The best loan options for apartment property investors depend on the investor's individual needs. Generally, HUD, Fannie and Freddie loans, and CMBS financing are the most popular options. Bank loans are also an option, but they may not always have the best terms. For more information, investors should explore beyond their local bank to learn of their other financing options.

HUD loans are insured by the Department of Housing and Urban Development and are available to borrowers who meet certain income requirements. Fannie and Freddie loans are backed by the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation, respectively. CMBS financing is a type of commercial mortgage-backed security that is backed by a pool of commercial mortgages. Bank loans are typically recourse loans with a 5-year adjustable-rate term and a 25-year amortization.

For more information, investors can visit Small Apartment Loans: The Best Options for Borrowers and How to Purchase an Apartment Property.

The advantages of MLS financing for apartment properties include:

• Flexible terms and conditions
• Competitive interest rates
• No prepayment penalties
• No reserves required
• Ability to include secondary financing (i.e. mezzanine debt or preferred equity)

The disadvantages of MLS financing for apartment properties include:

• Can be expensive (up to 20% for some borrowers)
• Not allowed by all lenders
• High fees and additional legal costs
• Strict enforcement of prepayment penalties
• Higher closing costs
• Dishonest tranche ratings can have serious negative effects for borrowers and investors
• Less autonomy in the operation of the property and limited flexibility to deviate from the terms of the loan documents.
• Difficulty in releasing collateral.
• Expensive to exit.
• Lock outs often prevent prepayment or up to two years.

The most common types of apartment loans are conventional loans, Fannie Mae Fixed-Rate Loans, HUD loans, Fannie and Freddie loans, and bank loans. Conventional loans are typically offered by banks and other financial institutions, and are often used to purchase or refinance existing properties. Fannie Mae Fixed-Rate Loans offer a variety of fixed-rate terms between 5 and 30 years and allow LTVs up to 80% and DSCRs as low as 1.25x. HUD loans are insured by the Federal Housing Administration and are typically used to finance affordable housing projects. Fannie and Freddie loans are offered by Fannie Mae and Freddie Mac, and are typically used to finance larger multifamily properties. Bank loans are typically offered by local banks and offer a 70-75% LTV, full recourse loan with a 5-year adjustable-rate term and a 25-year amortization.

Sources:

• Fannie Mae
• Multifamily Financing: Your Comprehensive Guide
• How to Purchase an Apartment Property

In order to get a multifamily loan, you would first need to get approved. Approval criteria varies with different lenders and loan types across programs, but in general, borrowers will need to have good credit (660+ is typically expected) and between 25-30% of the total loan amount as a down payment. Additionally, the property itself will need to have a debt service coverage ratio or DSCR, of 1.25-1.30x. This means that the building’s income will need to exceed its annual debt service by at least 25-30%. Skin in the game is equally important in most cases, but that does not mean first time investors are automatically overlooked.

Throughout the loan application process, borrowers will also need a significant amount of documentation, including an appraisal and other required third-party reports. Borrowers will typically be expected to pay for all of this themselves. The required documentation and reports generally include:

• Appraisal: An appraisal attempts to denote the current market value of a property. Appraisals are typically required to be conducted by a professional appraiser currently licensed in the area in which the property is located. Appraisers will generally use a combination of methods, including:
  • The income approach, which estimates the value of a property based on its income.
  • The sales comparison approach, which estimates the value of a property based on recent sales of similar properties nearby.
  • The cost approach, which estimates the value of a property based on the estimated cost to rebuild it, plus the value of the land, and minus any depreciation.
• Property Condition Report/Physical Needs Assessment/Engineering Report: This report observes the physical condition of an apartment property to determine when specific components will need to be repaired or replaced. The report is used to calculate required replacement reserves (funds set aside each year for expected future repair costs). These reports can be requested by a variety of apartment lenders, but are more commonly required for lenders originating HUD multifamily and Fannie Mae/Freddie Mac multifamily loans.
• Phase I Environmental Assessment: A Phase I Environmental Assessment (ESA) examines the area of a property for environmental issues, such as contamination, that could pose a threat to current/future residents or the surrounding community. This could possibly escalate to Phase II and Phase III ESAs if issues or evidence of contamination have been found in the initial Phase I assessment. Phase I ESAs are not always required by lenders, but in most cases are.
• Title Report: Like with the purchase of a single-family home, a title report will make sure that there are no legal claims to a property’s title that could supersede your own.
• Property Survey: A property survey records the boundaries of a property, as well as determining any easements and or other title issues that could impact the property’s use or profitability. This is not always a requirement by lenders, especially if a report is available from the past several years, however, it is more commonly required when potential title issues are found or even suspected.
• Seismic Report: Reports generally only required in areas where earthquakes are common, such as Southern California.
• Zoning Report: May sometimes be required when there are potential issues or confusion around the zoning status of a property.

Using an MLS for apartment property financing can be beneficial for a few reasons. First, it can provide a great idea of the prices and selection in a particular geographic area. Second, leverage for most agency loans goes to 80%, with up to 75% for cash-out refinances, which is slightly more generous than most banks or CMBS lenders. Third, agencies generally offer long amortizations (with lots of flexibility), and some loans even offer fully-amortizing options. Finally, rates are typically quite low with this type of financing, as the risk for lenders is somewhat limited.