BiggerPockets

New Loan Documents – Fannie Mae Multifamily Loans

Wednesday, April 06

If you have not already heard Fannie Mae is in the process of changing their loan documents.  This is the first major rewrite of Fannie docs in about 10 years and this is a substantial change from previous documents, both in form and content.   Since Fannie is one of the largest multifamily lenders and anyone financing a property is, or should be, getting a Fannie quote, you need to understand these changes. 

Ok, before you fall asleep or click off this article because this is legal stuff and that’s your attorney’s responsibility and you really don’t care, take a moment.   While this stuff is a little dry, it’s important.    Anyone refinancing a small or larger property should be looking at a Fannie loan as a possibility and you need to understand the terms you are getting before you start the loan process.   If you wait until your attorney gets involved it’s too late, you have already spent your due diligence funds and may even have already signed a commitment tying you to the deal.  So take a minute and continue reading.

Fannie Mae is the largest GSE lender and the only one really covering the full range of multifamily loans from small properties owned by local owner/operators to large ones owned by institutional investors.   These new loan documents affect all of these borrowers and, at least for now, these are one size fits all documents.  Fannie Mae documents are available on the Fannie multifamily web site.   Finding the documents is a bit daunting, because Fannie has so many  different programs and there are many versions of each document, but be patient and look around and you will find all the documents.   They were scheduled to go into effect on April 1, 2011 (could this have been an April fool’s day joke), but their adoption has been proponed till June 1^st.   Hopefully to address some of the negative  issues we will discuss below.

So what are the changes?  Well I am not an attorney and have not compared the documents side by side, but I have been at a couple of presentations by attorneys and DUS lenders who specialize in Fannie lending and these comments are the results of their comments.   If you want to know the full scoop please consult with your attorney.  The biggest change in the documents is structural.  Instead of signing a bunch of separate documents where the business terms are hidden thought they have streamlined the documents.  You still have to sign a note and security instrument (that’s a legal necessity) but these are stripped down and the main terms of the loan are in a new document which is a exhibit to the multifamily loan and security agreement. 

The loan agreement, covers the basic business terms of the loan and how it works.  This is a better approach and much more consumer friendly allowing anyone to read and understand the document and determine the terms of the loan.   While the documents are still legal speak, they are more understandable then older documents and the Schedule 2 listing the terms is very easy to read and understand.  Also, by using this approach Fannie Mae has eliminated many of the documents that were previously signed and incorporated them into this document.    There is no longer a separate repair or replacement reserve agreement. It’s a much simpler approach and one which I would hope other lenders follow. 

This is nice for privacy reasons given the loan agreement is not a recorded document so it’s private between you and your lender.   Of course many terms of your loan are still available because most agency loans are securitized and some information on securitized loans is in the public domain.  However, that information is harder to find than information recorded at the local title office.

These structural changes are interesting, but what has really changed.  One big change is in defaults where Fannie has identified different types of defaults and assigned different cure periods.  They have the “automatic events of defaults” sort of the big items like nonpayment, failure to maintain insurance, etc. which you can’t do under any circumstance and other types of defaults which you can’t do, but which have a 30 day notice and cure period as well as an extended discretionary cure period.  This gives you some flexibility and time if you inadvertently do break one of these covenants.

Other items on the positive side relate to certain items which were considered “standard” or easy to request modifications to the old documents.   As someone who is not scrutinizing the documents you now get the benefit of these items without asking.    You can now convert the borrowing entity type for tax or estate purposes, certain transfers are now allowed without Fannie approval (mainly to and between existing partners) and some commercial leases can now be negotiated and renewed without lender approval.  I bet you did not know you needed their approval for any new commercial lease you sign.   Also, the borrower now has a 60 day cure period for certain liens on the property and there is also more flexibility with settling small insurance claims.  Borrowers, in most cases, can now settle an insurance claim under $50,000.

On a negative side Fannie has modified and increased some of the non-recourse default provisions.  The non-recourse loan is now full recourse for environmental items, claims related to the repair or replacement escrow and other indemnifications given by the borrower on the loan.   Additionally, recourse springs if there is fraud, willful misconduct, etc, by not just the key principal (as has been standard for 20 years), but by officers, directors, members or shareholders.   If you are signing a springing guarantee you are now responsible for your partners’ acts so make sure you know who they are.  As a guarantor you also have additional, but more limited, liability for loss or damage relating to failure to maintain proper insurance, complying with reporting requirements, misappropriation f rents as well as some other items.  These changes are not unusual and I am told are in line with Freddie Mac documents, but they are still more stringent than current documents. 

