Financing Your First Multifamily Investment: Tips for New Real Estate Investors
By Jason Malabute, CPA and full-time real estate investor
Know the Local Market
One of the most important things to keep in mind is that the type of commercial loan you get should be matched with the real estate cycle. Real estate is hyper-localized, meaning that what works in one market may not work in another. That’s why it’s essential to have a deep understanding of the local real estate market and its dynamics.
Here are two cautionary tales for first-time real estate investors:
- Applesway Investment Group defaulted on its loans due to rising interest rates and the declining value of its multifamily properties in Houston.
- Veritas Investments defaulted on a $448 million loan on 62 older apartment buildings in San Francisco, which had been securitized into two CMBS by Goldman Sachs. The loan was originated during the free-money era, and investors eagerly piled into it without considering the possibility of much higher rates.
Both examples illustrate the importance of being conscious of the investment property loans you take out based on the current real estate cycle.
Real estate values can fluctuate rapidly in an environment of rising interest, and cap rates decompress in the oversupply or recession phase of the market cycle, putting borrowers in a precarious financial situation.
As an investor, you should talk to several agency loan brokers, lenders, and local community banks to be informed of best loan option you should use. Remember not all lenders are the same.
Not All Lenders Are Equal
Let me tell you a quick personal story that illustrates that not all lenders are equal. I once invested in a property in Indianapolis for $40k and allocated $30k for rehab work. I estimated the property’s worth would increase to $80k after the rehab. However, my rehab budget unexpectedly increased to $38k, leaving me with a total investment of $78k.
After completing the rehab work, I had the property appraised, but the first two appraisals came back lower than I expected. The first appraisal was $62k, and the second one was slightly higher at $65k. I was disappointed, but I didn’t give up.
I reached out to other local investors for advice, and they recommended that I connect with a particular local bank. I followed their advice and contacted the bank to request a third appraisal. The new lender also recommended a new appraiser.
The third appraisal came back at $85k, which was more than my initial projection of $80k. I was ecstatic! Moreover, the new lender offered me a lower interest rate than my old lender.
This experience taught me the importance of networking with multiple lenders. Different lenders may have varying perspectives on the same deal and offer better terms and rates than others. Additionally, some lenders may have better connections with local vendors, which can be beneficial in the long run.
When it comes to real estate financing, there are several options available, including agency loans, community bank loans, and bridge loans. Each type of loan serves a different purpose and choosing the right one can be critical to the success of your project. Let’s take a closer look at each type of loan and when it might be appropriate to use them.
Types of Loans
Agency Loans
Agency loans are issued by government-sponsored entities such as Fannie Mae, Freddie Mac, or the Federal Housing Administration (FHA). These loans are usually long-term, fixed-rate loans with low interest rates and favorable terms. They are typically used for the purchase or refinancing of multifamily or commercial properties. Agency loans are ideal for borrowers who have good credit, a stable income, and are looking for a long-term financing solution.
Community Bank Loans
Community bank loans are issued by local banks or credit unions. These loans are typically smaller in size and have a shorter term than agency loans. Community banks often have more flexibility in their underwriting criteria and can be more willing to work with borrowers who have less-than-perfect credit or are financing a unique property type. Community bank loans are a good option for borrowers who need a smaller loan amount and value personal relationships with their lenders.
Bridge Loans
Bridge loans are short-term loans that are often used when a real estate deal won’t qualify for traditional financing due to high vacancy rates or the property needing significant rehabilitation. These loans are secured by the borrower’s current property and can provide the necessary funds to make a down payment on a new property or cover renovation costs. Bridge loans can be an excellent solution for real estate investors who need quick financing to take advantage of time-sensitive opportunities or to overcome financing challenges. However, it is important to note that bridge loans typically have higher interest rates and fees compared to traditional financing options, so borrowers should carefully consider their ability to repay the loan before moving forward.
