Multifamily construction loans work as a means for developers to get the necessary funding to complete work on a commercial property.
Multifamily properties, such as apartment buildings, senior residential complexes, and student housing are some of the best ways to build a passive income. This is because the monthly rents coming from each unit in the complex are highly attractive to developers. However, to get a multifamily building in rentable condition, a significant investment must be made to building and improvement, leaving many developers unsure how to get started.
To successfully obtain funding, the developer must convey to the lending institution key financial factors, such as projected construction costs, developer’s assets, total income, and projected revenue.
It is important to note that multifamily construction loans are fundamentally different from single-family mortgages or typical home improvement loans taken out by homeowners. As a result, developers should consider the helpful information listed below to get a clear understanding of the ins and outs of multifamily loans.
How Do Multifamily Construction Loans Work?
Multifamily construction loans are a means for developers to secure the necessary financing to build, expand, and/or rehabilitate commercial properties, such as apartment buildings, senior residential complexes, or university housing.
As the cost of these properties typically runs into the seven figures or higher, significant capital is required to get construction underway—often more than the developer or development team has readily available. Therefore, developers must turn to lending institutions to secure financing.
Some general characteristics of multifamily construction loans include:
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- Large sums: typically at least $2 million for small properties, but loans reaching into the hundreds of millions for luxury condos
- Higher interest rates: lending institutions view multifamily construction projects as riskier than single-family mortgages, as there is less ability to seize a commercial property in the event of a default
- Often shorter-term: some multifamily loans can be for as few as six months, with standard repayment terms between 12 and 24 months after completion of the project
- Funds disbursed as you go: while single-home mortgages are disbursed in a lump sum, multifamily loans are commonly disbursed as construction is completed, up to the maximum amount of the loan
- Prepayment penalties: longer, more expensive loans can sometimes be obtained through life insurance companies. The downside is that these longer loans have prepayment penalties.
Types of Multifamily Construction Loans
There are several different ways that a multifamily construction loan may be used. Look through the following list to see which option makes the most sense for your project:
- Land Development Loan – This is a type of loan when a developer wants to make raw land construction-ready. Once developed, it can be used to establish multifamily properties. Land development loans can be used for things such as water, sewer, and electricity.
- A&D Loan – This is another type of land development loan, as it is used for raw land that is ready to be developed. It can also be used for run-down properties that need to be upgraded. An A&D loan will typically cover the purchase of the land and any building or renovation required to make the multifamily building construction-ready.
- Interim Construction Loan – This is a short-term commercial construction loan. It covers the cost of materials and labor and is typically good for 18 to 36 months. Based on these characteristics, an interim construction loan is an excellent option for renovation, remodeling, and rehabilitation projects.
- Mini Perm Loan – This is another type of short-term financing. It is a temporary loan used to settle outstanding construction on a multifamily property that, upon completion, will produce income. After up to seven years, a mini-perm loan is replaced with long-term financing.
- Construction-to-Permanent Loan – This is a long-term loan that would be used to fund the building of a new residence. It would provide the funding for the construction, and once the construction is completed, the loan would turn into a mortgage-type instrument in which rents collected from the property are used to pay down the loan’s balance.
Multifamily Construction Loan Rates
As mentioned, multifamily construction loans will be slightly higher than typical single-family mortgages, which currently sit at a national average APR of 3.34%. As of July 1, 2021, the rates for typical multifamily loan products are as follows:
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- FHA Commercial Construction Loan, Multifamily (3.49 – 3.89%): based on the 10-year U.S. Treasury rate. The rate is fixed for the life of the construction loan and for the full 40 years of the permanent loan.