Other notable changes you will see as negative relate to mezzanine debt which is now banned whether it’s secured or not and more concerning to me, reporting requirements.  The new documents call for not only annual reporting of the properties performance and borrower financial condition, but now any key principal or guarantor can be asked for their financial reports on an annual basis.   This is new and can be intrusive, especially for smaller owners.  The documents also give pre approval for the lender to obtain credit reports, whenever they want, on any borrower, key principal or guarantor.       I understand there may be some blanket waivers of some of these reporting items for small loan borrowers, but for now its part of the new docs.

While these changes are interesting the reality is you probably will accept any documents they require to get the loan as long as the business terms are what you want.    With the exception of payment and some other items you really don’t concern yourself with loan documents.   If you make your payments then most non-monetary defaults will never be found or addressed.  However if for some reason you do go into default and need a workout or you want to ask the lender for a favor such as an assumption or release of minor collateral, these non-monetary defaults might be found and effect your  situation.    Therefore it’s important to know and understand the full terms of the loan so you can make sure you don’t run afoul of their covenants and restrictions.  Or, at least if you do, you understand the limitations and risks you are taking.

If you are interested in discussing these changes further or have an apartment property you are looking to finance, please give me a call at 847-421-2217 or visit my blog at www.mfloan.com.

Fannie Mae Small Multifamily Loans - Demystified

Wednesday, February 09

During the economic crisis of the last two years many banks that traditionally made loans to owners of small apartment properties have either left the business or cut back on lending.  This has left many owners of small apartment properties with limited borrowing choices.  One lender that has stuck with the small multifamily market and even expanded their outreach is Fannie Mae.  A number of Fannie Mae DUS lenders have embraced this program and its being marketed by almost every loan broker/banker in the country.   This program is different from bank loans that most owners are familiar with and many of the brokers/bankers who are selling the program don’t really know how it works.    Hopefully this article will explain some of the issues with these loans and make it easier for you to evaluate these loans.

First lets talk about who makes these loans.   These loans are made by one of a few select small loan lenders and then are either sold to Fannie Mae or are sold as Fannie Mae guaranteed mortgage-backed securities.  Because Fannie either buys the loans or guarantees the bonds backing the loans they must follow Fannie Mae guidelines.   According to the Fannie Mae web site there are 12 Market Rate Small Loan Lenders.  However, not all of these lend in every market and many are really not active in lending today.  My experience shows that there are really 4-5 lenders who are actively pursuing this business.  These lenders predominantly work through mortgage bankers/brokers and do not work directly with borrowers.

Let’s take a brief look at the program.  The basic program terms (listed below) are very similar to the standard Fannie Mae DUS program.  These are long-term fixed rate balloon mortgages with excellent rates, but a harsh prepayment premium. 

Loan Amount:                         $500,000 – $3,000,000 ($5,000,000 in major markets)

Loan Term:                              5, 7, 10 or 15 year terms

Amortization:                          Typically 30 years, but shorter amortization is available

Loan to Value Ratios:             Up to 80% LTV, but 75% is more typical

Debt Coverage Ratios:            Over 1.25x, based on a floor underwriting rate

Pricing/Rates:                          Risk based pricing based on the properties LTV and DSCR

Personal Recourse:                  Non-recourse is available in major markets, but recourse is sometimes required.  Recourse is typically required in other markets

Prepayment Premium:             Typically Yield Maintenance;  Step-down prepayment premiums are available for a cost.

While these are the basic terms, it must be understood that these terms are not offered on every deal or in every market.   Most lenders are only interested in making these loans in major metro markets.   Loans are available in smaller markets, but typically on more conservative terms and not with every lender.  Also, while Fannie Mae has guidelines some lenders are more conservative than Fannie and won’t make certain loans even if they fit the guidelines.  Others stick to the letter of the law and won’t ask Fannie for a waiver of the guidelines when it might be warranted. 

The Process - The first thing to understand is that these loans have a process and they require a bunch of documentation.   These lenders do not issue a commitment or lock rate until all the reports are in and all the underwriting is complete.   However, once the commitment is issued rate lock and closing can be done quickly.    As a general overview of the process the lender will review some basic information about the properties historical income and the borrower’s financial situation and then issue a quote or application.  This application will not guarantee the borrower anything, but is an indication of what the lender believes they can do.  If the borrower likes the quote they will sign the application and provide the lender with an application deposit.   The lender will request a number of other documents from the borrower and will order the appraisal and other reports.  Once the reports are in and the borrower has submitted all the required documentation they will complete their underwriting and issue a commitment.    Total time from application to commitment is typically 45-60 days.  After the commitment is accepted and the borrower posts a good faith/rate lock deposit (1%-2% of the loan amount) the lender will lock the rate and quickly close the loan.

