Over 350 investors attended the Old Capital Speaker Series event April 26th in Grapevine with Mark Dotzour. Here are my takeaways from his presentationRead More
The obvious and immediate impact of rising interest rates are:
1) Increase borrowing cost for investors. Post-election the 10 year treasury increased 60bps from 1.75%-2.35%, which increased borrowing costs from 4.40% to 5.00% on a typical 10 year loan.
2) Decreased leverage as loan proceeds are typically maxed out at 1.25x debt service coverage. Most Fannie Mae loans do not lock an interest rate until a week before closing. Due to higher debt service, loans originally sized at 80% LTV were cut back to 75% LTV.
Both of these changes drive investor returns lower as 75-80% of their capital stack (debt) is more expensive, and a larger percentage of their capital stack is coming from equity.
If these were the only factors of multifamily valuations, then higher interest rates would lead to lower multifamily values in 2017. However, we have to understand the underlying causes of the interest rate increases to better gauge how valuations will be impacted.
Why did interest rates move upwards in Q4 2016?
President elect Trump has promised tax cuts and higher infrastructure spending. Both of these items are going to increase inflation so bond investors demanded a higher yield on the 10 year treasury, which drove the yield up 60 bps.
Let’s look at how the underlying causes of the interest rate increases might raise the value of multifamily properties:
1) Infrastructure spending leads to more jobs, which leads to higher demand for housing and thus higher rent and occupancy.
2) Tax cuts leads to more investment dollars available, which leads to higher demand for multifamily properties and thus Lower cap rates.
As you can see the immediate impact of rising interest rates negatively impacts values through higher borrowing costs and decreased leverage, but the underlying causes of these interest rate increases might benefit multifamily valuations in the long term through more jobs and more investment dollars available for multifamily properties.
It is hard to say whether multifamily values will continue to rise in 2017, but one thing is clear that as multifamily investments continue to generate cash on cash annual returns of 8-10% the demand for these investments will continue to be strong due to their 2x-3x return relative to other asset types.
If you have any questions about your next refinance or acquisition, please contact James Eng at 214-300-5035 or firstname.lastname@example.org.
Fannie and Freddie continue to lend in today’s environment:
By: James Eng, Senior Director Old Capital
Begin with the end in mind. How are you going to exit your investment? What challenges will your buyer encounter when you sell the property? If there is a market downturn, does your debt allow you to ride out the storm?
This article will look at three investment strategies and the ideal debt for each strategy.
Value Add- Fix, Lease Up, Sale/Refinance. Investment horizon: 2-3 Years
Property needs a capital infusion to cure deferred maintenance, change the tenant profile, and bring down units to market. These will not qualify for conventional agency financing due to low occupancy and large amount of rehab needed.
A bridge loan will work well with this type of acquisition, as the lender will give you rehab dollars to bring the property up to market. Typical terms are: 75% Loan-to-cost, 5 year fixed, 4.50-5.00%, 20-25 year amortization, and recourse under $5MM in loan amount. Benefits of this loan are you can roll a large amount of rehab into the loan and have no or a small prepayment penalty once the asset is stabilized. Disadvantage of a bridge loan is that at the end of your loan term, there is balloon payment where the entire principal balance is due. If the financing market is not as liquid as it is in today’s market, it might be difficult for you to sale or refinance the property. In order to avoid the balloon, some bridge lenders allow you to have a fully amortizing loan by allowing you to float the interest rate after the initial fixed rate of the loan.
Yield Play- Limited deferred maintenance, improve operations. Investment horizon: 7-10 Years
Property is above 90% occupancy, no large capital projects are needed, and tenant profile is where you want it.
Agency loan (Fannie Mae or Freddie Mac) works well with this type of acquisition, as you can fix the interest rate for 5, 7, 10, or 12 years with 30 year amortization and the loan is non-recourse at interest rates of 4.25%-4.75%. In addition to very favorable terms upfront, if the value improves significantly in the first 2-3 years of your ownership there is an opportunity to take additional debt through a supplemental loan. Disadvantage of these long term loans are if you decide to sale the property, the new buyer will have to assume your loan or you will have to pay a very large prepayment penalty called Yield Maintenance.
Hybrid- Well occupied, but upside available through light capital improvements (under $5,000/unit). Investment horizon 5-10 years.
In this scenario, you have 2 options: Bridge loan or agency loan.