- National Bank Commercial Construction Loan (3.79%): based on the 30-day LIBOR (London Interbank Offer Rate) rate, with rates changing monthly
- Life Company Commercial Construction Loan (4.25%): based on the 30-day LIBOR rate, with rates changing monthly
- Regional Bank Commercial Construction Loan (4.45%): based on the 30-day LIBOR rate, with rates changing monthly
- Community Bank Commercial Construction Loan (4.75%): based on the prime rate, with subsequent rate changes reflected by changes in the prime rate
- Private Debt Fund Construction Loan (6.5 – 8.24%)
- Hard Money Commercial Construction Loan (7.95 – 12.00%)
(Source: Apartment Loan Store)
Key Terms to Know for a Multifamily Construction Loan
There are several important terms and abbreviations developers must be familiar with when working with multifamily construction loans:
Loan to Value Ratio (LVR)
The loan to value ratio is the amount of funding provided compared to the project’s total value after the project is completed. Most loans will have an LVR of 80%, but some institutions will not offer more than 60%.
Say a proposed construction project is estimated to be worth $20 million. If the lender puts down $16 million, then the LVR will be 80%.
Loan to Cost Ratio (LTC)
Similar to the LTV, the LTC looks at the amount of financing provided compared to the projected cost of the construction itself. In most cases, the value of the completed project will be higher than the actual cost to complete the project, so the LTC will be higher than the LTC.
For example, if the cost to perform a construction project will cost $10 million, and the lending institution provides $8.5 million in funding, with the other $1.5 million coming from the developers in the form of the down payment, then the LTC will be 85%.
Housing and Urban Development (HUD)
HUD plays an essential role in protecting the residential housing market, with the government setting aside funds for things such as the building and development of multifamily complexes. It is important to know if HUD may impose any restrictions or offer an avenue of financing for your multifamily project, so be sure to research what is and is not permissible under HUD guidelines.
Where to Secure a Multifamily Construction Loan
There is a multitude of avenues developers can take to secure multifamily construction financing, including:
- Commercial Banks: this is a great place to turn for long-term, high-value construction projects, as commercial banks have deep pockets that will withstand adverse market conditions better than some other funding sources.
- Savings & Loan Associations: this may be a better option for smaller, community-centric projects, as S&Ls are prohibited from allocating more than 20% of their lending interests to commercial projects. However, they do offer some favorable terms, such as one-time closing, locked-in interest rates, and interest-only payments.
- Real Estate Investment Trusts (REITs): REITs are companies that own, operate, and finance income-producing projects. If the REIT is confident that a project will turn a profit, it may be quick to offer financing. However, as REITs are required to pay a dividend to their shareholders, you may be required to pay a portion of your profits to the REIT, even after the loan is paid off.
- Life Insurance Companies: this is a great place to turn to for loans above $5 million. Life insurance companies will offer long-term construction loans but, as mentioned, will assess prepayment penalties.
- Government Agencies: if your multifamily complex is deemed a HUD project, the government will be able to provide some attractive financing options.
How to Get Approved for a Multifamily Construction Loan
As with any type of loan, a formal application must be completed to determine the developer’s creditworthiness. Among the information the developer can be expected to provide in the application include:
- Projected cost of the project: the lender will want to see estimates on any land, labor, materials, and contractor costs expected for the project.
- Developer assets: the developer must be able to show that they have sufficient collateral to justify the size of the loan.
- Developer credit history: the lender will scour the developer’s credit rating and see if there is any other outstanding debt that may preclude the borrower from repaying a new construction loan.
- Total income: the developer must demonstrate proof of income to show that its current operations warrant expansion.
- Projected revenue: how much value will the construction add to the property? What can the developer expect to charge in the form of new rents upon completion of the work?
While multifamily construction costs can be steep, the developer is expected to submit a down payment, usually of at least 10%, but commonly 20% for many construction loans.
Although interest rates across the board are favorable in recent years, making financing construction an attractive option, getting approved for a multifamily construction loan is far from a slam dunk. Since the real estate crisis of 2008, lenders are performing more meticulous due diligence before handing out construction loans. The following points are some ways for developers to improve their chances for approval:
Secure an Experienced Development Team
Before handing out a loan, lending teams ask themselves: Can this development team do the job? As such, they will do extensive homework on not only the financial standing and track record of the lead developer(s) but also the competence of any architects, contractors, and property managers.
