Real estate entrepreneurs have flocked to the multi-family sector. It’s clear why. As research shows, multi-family properties have delivered an average annual return of 9.95% since 1992—higher than any other type of real estate.
Understandably, you’d like to reap all the benefits you can from multi-family investing. But perhaps a lack of capital has been holding you back. You can’t scale your operation without adequate funds.
You’re not alone if you lack capital. At Direct Lending Partners, one of the main reasons we see investment deals fail is because they’re undercapitalized. The sponsor or investor simply can’t raise enough equity to purchase the property.
After all, since multi-family investments have a higher barrier to entry (i.e. a higher purchase price), you need a larger downpayment to buy the property.
That’s why you need reliable sources of capital.
In this article, we’ll discuss all you need to know about sourcing capital for multi-family acquisitions. This way, you can get money for real estate investments and achieve your goals.
An overview of bank financing for multi-family investments
If you need money for real estate investments, you have numerous options with various banks. Listed below are four main avenues you have for sourcing capital.
What is a bridge loan: A bridge loan is a short-term real estate investment loan. With terms typically lasting 12-24 months, a bridge loan offers temporary financing capital until you can either secure permanent financing or pay off your existing obligation.
Rates can be low as 7.99% for bridge loans. Lenders should offer funding for up to 80% of the deal cost. Deal costs include all phases of the investment, from acquisition to renovations and maintenance.
An example of when to use bridge funding: You want to acquire a “value-add” multi-family, one where renovations and/or better management could boost returns. After using the funds to add value to your investment, you can either sell or refinance to pay off the bridge loan before it comes due.
What is an agency loan: Agency lenders are government-sponsored enterprises, such as Fannie Mae and Freddie Mac. According to Federal Reserve data, agency loans account for 37% of loans in the multi-family market. That makes them the number one source of lending for multi-family acquisitions.
If you need money for multi-family real estate investments, the advantages agency loans offer includes attractive interest rates and terms. For instance, rates at Freddie Mac sit at 3.75% on a 30-year mortgage (as of late 2019).
An example of when to use agency funding: Since agency loans have a lengthy underwriting process, don’t use them if you need to execute a deal quickly. They best suit refinancing short-term loans, such as bridge loans.
Keep in mind most multi-family deals agency lenders fund exceed $1 million in value. For instance, you probably won’t be able to get an agency loan if you want to buy a $500,000 multi-family property.
Commercial Mortgage-Backed Securities (CMBS)
What is CMBS financing: Commercial mortgage-backed securities are fixed-income investment products sold in the form of bonds. They’re secured by mortgages on commercial properties, instead of residential properties, and the loans are contained within trusts. CMBS financing serves as a source of capital for real estate investors.
As data shows, CMBS loans typically last 5-10 years, with a 20-30-year amortization period. This means monthly payments reflect a 20-30-year loan period, and you’ll have to make a one-time balloon payment at the end of the 5-10-year term.
An example of when to use CMBS loans: CMBS loans offer attractive interest rates and a faster underwriting process than agency loans or traditional bank loans. Therefore, they can be used to finance any sort of multi-family investment, especially time-sensitive deals.
However, because CMBS loans are packaged and sold to investors, they often have prepayment penalties. Only take a CMBS loan if you don’t plan to refinance or repay early. Moreover, the balloon payment at the end of the loan term may catch you by surprise. Prepare for it.
Traditional bank home loans
What is a traditional bank multi-family loan: 35% of loans for multi-family investments come from traditional banks, according to Federal Reserve data. For multi-family investors with strong credit and solid income, traditional mortgages offer the chance to get a long-term loan at a low-interest rate.
With interest rates quite low currently, you could get a 15-year fixed rate from as low as 3.4%. If you’re looking for affordable financing capital, consider traditional banks.
An example of when to use traditional bank funding: You took a fix-to-rent loan to close a deal quickly on a multi-family property. Now that you have cash flow from the property, you want to refinance with something more long term.
Note: Traditional bank loans can take well over a month to get. If you find a great multi-family deal and need capital to close, seek more efficient sources of capital.
An overview of private capital raising options
Raising your own capital can provide you greater control over multi-family acquisitions. It can also give you more options for growing your operation.
When it comes to sourcing capital from private investors, you have two options: real estate syndication and opening a fund.
With both, the goal is to find high net worth investors. This requires savvy business development and sales and marketing execution.
“Be aware of common pitfalls when raising equity. For example, I’ve seen too many real estate investors give up too much control through equity financing. I’ve also seen too many entrepreneurs bring on difficult investors. You need like-minded partners, while still retaining sizable ownership,” states Nathan Trunfio, President of Direct Lending Partners, a provider of private loans for real estate investors.
Trunfio also talks about the chicken and the egg problem when it comes to sourcing capital from investors. Do you first invest yourself and then raise capital? Or do you raise capital and then enter multi-family investments?
It can be tricky, especially if you lack the funds early on in your endeavors.
“You can always use loans and another type of debt financing to start. Build and document a track record of success. Take photos and write down details and the financials. Tell your story. Look professional by having a website and collateral material. And show you’re committed to not losing a penny of investor money,” advises Trunfio.
Once you’ve done that, then decide between syndicate deals or opening a fund. This comes down to a matter of preference and your goals.
“Most people syndicate their first few deals, then they grow into creating funds. Syndications typically are on single assets, whereas funds can be for single deals or multiple deals,” describes Trunfio.
It also comes down to time and control. With syndication, you can spend a lot of time finding the investors and convincing them to invest. You must continually report to them on the project’s process.
“The investor has control of your time and can pull the plug on the project by closing their wallet whenever they want. Keeping investors abreast of every detail of the project is a major distraction,” attests Brion Yarnell, Vice President of Business Development at Direct Lending Partners.
“Conversely, with a fund, you hold the control. Yes, you still need to find investors, but you control the decision-making in the project. You control when the investor ‘cashes out’ and gets their return,” adds Yarnell.
To summarize, syndicate deals bring together real estate investors and poll their financial resources to complete a deal. This enables you to invest in properties that you couldn’t afford on your own. You can leverage your partnerships to close even more deals.
Opening a private real estate investment fund suits those who want more control. If you want greater decision-making control and less distraction with ‘managing the investor group’, a fund makes sense. And it can be a very profitable way to scale your real estate investment business.
After deciding between real estate syndication and opening a fund, begin the process of raising capital. Hire a law firm to assist with creating a private offering, but be aware this can cost $40-100K. Then, figure out all the business terms so you know how to market and sell the fund. Prove you can execute, and you’ll have partners and investors ready to work with you.
“Finally, don’t look for deals until you have capital. If you have capital before you have the deal, you can negotiate better deals. Remember: You make money on the buy.” says Trunfio.
Choosing the right capital strategy for your multi-family investment goals
As you can see, you have a variety of options for sourcing capital for real estate investments. These include financing via bridge loans, agency loans, commercial mortgage-backed securities, and traditional bank loans. Funding sources also include raising capital through syndicated deals or your own fund.
The point is this: To succeed in the real estate business, you require good sources of capital. Additionally, you should have control over how you invest. You entered this business for yourself and shouldn’t let decisions be made for you.
At Direct Lending Partners, we provide a full-service capital advising and the facilitation of direct financing. We have a lot of knowledge in the field and are ready to help.