwrite smaller deals.
Thus, smaller balance multifamily loan deals are more likely to get rejected, and borrowers may also suffer from more conservative underwriting, which may manifest itself in the form of:
Lower maximum LTVs
Higher DSCR requirements
More onerous pre-payment requirements
Full recourse loans
In addition, borrowers should understand that loan application and lender fees can often be very high, often as much as $25,000, not including the costs of third-party reports. This may be chump change for an investor looking for $30 million in financing, but for an investor looking for a $1 million loan, that same $25,000 would be a massive 2.5% of the entire deal.
Fortunately, there are good options for smaller balance apartment loan borrowers-- in fact, there are many of them. In this article, we’ll discuss some of the best small apartment loan options for multifamily investors in 2021.
Freddie Mac Small Balance Loans
When it comes to small balance multifamily loans, the Freddie Mac Small Balance (SBL) loan program is the creme of the crop. No other small balance multifamily loan program comes close in terms of total loan volume. In fact, Freddie Mac has issued and securitized more than $33 billion of small balance loans since the initiation of the program.
Freddie’s SBL program offers non-recourse loans between $1 million and $7.5 million, with options including adjustable-rate, fixed-rate, and interest-only (IO) lending options. Loan pricing depends on the market, with markets being divided into “Very Small,” “Small,” “Standard,” and “Top” markets. Loans issued in markets, are considered higher risk and are accordingly priced higher than loans in larger markets.
Terms for Freddie Mac SBL loans include:
Loan Size: $1- million $7.5 million
Loan Use: Buying or refinancing of stabilized apartment properties (restrictions mentioned above)
Loan Terms: 20-year floating-rate loan with a 5, 7, or 10-year initial fixed-rate period, or a 5, 7, or 10-year fixed-rate loan (interest-only loan options also permitted)
Recourse: Loans are typically non-recourse with standard carve-outs
Amortization: 30 years maximum
LTV:
Top and Standard Markets: 80% LTV
Small/Very Small Markets: 75% LTV for purchases, up to 70% for refinances
DSCR:
Top Markets: 1.20x
Standard Markets: 1.25x
Small Markets: 1.30x
Very Small Markets: 1.40x
Full-Term Interest Only Requirements:
Top Markets: Min. DSCR 1.35x/max. LTV 65%
Standard Markets: Min. DSCR 1.40x/max. LTV 65%
Small Markets: Min. DSCR 1.40x/max. LTV 60%
Very Small Markets: Min. DSCR 1.50x/max. LTV 60%
Net Worth Requirement: Loan sponsors generally must have a net worth of 100% of the loan, excluding their primary residence, and liquid funds of at least 10% of the loan, though this may be flexible. 9 months of expenses in escrow is also typically required.
Commercial Space: Allowed up to 40% of total gross potential rent (GPR), no more than 40% of the net rentable area permitted
Assumability: Subject to approval and 1% fee
Rate lock: 60-, 90-, 120-, 150-, 180-day extended delivery options available
Closing Timeline: Loans typically close in between 45 to 60 days
SBL loans can be used with section 8 properties and properties with some degree of commercial (non-multifamily) income. However, they do not allow for:
Seniors housing
Student housing (greater than 25% concentration)
Military housing (greater than 25% concentration)
Low-Income Housing Tax Credit (LIHTC) properties with Land Use Restriction Agreements (LURAs) (except those in the last two years of the initial compliance period or in the extended use period)
LIHTC properties reward investors with a tax incentive for financing affordable housing via a federal tax subsidy program. A LURA, or land use restrictive agreement, is a legal contract that requires a LIHTC property to remain an affordable rental property for a specific period, usually 15+ years.
Fannie Mae Small Multifamily Loans
Other than Freddie Mac, Fannie Mae has perhaps the most competitive small apartment loan program on the market today. Approximately $24 billion of Fannie Mae Small Loans have been issued since the program began in 2009.
Like Freddie Mac Small Balance Loans, Fannie Mae Small Loans are non-recourse, offer flexible loan terms, and a streamlined application and closing process. Fannie Mae Small Loans may be particularly ideal for smaller investors, as they permit loans as little as $750,000. In some situations, lenders may even be allowed to waive replacement reserve requirements for borrowers. Borrowers can also finance up to 3% of the closing costs. A large amount of commercial space, up to 35% is also allowed.
Terms for Fannie Mae Small Loans include:
Loan Size: $750,000- $6 million
Loan Use: Buying or refinancing of stabilized apartment buildings with 5+ units
Loan Terms: 20-year floating-rate loan with a 5, 7, or 10-year initial fixed-rate period, or a 5, 7, or 10-year fixed-rate loan (interest-only loan options also permitted)
Recourse: Loans are generally non-recourse with standard carve-outs for “bad-boy” acts like fraud or intentional bankruptcy
Amortization: 30 years maximum
LTV: 80% max. LTV
DSCR: 1.25x
Rate Lock: 30 to 180 day locks available, with a streamlined rate lock option.
Prepayment: Yield maintenance or a declining (step-down) prepayment premium.
Net Worth Requirement: Loan sponsors generally must have a net worth of 100% of the loan, excluding their primary residence, and liquid funds of at least 10% of the loan, though this may be flexible.
