Adam Klingher's Blog

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 web site at https://www.efanniemae.com/mf/loandocs/index.jsp   
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.

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.

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 than bank loans that traditionally have lent to small owners 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 to Wall Street.  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. 

In the good old days, before the collapse of the CMBS market and partial failure of the banking system, interest only (I/O) loans were everywhere.  Banks were offering them, Life Companies were offering them, and Conduits were putting them on practically every deal as were Freddie and Fannie.   And it wasn't only partial I/O, for the first year or two of the loan term; it was full term I/O, for the life of the loan.  The thought was that I/O improved the cash flow for the investor and with cap rates running at historic lows this extra cash flow was needed to support the value.  If you had to pay amortization then you could not support the debt service and still get a reasonable return.  Anyway, principal payments aren't tax deductible so why pay them.   No one cared about principal pay downs because the values of these properties were going up so there was really no refinance risk.  

How times have changed.  For the most part banks have pulled back from I/O loans and, in fact, have generally shortened their amortization schedules.  The standard for banks doing apartment loans now is a 25 year amortization schedule.  Some banks are willing to stretch their amortization schedule to 30 years for a good deal or client while others are shortening the amortization to 20 (or even 15 years) for more risky loans.  Conduits have disappeared and most Life Companies are hiding from new loans, but Freddie and Fannie are still lending and still offering I/O.

First let's talk about what they are offering.  Since both lenders have become more conservative they have also pared back their I/O offerings.  For 5 year loans, I/O is only available on lower LTV/higher DSC loans and typically for only the first 2-3 years of the loan term.  To get the full term, 5 years I/O you need to be 55%-60% LTV.   For 7 year loans the story is not much different, but a 65% LTV loan (in a good location with a good borrower) will probably be able to get full term I/O.  On 10 year deals (which are most of what Freddie and Fannie do) 2 years of interest only payments are available on most loans.   However, in order to get full term I/O you need to have a very strong DSC.

You hear in a lot of places that the only commercial loans available today are for apartments.  Apartment loans are available especially for larger apartment project (over $5 million) where the agency lenders, Freddie Mac and Fannie Mae, and HUD are keeping the market going.  These lenders are offering very aggressive rates and in some cases aggressive loans.   HUD loans are still available up to 85% LTV and Freddie and Fannie loans are available in the 75%-80% LTV range in most markets.  However, Freddie and Fannie do not generally service the smaller loan market.  You can get a loan from them in the $3-$5 million range, but only if you find the right correspondent lender.  For loans under $3 million its very tough to get a Freddie or Fannie lender interested in talking to you at all.

So for smaller properties is there capital still available?  Thee quick answer is yes.  Owners of properties under $5 million still have choices.   There are fewer choices today compared to last year, but of coarse who has more choices today when compared to last year.  There are still some banks lending and some Fannie lenders are offering loans to borrower needing between $1 and $3 million.  

Over the last week my office called over 100 banks in the Chicago area looking to see who is lending.  We found 21 banks (about 20%) who said they were willing to consider new loans.  A slightly smaller survey earlier in the year found almost 50% of the banks we called saying that they were lending.   Additionally many of these lenders who said they were looking to make loans were offering terms so onerous that I would not really consider them in the market.   These banks were only willing to do amortization schedules of 20 years or less and/or requiring LTV's under 60%.  The rates offered had a wide range with some offering rates slightly below 6% and others being at 7.5% or higher.  In reality fewer than 10 loans were really looking for new loans and wanted to compete for new business.

Earlier today the census bureau issued a press release on second quarter residential vacancy and homeownership.    The report stated that residential vacancy has increased to 10.6%.   Based on this report the public press announced that residential vacancy was at an all time high.   This is true, but unfortunately this does not really tell the story.  You have to look farther into the data to see what's really happening. 

First the 10.6% vacancy is for all residential housing (single and multifamily) and not just multifamily housing.  For Multifamily (properties with over 5 units) the data is much worse.   The census multifamily vacancy shows at 12.1% eclipsing the historical high of 12% from Q2 2004.  This is truly a scary number, but I am afraid it's not going to drop for quite a while.    If you look at the long view of the data you see vacancy has generally increased over time.   And the volatility of vacancy has been relatively high over the last few years.