Bridge loan brings more risk as it is recourse (under $5MM loan amount) and has a loan term of only 5 years, but there is no limited prepayment penalty when you exit or refinance.
Agency loan is less risky as it is non-recourse ($1MM or above), locks in the interest rate for up to 12 years, and gives you the option of a supplemental loan, but there is a large prepayment penalty if you sale the property early in the loan term. If you do not want to pay the prepayment penalty, the buyer can assume the loan, but they will be capped at 75% LTC and typically not get as much interest only. Due to the challenges of an assumption you have to sale the property at a discount compared to offering it free and clear.
As you can see there are many things to consider when matching your debt with your investment strategy on your next multifamily acquisition, Old Capital provides multifamily debt for all 3 investment scenarios and can be your advisor on your next deal. If you have any questions about your next refinance or acquisition, please contact James Eng at 214-300-5035 or email@example.com.
By: James Eng, Senior Director Old Capital
What determines if a multifamily is a Class A or B or C? Is it the location, the year built, the property and unit amenities, the building characteristics, tenant base, etc..? In this article, I am going to walk through what makes determines what class a property is, what they are trading for in today’s market in DFW, and who is lending on each type of property.
Typical submarkets: Uptown, East Dallas, Plano, Frisco, McKinney
Year built: Late 1990’s-Present
Amenities: Structured or garage parking, gated, pool, clubhouse, fitness center, 9 ft ceilings, stainless steel appliances, faux wood flooring, granite counter tops, 2 inch blinds, and tile back splash
Building characteristics: Pitched roof, individual HVAC and water heater, and washer/dryer connections. Avg. SF of units 900-1,100 SF.
Typical tenants: White Collar professionals earning over $75,000
Sales price per unit: $125,000-$200,000
Lenders: Non-recourse financing at very low rates (under 4.00%) is available for these properties as life insurance, agency, and local banks have no problem lending on Class A properties as they are very stable.
Typical submarkets: Richardson, Carrollton, Irving
Year built: 1980’s-1990’s
Amenities: Covered parking, gated, pool, clubhouse, fitness center, 8 or 9 ft ceilings, black appliances, faux wood flooring, refinished countertops
Building characteristics: Pitched roof, mostly brick exterior, individual HVAC, boiler or individual water heater, and washer/dryer connections. Avg. SF of units 800-1,000 SF.
Typical tenants: Blue/White Collar professionals earning over $50,000 annually
Sales price per unit: $65,000-$95,000
Lenders: Non-recourse financing at rates near 4.50%-5.00% is available for these properties as agency and local banks are comfortable lending on Class B properties.
Typical submarkets: Garland, Irving, Arlington
Year of construction: 1960’s-1970’s
Amenities: Surface parking, no perimeter fencing, no clubhouse and very small leasing office, 8 ft ceilings, white appliances, carpet, 1 inch blinds, laundry rooms
Building characteristics: Flat roof, Chiller for HVAC, Boiler, No washer/dryer connections. Avg. SF of units 600-800 SF.
Typical tenants: Blue Collar supporting service industry earning $30,000-50,000 annually
Sales price per unit: $40,000-$65,000
Lenders: Non-recourse financing available for experienced owners through agencies and CMBS. Recourse financing through local banks for inexperienced owners.
Most properties do not have all the characteristics listed in each class. As an investor, you have to look at all the components together and decide what class the property currently is and what it can become. Some aspects of a property you cannot change, but other things you can improve to take a property from one class to the next.
I help investors in all 3 classes of multifamily on the lending or equity side of the transaction. I can be reached at 214-300-5035 or you can send me an e-mail at firstname.lastname@example.org.
By: James Eng, Senior Director Old Capital
After deciding that you want to become a multifamily investor, the next decision you have to make is how you are going to actually invest in multifamily properties. The 3 most common ways of investing are: Independent rental owner, lead partner/general partner, or limited partner. Each of these ways of investing has its advantages and disadvantages. Depending on your current personal balance sheet and current job, will determine which of these ways will be the most beneficial for you.
Independent rental owner: Individual with strong balance sheet looking to own their own properties without partners
- Ability to control investment and make decisions based on your personal situation
- No general partners or limited partners to answer to
- Ability to roll capital gains from one investment to the next utilizing a 1031 exchange
- Depending on amount of capital, might not be able to acquire enough units to leverage full economies of scale
- Must sign as guarantor on loan
- Must find, negotiate, close, and manage the property
- Concentrated risk in a small number of properties
- Must spend time learning to be asset manager/property manager
Example: Doctor purchases 25 unit property for $1MM. He invests $250K as a down payment and takes out a recourse bank loan for $750K. He must personally sign recourse for the loan. Due to the small number of units, he either self manages the property or pays a high management fee of 7%-10% of income.