Third-Party Reports: Appraisal, reduced physical needs assessment (PNA), and environmental screen generally required.
Replacement Reserves: $250/unit
Closing Timeline: Loans typically close in between 45 to 60 days
HUD/FHA Multifamily Loans
HUD/FHA multifamily loans can be some of the most difficult to qualify for, but they do offer excellent terms, including fully-amortizing loans HUD 221(d)(4) loans with up to 40-year terms for new construction and substantial rehabilitation, and fully amortizing HUD 223(f) loans with up to 35-year terms for purchases and refinances. This means that they are usually only ideal for small apartment borrowers who can handle lots of paperwork and a relatively long closing period. HUD multifamily loans, while offering long terms and low rates, require a significant amount of third-party reports (which can get expensive) as well as strong sponsorship.
HUD 221(d)(4) loan terms include:
Loan Purpose: Building or substantially rehabilitating multifamily properties.
Size: $2-$4 million to $100 million+ (some loans of $1 million are permitted in special situations)
Terms: Up to 40 years fixed-rate loans for new construction or substantial rehabilitation, with an up to 3-year interest-only (IO) construction period.
Maximum LTV:
Market Rate: 85% LTV
Affordable Properties: 87% LTV
LIHTC Properties: 90% LTV
DSCR:
Market Rate: Min. 1.20x DSCR
Affordable Properties: Min. 1.15x DSCR
LIHTC Properties: Min. 1.11x DSCR
Assumability: Assumable for 1% of the loan amount for qualified borrowers
Third-Party Reports: Appraisal, Phase 1 Environmental Assessment, Zoning Report, Seismic Report (in some areas), Engineering Report, Asbestos and Randon Reports often required, a wide variety of HUD specific reports are also required.
HUD 223(f) loan terms include:
Loan Purpose: Purchasing or refinancing stabilized multifamily properties.
Size: $2-$4 million to $100 million+ (some loans of $1 million are permitted in special situations)
Terms: Up to 35 years fixed-rate loans
Maximum LTV:
Market Rate: 85% LTV
Affordable Properties: 87% LTV
LIHTC Properties: 90% LTV
DSCR:
Market Rate: Min. 1.20x DSCR
Affordable Properties: Min. 1.15x DSCR
LIHTC Properties: Min. 1.11x DSCR
Assumability: Assumable for 1% of the loan amount for qualified borrowers
Third-Party Reports: Appraisal, Phase 1 Environmental Assessment, Zoning Report, Seismic Report (in some areas), Asbestos and Randon Reports often required, a wide variety of HUD specific reports are also required.
CMBS Small Balance Loans
CMBS is another potential option for small-balance borrowers, particularly those with credit or legal issues, which lenders may be able to overlook. However, many CMBS loan applications end up going nowhere due to the fact that lenders are careful with the properties they select and often want to favor newer properties with less deferred maintenance. This is to reduce the risk profile of the loan, as CMBS loans are pooled together and sold on the secondary market as bonds called commercial mortgage-backed securities, hence the acronym CMBS.
One major downside of CMBS loans, however, is that they are generally not serviced by the original lender, and are instead serviced by a separate servicer. These services can be extremely strict when it comes to missing payments or violating loan covenants (such as failing to submit a quarterly P&L disclosure), meaning the loan can easily go into default. In this case, the loan servicer will generally attempt to take the borrower to court to repossess the property.
Typical CMBS loan terms include:
Loan Size: $2 million+ ($1 million allowed in some situations)
Loan Use: Purchasing or refinancing multifamily properties (though a wide variety of other property times, including student housing, senior living, office, retail, and other property types are allowed)
Loan Terms: 5, 7, and 10-year fixed-rate loans allowed
Recourse: Loans are non-recourse with standard carve-outs for “bad-boy” acts like fraud or intentionally bankruptcy
Amortization: 30 years maximum
LTV: 75% max. LTV for most loans
DSCR: 1.25x
Net Worth Requirement: Flexible, typically up to 50% of the loan amount.
Assumability: Loans are fully assumable for qualified borrowers
Prepayment: Typically defeasance or yield maintenance, 1-2 year prepayment lockout periods are usually required.
Reserves: Insurance, taxes, replacement reserves, and leasing costs must typically be set aside in an escrow account
Closing Timeline: Loans typically close in between 45 to 60 days
Bank and Credit Union Loans
Banks and credit unions can be among the worst institutions for small-balance borrowers, but they can also be among the best. It all depends on the size of the bank and its focus. For instance, a large national institution such as Wells-Fargo does offer commercial real estate loans, but they generally only deal with large institutional borrowers. In contrast, a small local or regional bank with a focus on commercial real estate financing could be the perfect option for a smaller apartment borrower.
Typical bank loan terms include:
Size: $1 million to $50 million+
Maximum LTV: 75%-80%
DSCR: 1.20x+ required
Recourse: Most loans are full recourse
Term: Generally 5, 7, or 10-years, with some banks offering terms up to 30-years
Amortization: Up to 30 years
Interest Rates: Fixed and variable rates available, interest-only (I/O) options available