The biggest issue in the process is the amount of paperwork that the lender will request.  They will ask for organizational documents, personal financial statements, copies of bank statements, real estate schedules, property income and expense statements for 2-3 years, trailing 12 month income and expense statements (though you can get away with just income), copies of leases as well a numerous forms.  These are required and there really are no shortcuts.  You need to give them this information when they ask for it in order to get your loan.   On a positive side they don’t require tax returns which most banks require.   The process will go smoother with a mortgage broker/banker who has experience with this program and if you have a good attorney who is brought on board at the beginning.  However there is no way to eliminate the paperwork or process.  Just go with the flow and know that in the end you will get a good loan.

Rates - The rate is determined by a number of factors including the LTV and DSCR (based on the actual rate or a floor underwriting rate) on the property as well as the loan size and term.  Because of this you may get different quotes from different lenders depending on how aggressive they are in both their preliminary (quoting) underwriting and in their final underwriting.  Some lenders will be much more aggressive on their preliminary underwriting in order to get a borrower to sign an application, but may not deliver that quote at commitment.  The rate may also consist of pricing add ons for different features or fees to the lender or broker.  There are also pricing add ons based on loan size with smaller loans having higher prices.  It is hard to determine what add ons have been charged and if the lender or broker is taking excess premium (up front income from sale of the loan).   If you ask your broker/banker about the rate build up, they should be able to give you an idea of how the rate is created. 

Since the rate on these loans is not locked until after commitment the rate can change.  When getting a quote a lender will give you the current rate as well as a spread on the loan.  While the spread is not locked it should not change much during the process.  Having the spread allows you to track the rate.   If, when you get the commitment, the spread is different than on the quote you should ask about this to understand the differences and what occurred.

Costs - The transaction costs on these loans vary by market and lender.  The processing of these loans costs lender almost as much as on a larger Fannie Mae loan.    The lender must pay for their staff, an appraisal, physical needs and environmental reports and lender legal.    These costs often run well over $10,000 per loan.   Some lenders are taking a deposit at application and charging actual costs of the appraisal, engineering report, and lender legal to the borrower.  However, most are capping their fee at the amount of the application deposit and paying for any additional costs by increasing the rate.   Today most lenders are charging a deposit $4,500 in major markets and up to $8,500 in smaller markets.

In addition to the transaction costs on these loans you will have to pay for title, possibly a current survey and your own legal.   These costs vary by market and property.  The other cost of the transaction is the origination fee.   The lender themselves will charge some fee, but this is often built into the rate and is not identifiable.  However, the mortgage broker or banker showing you this loan needs to make a fee.  This can be paid as a direct fee or as additional rate into the loan.    Depending on the loan term, amount of fee being added and LTV the add-on can increase your rate by ½% or more.   I encourage you to ask the broker/banker if they are getting paid by the lender and if so how much the rate has been increased for their origination fee.  Typically brokers will make 1% of the loan amount (1 ½% for some smaller loans).  If you are getting charged more than that you should check around or give me a call.  Mortgage brokers/bankers should get paid for their work because they do provide you value, but that does not mean they should overcharge you for their services.

Underwriting - The underwriting of these loans is also a bit different than most small multifamily owners are used to.    The income and expense analysis is straightforward.  The lender looks at the current rent roll, adds in miscellaneous income and applies a vacancy rate to get their underwritten effective gross income (EGI).    Today lenders will be very careful to compare the EGI to historical collections and may ask for a trailing 12 month statement to show collections for the last 3, 6, 9 or 12 months.   If the trend is not favorable then the lender may underwrite a more conservative vacancy figure.  Expenses are underwritten based on the last full year’s expenses and what the appraiser says are stabilized expenses for the property.  Additionally a replacement reserve figure is underwritten based on the engineer’s estimate of replacement over the life of the loan.  This is typically $250-$300 per unit per year, but can be higher on older properties and is often the number most understated at preliminary underwriting.

The borrower and borrowing principals are also carefully underwritten by the lender.  They are looking for borrowers with FICO scores over 680 (over 720 is better) and who have strong financial strength.  Typically they want to see borrowers with a net worth greater than the loan amount and liquidity greater than 9 months of loan payments (principal and interest).  This was recently raised from 6 months.    Lenders will verify liquidity by requesting bank statements and will only consider liquidity they verify as legitimate.  The other borrower item underwritten is their global real estate schedule.  The lender will require a complete real estate schedule listing all properties, their current loans and current income and expense.  They will analyze the borrowers’ global cash flow and make sure there are no properties with either risky ballooning mortgages or significant negative cash flow.