Lead Investor/General Partner: Individual who puts deals together by leveraging other people’s money and 3rd party property management to buy larger multifamily properties
- Earn acquisition fees, sponsorship equity, and/or larger return compared to cash invested in deal
- Control over property investment decisions
- Ability to leverage other people’s money to buy larger apartment properties
- No limit to the size of properties you can buy
- Leverage 3rd party property management
- Must sign on loan as guarantor
- Must spend the time to find the deal, negotiate the deal, raise the equity, and be asset manager of the property
Example: Lead investor acquires a 100 unit multifamily property for $5MM. Lead investor signs a non-recourse note for $4MM and raises the down payment of $1MM from limited partners. Lead investor might earn a 1% acquisition fee and/or 10% sponsorship equity for putting the deal together.
Limited Partners: Individual looking for truly passive income at a slightly lower return with diversification across multiple properties, general partners and markets
- Do not have to sign as guarantor on loan
- Do not have to find, negotiate, close transactions
- No day to day responsibilities of managing the property
- Receive monthly or quarterly distributions of cash flow with limited investment of time after initial due diligence at acquisition
- Receive same tax benefits in terms of depreciation as independent rental owner and lead investors
- Ability to receive benefits of economies of scale of larger properties
- Ability to invest across thousands of units with multiple general partners in multiple submarkets for diversification of risk
- Must spend time identifying and meeting lead investors
- No management control of property. Must rely on general partner to make day to day decisions
- Limited liquidity as general partner will make decisions about when to sell or refinance the property
- Lower return due to payment of sponsorship fee and/or sponsorship equity for general partner putting deal together
- Difficult to utilize 1031 tax deferred exchange as all members of the LLC must go to next transaction
Example: Retired corporate executive has $1MM to invest in real estate. He invests $50K across 20 separate deals with 5 general partners in 4 different markets: Dallas, Houston, Austin and San Antonio.
No matter which way you decide to invest in multifamily, Old Capital can assist you in getting started in all 3 ways. Feel free to reach me via phone or e-mail at my contact information below.
7460 Warren Parkway, Suite 100
Frisco, TX 75034
James Eng, Senior Director Old Capital
Before you purchase your first multifamily, you should ask yourself 3 questions to determine what type of loan you can qualify for:
- Is the property stabilized (yield play) or distressed (value play)?
- What is your ownership experience with multifamily (5 units and above) real estate?
- What is your net worth and liquidity?
Let’s take these questions one by one.
1. Is the property stabilized (yield play) or distressed (value play)?
Stabilized property characteristics:
- At least 90% occupied for the past 90 days
- No major rehab needed (less than $5,000/unit)
- Clean and accurate historical financials to show consistent income/expenses (no large income or expense swings)
Distressed property characteristics:
- Under 90% occupancy for past 90 days
- Large rehab needed (more than $5,000/unit)
2. What is your multifamily ownership experience?
- At least 12 months on multifamily ownership. Managing member or guarantor on multifamily property (5 units or more)
- No experience, but a lot of enthusiasm
3. What is your net worth and liquidity?
Net worth must be equal to or greater than the loan amount.
Liquidity must be a minimum of 10% of the loan amount in cash or marketable securities not including the down payment.
Assuming you meet the net worth and liquidity requirements:
- Stabilized Property + Experienced Operator= Non-recourse loan (Agency or CMBS)
- Stabilized Property + New Investor= Recourse loan (Bank)
- Non-stabilized Property + Experienced Operator= Recourse loan (Bank)
- Non-stabilized Property + New Investor= Recourse loan (Bank)
Typical Non-Recourse Loans terms:
- 75-80% Loan to Cost
- 5 or 10 year term
- 30 year amortization
- No personal guarantee of loan shortfalls
Typical Recourse Loans terms:
- 70-75% Loan to Cost
- 5 year term
- 20 or 25 year amortization
- Personally guarantee any loan shortfalls
If you are looking at acquiring or refinancing a commercial real estate property, give me a call at 214-300-5035 or send me an e-mail at email@example.com. To see recent deals I have closed they are highlighted here: https://www.linkedin.com/in/jameseng