Freddie Mac vs. Local Commercial Bank Loan for Small MF

15 Replies

Hi BP members:

What's your thoughts on doing a Freddie Mac vs. local commercial bank loan for a small MF apt (acquiring a 30 units apt)?  Freddie Mac loan has its own advantage obviously (non-recourse, fixed rate, 30 year amortization), but it has more stringent qualification requirements, higher closing cost (origination fee, other report like PCA which is not required by local bank, etc), and prepayment penalty (this could be a plus or minus since future buyer can assume the loan depends on how you see it). On the other hand, the local bank (I'm already a client for another loan) has less stringent qualification requirements but it's floating interest rate (based on prime rate), personal guaranteed, and only 20 year amortization. What would you prefer the better option to go and why? Thanks in advance

@Brandon Yuan

It sounds like you have a pretty good understanding of the Freddie and bank products. I would say the choice will depend on your pressure points, and that may be deal specific. Are you okay with recourse and lower leverage to have lower up-front costs and a flexible prepay. Are you looking for good cashflow with a 30 year am? Are you on the cusp of qualifying for Freddie and may have some headaches getting that box checked? All things to consider.

Its also a relationship play. Getting in with Freddie bodes well for that relationship and future deals, as it does with a local bank; but the bank can only lend in your footprint, may have a cap on an individual borrower etc. In my experience, borrowers move into agency financing after 3-4 deals with their bank(s) and as they start to do larger deals.

You understand the pro's and con's of both so I would get with a mortgage broker (or do it yourself since you already know the bank) and compare the quotes side by side. Run your proforma on both and then make a decision.

@Brandon Yuan My preference would be to go with the non-recourse option, but again, reiterating @Conor Freeman , it really depends on your risk tolerance as well as other factors such as what you are planning to do in the future with the property as well as other properties.

@Brandon Yuan another way of doing it is to purchase the property with local bank and refinance to long term agency debt once the asset is re positioned. 

this way you lock it in long term and when non recourse it goes off your balance sheet.

Originally posted by @Conor Freeman :

@Brandon Yuan

It sounds like you have a pretty good understanding of the Freddie and bank products. I would say the choice will depend on your pressure points, and that may be deal specific. Are you okay with recourse and lower leverage to have lower up-front costs and a flexible prepay. Are you looking for good cashflow with a 30 year am? Are you on the cusp of qualifying for Freddie and may have some headaches getting that box checked? All things to consider.

Its also a relationship play. Getting in with Freddie bodes well for that relationship and future deals, as it does with a local bank; but the bank can only lend in your footprint, may have a cap on an individual borrower etc. In my experience, borrowers move into agency financing after 3-4 deals with their bank(s) and as they start to do larger deals.

You understand the pro's and con's of both so I would get with a mortgage broker (or do it yourself since you already know the bank) and compare the quotes side by side. Run your proforma on both and then make a decision.

 Thanks @Conor Freeman for your comment. Do you think good relationship with a specific local bank proven more valuable than with loan agency, or vice versus? 

Also one of my main concern is the prepay penalty on Freddie Mac loan which then lead to selling the property with assumable loan in future. I get that with the upward trend of interest rate this could actually be a plus for future buyers a few years down the road, but is that a fairly accurate assessment? Some may argue that it actually may limit potential pool of buyers because some may find it challenging to qualify. How are deals with assumable freddie mac loans perceived in the market? 

Originally posted by @Jeff Kehl :

@Brandon Yuan for me, the big difference is 20 vs. 30 year amortization. It makes a very large difference on your cash-flow. 

 Yes true. not to mention it have a year or two of interest free option which would also help the cash flow additionally in the first couple of years, especially if you have to spend a bit time/money to stabilize the property..

but other factors together make this less straightforward .. sometimes i wish I just need to consider one thing to decide lol

Originally posted by @Hadar Orkibi :

@Brandon Yuan another way of doing it is to purchase the property with local bank and refinance to long term agency debt once the asset is re positioned. 

this way you lock it in long term and when non recourse it goes off your balance sheet.

 hmm interesting point.  this particular deal is fairly stabilized and there's no crazy uplift on the rent vs expense. so it may not make sense to refi in relatively short term. i'd still expect moderate growth and better control of cost though in the long run

then if it’s over a million of loan balance you may want to consider Freddie Mac small Ballance loan.  Do you have a broker for these? 

@Brandon Yuan  

In my opinion, I would go with banks since in this business, banking relationship really matters unless your loan is above 2m. 

There are banks like Green bank or City bank that would do 25yr amortization for the loan given strong relationship. 

Originally posted by Account Closed. Yes I know some local banks can go up to 25 yrs. the one I worked with only do 20 yrs for this amount of loan (they may do 25 if loan is bigger, may be $2MM+).

Do they typically do floating or fixed? the one I work with typically do floating just slightly above prime rate. for a few local banks I talked to they at least want around 2 points above prime if fixed (6%+) and they can't compete with Freddie Mac's rate...

I'm leaning towards Freddie Mac loan on this deal for a)30 yr am b) locked interest at relatively low rate for 7 years or 10, c) interest only for first year or 2, and d) fixed rate as it appears we are in an upward market for interest

You're not likely to find anyone wanting to assume a Freddie SBL because you can't get a supplemental on it. If you're looking to sell it within just a couple of years then get a bank or bridge loan instead. If you're looking to hold longer than that then get a step-down prepay so it won't hit you too hard if you do sell before the term is over. Or just model it into your returns that you will have some prepayment. Either way you should always try to get the right loan for your business model.

I love the rates from Freddie Mac small balance loans ($1m to $6m), however, local knowledge can be a problem.  For my current purchase which closes hopefully this Friday, they evaluated my cap rate by taking a 1 mile radius around the property.  Not a good approach for downtown Boston where they were mixing B's and C's with my property's A location.  Once I told them to work within a tighter range they quickly saw the acceptable cap rate should be lower.

I'll take this hand-holding though because I'm saving approximately 0.50% to 0.75% off the mortgage rate which makes a huge difference with the tight margins these days.

@Brandon Yuan

I think @Michael Le makes a great point. Assumptions are valuable to a future buyer if the rate is lower and they have the ability to add a supplemental. Freddie SBL is one of the only agency products that does not offer a supplemental and that is why you may be limiting your pool of future buyers. As Michael mentions, your decision should be based on your hold time and your business model.

Outside of SBL (Fannie DUS, Freddie Conventional) assumable loans are perceived well in the market. I'm working on a $12.5mm Fannie deal right now where my borrower is refinancing at 75% LTV on a 10/30 with plans to sell it through an assumption in 6-12 months. A future buyer can use get as many supplemental loans as they want as long as it conforms to the original loan docs (less than 75% LTV, greater than a 1.25x DSCR).

To your last point, relationships are important across the board. If you plan on growing your portfolio in multiple markets across the country, the sooner you get something done with the agencies the better. If you're staying local, continue to build the bank relationships.

@Brandon Yuan , you haven't told us what your business plan is. Are you planning on holding this long term (7+ years) or will you be wanting to exit in a couple of years? 

If you are planning to hold long term, going with a Freddie loan might be the better option because you can get a locked in rate for 7, 10, or 12 years in addition to the interest only payments, non-recourse debt, and 30 year amortization.  

If you plan on selling only after a couple years, going with a local bank could be a good option. True you will sacrifice cash flow and typically you'll only get a 5 year term (most cases) but the upside will be that you may not have a pre-payment penalty and you'll have the opportunity to pay down on the principal in the first couple years (vs the IO loan).

Ultimately it depends on your business plan.