Real estate investors typically use small apartment loans to purchase property that can generate cash flow, appreciate in value or earn capital gains. If you’re looking to secure financing for the purchase or refinance of a small apartment complex you may find yourself inundated with numerous batches of information on various programs that are available to you. Let’s go over some loan options that can help you invest in one of the most profitable areas of real estate, multi-family real estate investing.
GOVERNMENT-BACKED APARTMENT LOANS
Government-Backed Apartment Loans are loans backed by FHA, Fannie Mae or Freddie Mac. These government agencies are helpful when financing small apartment loans.
Many lenders refuse to finance properties that carry loan amounts below one million dollars making it hard to find financing for smaller complexes. Most government-backed multi-family loan programs can finance properties as low as $750,000 and some FHA loan programs can finance apartment complexes as small as two, three or four unit properties with as little as three percent down payment. FHA backed loans are offered in both fixed and variable rate options.
Government-backed multi-family loans are not the easiest to qualify for and do have some restrictions that vary from agency to agency. Some programs restrict an investor from purchasing property outside of where they live, referred to as “Local Ownership”. Other programs, like Fannie Mae, will back loans with a minimum of 20% down payment and as low as $750,000. With Fannie Mae, the interest rates are typically fixed for the term of the loan and can range from 5-8%. Fannie Mae requires a minimum FICO score of 680.
In contrast, Freddie Mac will only go to as low as $1,000,000 on the loan amount and the rates are usually only fixed for a five to ten year period. The Freddie Mac program requires the same 20% down that the Fannie Mae product requires but shares a lower FICO score requirement of 650 with the FHA programs.
Fannie and Freddie closely mirror each other in regards to many aspects and along with FHA are great loan programs. They do however carry some disadvantages. First, what works to get an approval with one lender could end up yielding a denial on another program. This could make the qualifying process difficult. That is when It’s beneficial to have someone in your corner that understands the difference in programs and what is needed to qualify. Make sure who you are talking to is apprised to advantages or disadvantages to each program.
Second, a real estate investor who likes to leverage their rental properties to add to their portfolios may not like the terms offered from conventional financing due to the long term prepay penalties. Some conventional financing can carry prepay penalties that go as long as ten years, with a reduction of 1% per year. Investors looking for shorter term prepay penalties and easier ways to qualify can look at our next option to obtain their apartment complex financing.
PRIVATE MONEY APARTMENT LOAN FINANCING
Private money loans are loans that are not government backed. They are loans made by private banks that don’t have to adhere to restrictions from outside entities. These banks call their own shots and ultimately can lend on whatever they want if they feel the project or property is a good investment.
Private money costs more than conventional, carries a higher rate sometimes too, but private money sometimes becomes the only option especially if you are in the smaller loan amounts. Private money loans can fund as low as $100,000 and as high as $30,000,000. Private loan terms can vary because of the vast number of private money loan programs available. It’s typical to see terms as short as 6 months to as long as 8 years. They commonly require 20-25% down and prepay penalties generally go to three years. Rates generally range from 6% to 10% depending on the project or property and a borrower’s FICO score and credit history. Private money programs can finance borrowers with as low as a 580 FICO Score. They can do this because they control the criteria and guidelines by which they lend money and each project or property is underwritten and offered terms based on the risk involved not so much the borrower’s past credit history.
Private money apartment loans are typically less common for apartment complex purchases because investors who purchase apartment complexes, generally do so for the purpose of long term investment. Investors who might want to rehab, renovate or build new construction, will typically use private money loans to complete the project, then go on to permanent financing.
Private money is also good for investors who are purchasing property and want to close quickly and with less hassle during the underwriting process. Private money loans have a streamlined underwriting process that generally moves quicker than the conventional programs we touched on earlier. Once you’ve been approved and your purchase is complete, you can obtain permanent conventional financing at the end of your private money loan term. This sometimes works to the advantage of some investors in many ways;
Let’s say John buys a 5 unit apartment complex in the city. He buys this complex for a purchase price of $1,000,000. His loan is a 5% interest only with a three-year term. John goes about his business for the next three years, paying on time and taking care of the property. At the end of that three years, he is delighted that his 5 unit apartment complex has increased in value by almost 35%.
This becomes advantageous to John because recently he has been approached by a realtor friend of his about a distressed 8 unit complex that is coming up for sale. John would need $200,000 for a down payment and another $50,000 for repairs. John, at this point, recognizes his opportunity to leverage his asset in order to obtain another property. John, refinances his 5 unit, leveraging the $250,000 that he needs to purchase and rehab the 8 unit property. With this refinance he goes into a permanent conventional loan on his 5 unit and does another temporary loan on the 8 unit. He does this because he knows that after the rehab is completed on the 8 unit, it will appraise higher than when he originally purchased the property, and he may be able to leverage that property in the future. Conventional loans sometimes carry prepay penalties that can go as long as 10 years depending on the program. John likes to be free from long prepay penalty provisions with at least one of his rental properties, just in case he may need to leverage them to add to his portfolio.
Private money loans are also ideal for fix and flip investors. Many fix and flip investors find themselves competing with “All cash buyers” who can close quickly and without hassle. Private money loans are easier to qualify for and close quickly. They allow investors that can’t buy with cash to compete in a very competitive marketplace without having to put a strain on their finances. Private money loans are also right for investors who need to season a property before refinancing into a permanent loan. This is especially needed in new construction situations.
Both conventional loans and private money loans are great ways to finance apartment complexes. Each has advantages and disadvantages depending on the type of investor you are or what stage you are in with your investing career. With the right strategy, anyone can become a successful real estate investor and build wealth. Make sure the advice you are getting from your team is the best advice for your situation. Give us a call to let us know about your specific situation, we can help you form a plan that fits your real estate investment goals.