On June 18th Freddie Mac finalized the sale of the first securities under their new Capital Markets Execution (CME) program.    These securities were backed by over $1 billion in multifamily loans secured by 62 multifamily communities across the country.     The securities consisted of a variety of classes each having different cash flow rights and different risks.  The securities were sold to a variety of investors including large money managers, life insurance companies and pension funds.  Does this sound familiar?  It should, it's very similar to the CMBS business that is in so much ill repute.  However, while this is similar, it's also different in some critical ways.

The reasons this is not your typical CMBS is because it's being issued by Freddie Mac with all that backing that implies and more importantly these loans were underwritten to current, relatively strict, standards.  These are all multifamily loans and most of the securities have the backing of Freddie Mac, giving them, in my opinion, the risk of a government security.     For the security holder these do not have the risk of typical CMBS, but it does have some of the same characteristics.  The issuance and acceptance in the market of these securities shows that the capital markets are still interested in securities with the cash flow peculiarities of CMBS.   This is an important first step in re-opening the capital markets to commercial real estate loans, particularly on the multifamily side.

Borrowers who never considered FHA/HUD are now being told they need a FHA/HUD 223 (f) loan.  However, most borrowers, and brokers who are selling this product, don't understand the issues relating to these loans.   The 223 (f) is FHA/HUD's acquisition/refinance program for conventional apartment projects.  With limited sources for apartment financing today, this program is being pushed by most mortgage brokers and bankers as the way to refinance your apartment project.

To get a complete, but very dry, description of the program visit the HUD web site at http://www.hud.gov/offices/hsg/mfh/progdesc/purchrefi223f.cfm.   The summary of this program states that "Section 223(f) insures mortgage loans to facilitate the purchase or refinancing of existing multifamily rental housing."  So first things first, this is not an FHA/HUD loan, because HUD does not lend money, FHA provides insurance on the loan allowing the lender to sell a security to fund the loan.  So while FHA/HUD underwrites and approves the loan they do not fund it.  It's really the original conduit loan. 

FHA/HUD underwriting, loan terms and restrictions are not like conventional loans.  They look at the numbers differently and limit loans based on things other than just LTV and DSC.   Because of this you really need to deal with someone who has experience in HUD lending and knows how to process your loan.  There are many approved FHA/HUD lenders and a list can be found at the HUD web site.  Some lenders are just small shops and some are FHA/HUD departments of national or regional mortgage bankers.  As long as they are a lender who annually processes a large number of FHA/HUD multifamily loans you should be OK, but make sure they are active lenders because some approved lenders only dabble in multifamily lending and only do a few loans a year.   If you don't know of a good FHA/HUD lender give me a call (847-421-2217).

Over the last month the 10 year treasury rates has moved up by over 30 Bps.  At the same time spreads on Freddie and Fannie multifamily loans have dropped (more for Freddie than Fannie) easing some of that upward interest rate pressure on multifamily loans.   Where they are going from here is any ones guess but many people believe this upward pressure will continue. 

In the long run we must all agree that rates will go up.  Treasury rates are at very low levels from a historical perspective.  They have maintained this low level because of the recent credit crisis, a flight to own safe treasury securities and government intervention to keep rates low.   At some point this must end.   I maintain that rates will not increase for, at least, a few months, but I have been wrong many times in the past.

You hear a lot today that, with the exception of FHA-HUD, the GSE lenders (Freddie Mac and Fannie Mae) are the best, maybe only, lenders in today's multifamily market.  This isn't really true, but its often said.  However, with the exception of a sales call, there's very little discussion of the best way to access GSE capital. Today we will address that issue. 

Let's start with the basics. First, Freddie Mac and Fannie Mae do not make any loans.  They are not direct lenders and, by law, cannot make new loans. They buy (or credit enhance) loans or pools of loans from approved lenders. For multifamily loans these approved lenders are called DUS (delegated underwriting/servicing) lenders for Fannie Mae and Program Plus lenders for Freddie Mac. There are not many of these lenders and a list of approved lenders can be found at Freddie and Fannie's web sites. Some lenders represent both Freddie and Fannie and some just one or the other. 

Second, the two agencies are very different in how they treat their lending partners and how they underwrite their deals.  Fannie, for the most part, allows the DUS lenders to make decisions on the loans they buy and Freddie makes their own lending decisions.  Fannie lenders also take part of the risk on the loan and in exchange for taking some of the risk they are allowed to make lending decisions. Underwriting is mainly done inside the lenders company with their own staff and not with Fannie Mae staff.