One additional item to consider in underwriting is the engineering report/analysis.  Each lender has someone look at the physical condition of the property.  This may be an engineer or just a property inspector.  This person will determine what items at the property are not in good condition and need to be repaired or replaced.  They will also estimate the costs of capital improvements over the term of the loan and thus the replacement reserve used in underwriting.   This is probably the biggest difference between this type of loan and a typical bank loan.  Be prepared, the lender may make you repair/replace some items before closing or within a few months of closing.   This does not mean you are running a bad property; it’s just that they are looking at this as a loan for a long term and want to make sure there are no life-safety issues that could cause a problem and that the property is maintained in good condition.  One way to avoid this issue is to make sure the property is in its best condition before an inspection and to know about the property so any questions that occur are answered quickly and thoroughly.

Why this loan - With all these requirements why should I even consider this loan.  Well the main reason is a long-term loan at very low fixed rates.   Most of these loans are for 10 years with the rate fixed for the term of the loan.  There are not many lenders willing to offer long-term loans on smaller properties.  Also, the rates are very attractive.  For most of 2009 the rates being offered on these 10 year loans were a good 1/4% lower than rates on 3 or 5 year loans being offered by banks.  And for shorter term loans such as a 5 year loan the rates are often ¾%- 1% lower than bank offerings.   The real bargain if for lower LTV - higher DSCR loans where the risk based pricing offers very low pricing.  Additionally, today many banks are only lending 70%-75% LTV while these loans are typically 75% LTV, sometimes up to 80%.

The second reason is these are often non-recourse loans.  Banks are almost always recourse lenders.  This means if the deal fails and you default on the loan they can go after your personal assets to pay the loan (this varies based on local law).  On a non recourse loan they can only take the property leaving all your other assets protected.  This is especially important for someone with investors and therefore does not own the whole property. 

From my perspective the biggest negative of these loans is the prepayment premium.  These loans almost always carry a yield maintenance prepayment premium.   I won’t explain how that works here, but let’s just say it means you should not expect to pay off the loan until shortly before it matures.   You can pay it off, but the premium (penalty) may be very high.  Smaller owners are used to a step-down prepayment premium.   This way you know the amount of the prepayment premium and you have some flexibility if you want to sell.   Such flexibility is nice, but it comes at a cost.  If you want a long-term loan and this type of rate this is the cost of obtaining it.  These lenders can offer you a step-down, but the rate is much higher.   The loan still allows you to sell the property and have the new owner assume this loan, so you are not totally stuck, but your flexibility is limited.

 Things to watch –

• Understand the quote before you decide to take the loan.  Talk with your broker and make sure you are considering all the issues when comparing this to another quote.  One item to evaluate is that these loans are quoted with an actual/360 calculation so the rate is not fully comparable to a 30/360 quote from a bank.  Another issue is many of these lenders quote the loan on just the DSCR.  They don’t cut the loan quote based on value, but state the maximum LTV for the loan.  Make sure you are comfortable the value that is needed before you start the process.

• Know the costs of the deal.  If you have to give a deposit of more than $4,500 in a major market or $10,000 in a smaller market you should know why.  Also, make sure the costs are capped or spelled out.  Finally, manage your own costs.  While I believe you need an attorney to close one of these loans, they should understand that the documents are not negotiable so don’t waste time, and money, trying to negotiate them.

• Understand the rates/spread.  There are lots of premiums being included in these loans to pay for the transaction costs and to make sure the lender is adequately compensated for their work.  However, this leaves opportunity for lenders and brokers to overcharge you for your loans. Fannie does have some rules limiting the amount of premium, but don’t leave it all up to them, do your own work and ask about premiums.

•  Know the lender you are dealing with.  All of the lenders participating in this program are not the same and each treats things differently.   Some will push for and can get waivers from Fannie and some wont.   I suggest you work with a broker/banker who has experience working with more than one of these lenders so they can advise you as to which lender is best for your individual situation and property.

This article tries to explain the main issues and with this program, but there are lots of features and issues that I did not address.  If you have more detailed questions on this program or want to discuss any specific deal please shoot me an e-mail at aklingher@mfloan.com or give me a call at 847-421-2217.

Yield Maintainance Prepayment Premium – Should I worry?

Monday, January 17

The question I get most asked is how does yield maintenance prepayment penalty work and should I be worried about it.    This is especially true for borrowers who had previously borrowed from banks and are now looking at a loan from Freddie Mac or Fannie Mae.    My short answer is that this is not something to worry about, but if you are taking a loan with yield maintenance you should not expect to pay it off until close to maturity because you will have a significant prepayment penalty. 

