The Basics of Commercial Real Estate Loans Part 3 – Types of Multifamily Loans

This is the third post of the Basics of Commercial Real Estate Loans blog series. The goal of this series is to provide you with a basic understanding of commercial real estate (CRE) loans so you are better equipped to invest in commercial real estate. You can find the links to the last two posts of this series below:

1. The Basics of Commercial Real Estate Loans Part 1 – Borrower Requirements and Terminology 
2. The Basics of Commercial Real Estate Loans Part 2 – Bank vs. Agency Loans 

At JP Acquisitions, we invest solely in multifamily real estate (apartment buildings with 5+ units), and thus this blog post specifically will take a slightly more narrow dive and look at commercial multifamily loans as opposed to talking about commercial loans in general.

Whether you’re eyeing an apartment building or a multifamily housing complex, securing the right financing is crucial for your success. In the realm of commercial real estate, multifamily loans come in various shapes and sizes, each tailored to meet different borrower needs and property types. In this post we will dive into the various types of multifamily loans with the exception of a few more niche loan types. That said, let’s jump into this post!

Note – The definitions of the technical terms in any of our posts can be found in the glossary section of our website.

Types of Loans

Traditional Commercial Bank Loans: Not all bank loans are cut from the same cloth. Banks operate within their unique niches, particularly noticeable when comparing community banks, credit unions, regional banks, and national institutions. While some banks provide fully amortizing loans, others may limit amortizations to 20 years. Surprisingly, your preferred bank might restrict leverage to 70%, whereas a neighboring bank you’ve never considered could be more lenient, financing multifamily properties at an 80% leverage ratio. Nevertheless, traditional commercial bank loans have the following pros and cons:

Pros

1.  Willing to do smaller loans
2. Faster closing than agency loans
3. More flexible loan terms

Cons

1. Can have a more rigid borrower requirements
2. Usually requires recourse for the borrower
3. Often shorter amortizations

Government-Sponsored Enterprise (GSE) Loans: Fannie Mae and Freddie Mac offer multifamily loan programs with fixed-rate, adjustable-rate, and affordable housing options. These entities are government-sponsored and help facilitate a liquid capital market. These loans boast favorable terms and are suitable for various multifamily properties. Eligibility for these loans requires a strong track record and previous experience in multifamily ownership, especially if the intention is to self-manage the property. The following are the pros and cons of GSE loans:

Pros

1. Majority of loans offer full non-recourse terms with bad-boy carve-outs (exceptions applied in cases of borrower fraud or intentional bankruptcy)
2. Offers competitive fixed and variable-rate terms
3. Flexible prepayment penalties 

Cons

1. Loan processing for small properties may extend beyond 3 months, with larger deals potentially taking even longer
2. Mandates strong sponsorship; typically requires sponsors to have a net worth equivalent to at least 100% of the loan amount, excluding personal residences.

Bridge Loans: Bridge loans, as the name suggests, are short-term financing options the bridge the gap between a property purchase/refinance and more permanent financing. These loans are Ideal for investors seeking quick funding or renovating properties before securing long-term loans. The following are the pros and cons of GSE loans:

Pros

1. Offers short term funding (6 months to 3 years)
2. Funding tends to be quick
3. Flexible terms 
4. Can be used to bridge the gap between two transactions

Cons

1. Higher interest rate due to the short-term nature and increased risks of these transactions
2. There are less lenders doing bridge loans than traditional loans

Construction Loans: Multifamily construction loans are a type of financing specifically designed to fund the development or renovation of multifamily properties, such as apartment buildings or condominium complexes. These loans convert into permanent financing upon project completion. The following are the pros and cons of construction loans:

Pros

1. Construction loans can be tailored to fit certain project

Cons

1. Higher interest rate due to the increased risks of these transactions
2. The underwriting process is complex 
3. It is more difficult to secure a construction loan compared to other loan types

Mezzanine Loans: Providing additional financing on top of primary mortgage loans, mezzanine loans cover equity requirements or fund value-added improvements. These loans function as a hybrid of debt and equity financing and typically lack physical collateral, making them unsecured. When senior debt doesn’t cover the cost of a purchase or development project, investors can use mezzanine loans to bridge the gap. Mezzanine debt assumes the second-ranking position within the capital stack, following all other existing debt obligations but preceding all equity investments. The following are the pros and cons of mezzanine debt:

Pros

1. This is a cheaper form of financing then raising equity from family offices or private equity firms
2. These types of loans are flexible
3. Mezzanine loans can be longer term

Cons

1. Mezzanine loans are more expensive than bank debt
2. Since these lenders take a greater risk due to their place in the capital stack, they often have warrants/contingencies tied to their money

Conclusion

By understanding the features, benefits, and considerations of each type of commercial multifamily loan, you can make informed decisions that align with your investment goals and financing needs. Consulting with a mortgage broker specializing in commercial real estate is highly recommended as their expertise often provides valuable insights and guidance throughout the loan selection and application process. That said, I trust that this blog post has helped you learn more about what types of loans are available to multifamily investors and the situations that they apply to. 

If you have any questions regarding the terms and concepts in this post or previous ones, please reach out to either me (tedi.nati@jpacq.com) or someone on our team so we can help explain further. If you’re interested in investing with us at JP Acquisitions, you can contact us via our contact form, by emailing a member of our team, messaging us on LinkedIn, or signing up for our investor portal to set up a meeting.

As always, I hope you enjoyed reading this post as much as I have writing it. Best of luck!