When choosing a real estate loan, it is essential to consider your specific needs, the property type, and the financing terms. Agency loans are ideal for long-term financing of multi-family or commercial properties, while community bank loans are best for smaller loans or unique property types. Bridge loans can provide short-term financing to take advantage of time-sensitive opportunities. Always consult with trusted team members to determine which option is best for you.
Building Relationships with Lenders
With experience, I have come to realize the importance of establishing solid relationships with established commercial lenders. One such lender that I have built a great relationship with is Old Capital. I have made it a point to attend their weekly webinars for about a year now and have had their lending broker as a guest at my meetups. This relationship has allowed me to stay up to date on rates, loan terms, and loan to value on agency debt.
Additionally, I have established a strong relationship with a mortgage broker from District Capital who is able to provide me with a second quote on rates and terms on agency loans specifically in my Midwest markets. This has proven to be invaluable as it allows me to compare loan options and select the best one for my investments.
When I visit my markets, like Kansas City, I make it a point to take my local community bank lender out for lunch so we can meet in person, and he can give me an update on the local lending market. This allows me to build a personal connection with my lenders and establish trust. More importantly, it allows me to show them that I am a real person and am serious about doing business with their bank in their market. I explain to them the projects I’m working on and my business plan. I make it a point to get their feedback, as it is essential for building a long-term relationship.
As we face uncertain economic times and a possible recession, it is more important than ever to strengthen our relationships with commercial lenders and build new ones. This can involve attending industry events, connecting with potential lenders through social media, or simply reaching out to local banks and credit unions in the markets where we are looking to invest.
As lending standards tighten, access to debt and equity will become increasingly challenging. Therefore, having a network of lenders who trust and believe in our business model is what will separate us from unsuccessful multifamily investors. By continuing to build strong relationships with our existing lenders and exploring new opportunities, we can ensure that we have the necessary resources to close deals and grow our portfolios, even during difficult times.
Key Principals Are Key
Having a key principal is critical when securing commercial lending for a multifamily deal. A key principal is an individual who has a personal guarantee on the loan and typically has a net worth equal to or greater than the loan amount. Lenders require key principals to ensure that someone is personally accountable for the loan. Additionally, key principals often have established relationships with lenders, which can be incredibly valuable when trying to secure financing. I make sure to stay in regular contact with my key principals, calling them every month to catch up and provide updates on my deals. This helps to build a relationship of trust and ensures that they are up to date on my progress as an investor. Having a strong relationship with a key principal can make all the difference in securing the necessary financing for a multifamily deal.
How to Raise Equity to Finance Deals
As a multifamily investor, I know that on top of building relationships with commercial lenders, it’s also essential to be able to raise equity to finance deals. Having access to capital is critical to success in this business. But how do you raise capital from private investors? It comes down to three phases: know you, like you, and trust you.
Phase 1: Know You
The first phase is getting potential investors to know you. It’s the most important step because people can’t like or trust you if they don’t know you. To spread brand awareness, I have been a guest on multiple podcasts, written blogs, and hosted a monthly local meetup. These activities allow me to connect with potential investors and share my story, experience, and investment philosophy.
Phase 2: Like You
The second phase is getting people to like you. To accomplish this, I post regularly on social media about my multifamily journey, sharing insights and updates on deals I’m working on. I also send potential investors monthly newsletters, updating them on the latest industry trends and my progress as an investor.
Phase 3: Trust You
The final phase is getting investors to trust you. This is achieved by building a personal connection with them. I call my investors every month to catch up on their lives, what’s going on with them, and provide updates on the deals I’m working on. These conversations help to build a relationship of trust and demonstrate my commitment to transparency and honesty in all aspects of my business.
It’s crucial to be confident that you can secure a loan and raise equity when you find a deal. Having a reliable network of investors who trust you and believe in your business model is key to being able to act quickly when opportunities arise.
Conclusion
In conclusion, as a multifamily investor, building relationships with commercial lenders is crucial, but it’s equally important to be able to raise equity from private investors. By following the phases of know you, like you, and trust you, we can build a network of investors who are committed to supporting our business goals. This allows us to take advantage of opportunities in the market and grow our portfolios with confidence.
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