Supplemental Financing Options for Apartment Properties
Learn about bridge loans, mezzanine loans, and preferred equity financing for apartment investing.
Exploring Bridge, Mezzanine, and Preferred Equity Financing for Apartment Property Investing
Information regarding conventional financing is typically readily available for apartment loan borrowers — but supplemental financing options often receive less attention. [Conventional debt financing]() is straightforward enough, and for many borrowers all it takes to get the process in motion is a trip to the local bank.
Conventional loans, however, are sometimes not capable of meeting all of a borrower's needs in particular situations. For example, the conventional loan process is simple in theory, but can be a drawn-out process in execution. Traditional lending is notorious for having a lengthy documentation, acquisition, and verification phase — and this can even delay the release of funds.
Landing in such a situation can seriously hurt a borrower's cash flow during a crucial time in the investment journey. This is where supplemental financing options come in handy. There are a few interesting ways for apartment and multifamily investors to leverage capital for their benefit.
Three of the more popular financing options investors tend to utilize for these purposes are
bridge financing, mezzanine loans, and preferred equity — all junior (second-tier) debt placement vehicles that combine debt and equity financing for securing and repaying a commercial real estate investment.
Bridge Loans for Apartment Investing
Bridge loans are often used as an interim solution when there isn’t adequate cash flow for the acquisition of a property. Bridge financing “bridges the gap” by allowing an apartment investor to be able to immediately execute the purchase of a property — while the primary lender performs the underwriting and processing for the primary financing vehicle.
Many traditional commercial real estate lenders offer bridge financing as well as other conventional offerings — but other sources of bridge loans can include venture capital firms and microfinance sources. While bridge loans are processed much like a standard mortgage loan, they tend to have much higher interest rates and loan terms of no more than six months on average.
Mezzanine Financing for Apartment Investing
Mezzanine financing is another prime example of supplementary financing. Mezzanine, after all, implies junior financing that sits above (supplements) a senior mortgage loan on an apartment property.
Mezzanine financing has an intricate structure (with relatively higher interest rates) that serves as a hybrid of both debt and equity — with features that both lenders and borrowers can find attractive. Borrowers get to enjoy tax-deductible interest, and in the event that a scheduled payment cannot be made, there is a chance for some interest to be deferred. Lenders are able to receive interest payments at monthly, quarterly, or annual intervals — and can sometimes receive purchasing rights to equity stake in the company. Equity in the property is the typical form of compensation in the event of borrower default.
In most cases, mezzanine financing can be restructured into additional senior-level debt at a lower interest rate.
Preferred Equity Financing for Apartment Investing
Preferred equity financing is incredibly similar to mezzanine financing. Both share the same supplemental role, but while mezzanine loans compensate the lender with an equity stake in the property in the case of a default — preferred equity rewards lenders with a stake in the company itself.
Preferred equity loans give lenders special or “preferred” equity rights to the borrowing company. The return on these preferred units are of the highest priority, and must come before any common equity distribution can be made to the company. Preferred equity investors even have the right to accelerate the repayment of the principal.
The terms of a preferred equity deal typically do not grant foreclosure rights to the lender like with conventional financing options, but there are certain contract clauses and verbiage that can transfer the managing control of the apartment property to the preferred equity investor.
What are the most common supplemental financing options for apartment properties?
The most common supplemental financing options for apartment properties are bridge loans, mezzanine loans, and preferred equity. Bridge loans are short-term loans that are typically used for properties that need to have fast cash for improvements that might be needed before a typical loan can be obtained. Mezzanine financing is a hybrid of both debt and equity with features that both lenders and borrowers can find attractive. Preferred equity is a junior (second-tier) debt placement vehicle that combines debt and equity financing for securing and repaying a commercial real estate investment.
What are the advantages and disadvantages of supplemental financing for apartment properties?
Supplemental financing options for apartment properties can be advantageous for borrowers who need additional capital quickly. Bridge financing, mezzanine loans, and preferred equity are all junior debt placement vehicles that combine debt and equity financing for securing and repaying a commercial real estate investment. These financing options can provide borrowers with tax-deductible interest, the potential for deferred interest payments, and the ability to restructure into additional senior-level debt at a lower interest rate.
However, these financing options also come with some drawbacks. Mezzanine financing typically has a higher interest rate than conventional debt financing, and lenders may receive equity stake in the company in the event of borrower default. Additionally, supplemental financing options can be more difficult to obtain than conventional loans, and the process can take longer.
What are the eligibility requirements for supplemental financing for apartment properties?
Eligible properties for HUD 241(a) supplemental financing must already be encumbered by a HUD-insured loan. Potential borrowers should review HUD's complete checklist of requirements before beginning the application process. The loan cannot exceed the property’s appraised value, and it is primarily for keeping multifamily units competitive in today’s market. Requirements should not exceed the existing terms of the underlying mortgage.
What are the best strategies for obtaining supplemental financing for apartment properties?
The best strategies for obtaining supplemental financing for apartment properties are bridge financing, mezzanine loans, and preferred equity. Bridge financing is a short-term loan that is used to cover the gap between the purchase of a property and the permanent financing. Mezzanine loans are a form of debt financing that is secured by the borrower's assets and is subordinate to a senior loan. Preferred equity is a form of equity financing that is subordinate to debt and senior equity.
These financing options are typically used when conventional debt financing is not capable of meeting all of a borrower's needs. For example, the conventional loan process can be a drawn-out process in execution, and this can delay the release of funds.
What are the most important factors to consider when applying for supplemental financing for apartment properties?
When applying for supplemental financing for apartment properties, the most important factors to consider are the loan-to-value ratio, debt service coverage ratio, credit history, collateral, financial state of the individuals behind the loan, historical financials, DSCR, loan ratios, expenses, and debt yield.
The loan-to-value ratio is the amount of the loan divided by the value of the property. The debt service coverage ratio is the building's income divided by its annual debt service. Credit history, collateral, and financial state of the individuals behind the loan are all important factors in determining an individual's creditworthiness for an apartment loan. Historical financials, DSCR, loan ratios, expenses, and debt yield are all important considerations when a multifamily mortgage broker arranges the financing for an apartment property investment.