Lenders want to feel confident that the project will be completed on time, and the completed work will be well-positioned to do what it is intended to do. Therefore, developers should surround themselves with the most competent team possible to increase the chances of getting the most favorable loan terms.
Examine the Financial Strength of the Key Principal(s)
The principal is the party responsible for the loan. For many multifamily projects, this will be a conglomeration of multiple people, businesses, and entities, between whom there be little more than a tangential relationship. As a result, some developers go into a project without a clear idea of exactly who they are doing business with or who may be responsible should the project go awry.
It is best to be doing business with partners who have deep pockets. While a 20% down payment is standard, the more money you can place down, the better. Lending institutions usually want to see the principles’ net worth to be at least 1.5 times the loan cost, with a post-closing liquidity of at least 20% of the loan value.
The more favorable you can make these ratios going into the project, the better the chances of securing a quality loan. Remember, the greatest threat to a commercial lender is a project that does not get completed on time, causing rent collection to be delayed. Knowing that the principals have a sizable nest egg to fall back on dramatically improves the chances of approval.
Be as Close to Breaking Ground as Possible
Construction lenders can spend as much as 50 hours just evaluating the proposed construction and concluding what kind of financing they will be willing to offer—and that is when everything is already in place.
Therefore, it is probably not worth your time to submit a serious loan application when you are in the initial stages of project planning. Among the key points that must be checked off before the construction loan stands any chance of approval include:
- Sufficient land has been allotted to meet the requirements of the project
- All city, county, and state building permits have been acquired, signaling a green light from the government to proceed with the project
- All buildings and renovations have been carefully planned and drawn out, providing a concrete blueprint to present to the lending institution
While this is not to say that you should not shop around throughout this process and compare the pros and cons among various lending institutions, it would be inadvisable to try and move forward full-steam with a time-consuming loan application without being able to demonstrate that the loan is the last ingredient needed to get construction started.
Perform Exhaustive Market Research
As in any type of business, there must be a demand for multifamily housing for a construction project to make sense. Lending institutions will not be eager to finance a multifamily project that shows no proof in being able to attract tenants.
Although there is a general boom in housing demand across the country, there are several market-related concerns that are especially relevant to multifamily construction in recent years that developers need to adequately research, plan for, and address to the lending institution before approval, including:
- With mortgage rates at all-time lows and millions of Americans rushing from the cities to buy homes in rural and suburban America, what will the demand for apartment living be 1, 5, and 10 years down the road?
- As online education continues to boom, how can new student housing construction prove effective at convincing students to continue to live on campus?
- After COVID-19 had spread particularly rapidly through senior communities, how can new construction improve the future of residential living, and how will it help families feel safe in sending loved ones back to these types of facilities?
Although these are just a few hypothetical scenarios of market concerns for multifamily projects, they help demonstrate how developers need to understand the demographic their project is set to address and accurately present to the lending institution how the project is set to address or overcome these concerns.
Demonstrate Environmental Consciousness
Climate change is arguably the single most important issue in our country in recent years. Simply put, you do not want to be on the wrong side of this position; it is a losing battle.
Lending institutions will conduct an independent appraisal of the environmental impact of your project, which will go a long way toward determining their willingness to issue a loan. Therefore, before applying, developers should:
- Demonstrate that the land or existing structures are not toxic or contaminated in any way
- Highlight any sustainable building practices set to be employed, such as through the use of recycled products and durable, low maintenance building materials
- Provide estimates of the projected energy consumption of the new building
Contact Superior Commercial Solutions
A multifamily construction loan serves as a means for developers to obtain funds when building, expanding, or renovating commercial properties, such as apartment buildings, student housing, or senior residential facilities.
While there are multiple avenues for developers to explore to secure a multifamily construction loan, all lending agencies will assess the loan application on the financial strength of the principles and their ability to complete the project on time.
Therefore, it is in developers’ best interest to work with experienced contractors, such as Superior Commercial Solutions, to help increase the chance of getting their financing request approved. No matter where you are in the United States, contact the professionals at Superior Commercial Solutions to find out how they can help you on your proposed multifamily construction project.
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