Interested in Multifamily Financing? A Mezzanine Loan Might be For You
In a recent article, we wrote about how financing is still available for multifamily investors. An article published this week in National Real Estate Investor (NREI) online demonstrates that not only is financing available, but certain loans are popping up more frequently. Working with mezzanine lenders is an option for those who want to invest in multifamily properties, and according to NREI, there is a lot of competition between these lenders which creates opportunities for the borrower.
The NREI data says that with so many mezzanine lenders getting into the game, you'll have plenty of options for this type of loan – which you may take out beside your main mortgage on the property. The lenders' competition is good for borrowers: interest on these loans is relatively low, although short-term interest rates are rising. These lenders are also offering what NREI calls “creative terms” as well as the highest leverage that banking rules permit. There may be some pitfalls with the amount of mezzanine lenders trying to one-up each other - NREI quotes one source as being worried that competition could also lead to bad underwriting.
These loans are also extremely important for some. NREI notes that with banks offering less financing for apartment construction, apartment developers use mezzanine financing to make up the difference. They cite bank financing as covering only 60-65% of apartment construction cost for a new development. The article says that “adding a mezzanine loan to the capital stack can help push the level of leverage much higher.” There are new regulations that add some turmoil to the process: capital requirements may view some loans as risky if the investor doesn't add his/her own equity equaling 15% of the project, and other regulations value that land at the sponsor-paid price but ignore if the land has increased in value. According to NREI, the US House of Representatives is looking to revise the land-value regulation but the Senate hasn't yet weighed in.
Mezzanine loans often skate to the edge of regulation limits, but the majority of multifamily construction loans do have some mezzanine financing. The loan amount is limited by how mortgage payments compare to income the property will earn. According to the article, lenders want to see a debt- service coverage ratio of 1.20x. Yet, since competing lenders have driven interest rates down, the amount of mezzanine debt a property can support has gone up. NREI cites interest rates as low as 750-1,000 basis points over LIBOR for new property development mezzanine loans. Lenders may offer 350 basis points for loans to purchase existing property and re-position it. The article gives one example of lenders using favorable terms: like a loan in which the borrower pays little to nothing during construction, and the interest accrues and adds to the mezzanine loan to be paid off by permanent financing.
According to NREI, smaller banks instead often offer preferred equity loans compared to mezzanine financing. They can function the same way, and many financial institutions offer both types. Yet mezzanine lenders can seize the property if the loan defaults, which is why according to NREI, preferred equity providers want yields 100-200 basis points higher than interest rates on similar mezzanine loans. Mezzanine loans can be a good option for a borrower and with many lenders competing you won't have trouble finding options; however, take care in choosing a lender and be cautious in using one who is new to multifamily lending. You can take advantage of lower interest rates and generous offers but in a worst case scenario, a mezzanine lender could take advantage of seizing your property if the loan defaults. If you choose to invest in multifamily property, a mezzanine loan can make up the difference you need after typical financing but be sure to find a lender and loan that are the best deal for your project.