First what is yield maintenance (YM)?  It’s basically a calculation that guarantees the lender will receive the interest payment from the loan for the full term of the loan (or yield maintenance period).  The idea is that if you pay back the loan early, the owner can reinvest the proceeds from the money you return to them, plus the penalty amount in safe treasury securities and receive the same cash flow as they would by holding your loan.   

How is YM it calculated?   All YM is not calculated exactly the same, but the general principal is the same.   Basically it’s the difference (spread) between the note rate and the current yield on a specific treasury security that has the same remaining term as the loan (this is called the reinvestment rate).   This spread is multiplied by the remaining term and then discounted back to current dollars.  A rough way of determining the penalty is to subtract the treasury rate from a security with the same remaining term as the yield maintenance period (usually the loan term less 6 months) from the note rate.  Then multiply that spread by the number of years left in the loan and multiply that by the loan amount.  This result will be slightly higher than the actual prepayment penalty because we have not discounted the payments, but it should be close. As a kicker most YM loans have a 1% minimum prepayment penalty even if the calculation results in no penalty.

Some people say with rates this low you do not need to worry about a YM prepayment penalty because when rates rise the spread will be reduced or eliminated completely.  The problem with this analysis is that as time goes on the remaining term of the note goes down.  So you are comparing your note rate to a treasury with a shorter term.  As long as there is a yield curve the rate on shorter term securities are less than on longer term maturities.   This has the effect of increasing the spread between the note rate and the corresponding treasury. 

To see if you really need to worry about YM we need to look at some real life examples.

The above chart shows a typical $1 million loan being offered today.    The chart shows examples of 5, 7 and 10 year loans with a payoff in year 3, 5 and 7.  The assumptions are that rates stay the same, increase by 1.5% from current rates, increase 3% from current rates or they return to the average rate for the last 10 years of a similar term treasury security.  We can run these numbers with many different assumptions, but I think these assumptions show the trend.

As you can see under most circumstances you will have a prepayment penalty even if there are only a couple of years left in the loan term.  With 2 years left on a 5 year loan you will have a 1% prepayment premium even if rates rise by 3% from current levels.    Of course many people think rates will rise more than 3% and be higher than historical averages.   If that is true then you might not have any prepayment penalty.  If you think rates will rise higher then these assumptions then the question to ask is, will the corresponding treasury rate will be higher than the loan rate when I want to prepay.  If the answer is yes they you will only have the minimum 1% to pay.  

The analysis shows, you should expect a penalty for most of the life of the loan, but because rates are relatively low today the prepayment penalties are not outrageous.   You should not expect to pay the crazy prepayment premiums we here today.    Under most circumstances you will have a prepayment premium of a few percent of the loan amount not the 20% of loan amount you hear today.   

If I am going to pay a prepayment penalty and sometimes a big penalty then why should I choose a loan with YM?  The answer is twofold.  First on most long term loans (over 5 years) there really is no option.  YM or something like it is required on almost all loans.  The second reason is that by guarantying the owner of the note that they will receive their interest for the life of the loan they are offering you the best rate.  Typically rates on loans with YM are 50-100 Bps lower than similar loans with step-down or more flexible prepayment penalties.    

The two biggest concerns about a YM loan are what happens if you sell the property or need to pull out more cash.     However, most lenders who make loans with YM (Freddie and Fannie included) allow for their loans to be assumed by a qualified buyer.   This means you can sell the property and just have the buyer assume the loan.  Also, Freddie and Fannie have programs that will allow them to lend you additional proceeds in the future in the form of a second mortgage.   There are restrictions and it does not always work, but it is there for some circumstances.   Selling the property that has a low interest rate mortgage may even boost your value if the financing is assumable and the rate is below the levels a buyer can get in the current market.

While I think the rate trade off for a YM loan is reasonable and would choose a YM loan because of the lower rate there are a few things to consider.   First, don’t just choose the longest term you can, try to match the loan term with the term you intend to keep the loan.  Second, look at all features of the YM prepay.  You need to look at the term of the YM as well as the amount of free time with no prepay.    Most calculations are for a YM period of 6 months less than the loan amount, but some run the full term of the loan.  Also, most YM loans call for only 3 months at the end with no prepayment premium, till then the 1% minimum is in place.  Finally it’s possible to buy a shorter term YM on a loan, say 7 years of a 10 year loan.   There is a cost to this, but depending on your real estate strategy the cost might be worth it.  

In general you have little choice on your prepay if you want the lowest rate.  However, you should understand the loan you are getting into.  If you have any questions please talk to your real estate finance advisor or visit us at www.mfloan.com.