Borrowers looking for small apartment loans are being courted like never before with low interest rates, flexible terms, and even interest-only financing.
These borrowers can find interest rates ranging from 87 to 130 basis points over the yield on 10-year Treasury bonds at ARCS Commercial Mortgage Co., L.P., just one of the lenders aggressively working to grow their small loan business.
ARCS was one of the first lenders in Fannie Mae’s small loan program, and is still fighting to overcome the largest hurdle to making loans through the program, now called 3MaxExpressSM.
“A lot of the borrowers are turned off by the amount of paper,” said Nicholas Matt, mortgage broker and managing director for Holliday Fenoglio Fowler, L.P., a privately held real estate mortgage broker.
Loans with low, fixed interest rates and long terms of 10 or even 30 years are just one way to lure small borrowers. “The margins are so thin, it’s probably a loss leader,” said John Barbie, vice president for ARCS. “We’re getting people in the door.”
But ARCS and Fannie Mae are also trying to address the heart of the problem by trimming the high cost of appraisals and inspections that might make sense for a larger loan but that a smaller loan can’t support.
Borrowers now typically ring up $3,500 to $5,500 in closing costs when they take out a small apartment loan from ARCS. That’s an improvement of a few thousand dollars over recent years. ARCS has removed its processing fees and document preparation fees.
Fannie Mae is also cutting back the amount of maintenance it demands on these small loans. “It would be wonderful to get all of the inspections every quarter, but that’s just not economically feasible,” said Richard Wolf, vice president for Fannie Mae.
Fannie Mae currently captures 15 percent to 20 percent of the small loan market, Wolf said, and he hopes to win more of the business. The agency did $3.2 billion in small loan business in the first six months of 2006. That’s a sharp increase from the $2.3 billion Fannie Mae did in the same period the year before.
But the agency wants to grow even faster. Fannie Mae has added four lenders to its small loan program in the last year, bringing the total to 12. Interest rates for Fannie Mae’s small loans typically range between 100 and 150 basis points over the yield on 10-year Treasuries, with a standard debt- service coverage ratio of 1.25x.
Freddie Mac takes its share
Conduit lenders are pushing hard to make small apartment loans with a little help from Freddie Mac, which buys many small apartment loans originated by conduits as commercial mortgage-backed securities (CMBS).
“I still think the conduits are the best deals,” said Matt of Holliday Fenoglio Fowler.
Conduit interest rates can be as low as 100 basis points over the yield on 10-year Treasury bonds, Matt said. Conduit lenders are willing to barely break even on their loans to apartment properties because including multifamily mortgages in their loan pools helps them to sell the other, more profitable loans in their pools to investors. Many investors, including Freddie Mac, will only buy CMBS that are backed by a significant amount of apartment mortgages.
Conduits can also offer interest-only, 10-year loans as small as $1 million for repeat borrowers, Matt said. Conduit loans typically cover up to 80 percent of the value of properties and conduits usually require a debt-service coverage ratio of 1.2x. Freddie Mac has purchased $1.2 billion in CMBS backed by small-balance loans since December 2005.
But Freddie Mac is also planning to create its own small loan program by partnering with small, local banks.
Most borrowers looking for small loans still turn to local banks that they already do business with. The existing relationship can be a great help in arranging financing, though these banks typically demand recourse loans. Worse, they typically only offer floating-rate loans with a term of seven years or less.
That could put a small borrower in a very tight spot if interest rates rise or the value of the property falls near the end of the loan term.
But once Freddie Mac’s small loan program rolls out, beginning in the second quarter of 2007, these small banks will be able to act as conduits for Freddie, offering longer-term, fixed-rate loans at competitive interest rates. The terms of these loans will track closely with the rest of the industry, with loans covering up to 80 percent of the value of the property with a debt-service coverage ratio of at least 1.2x.
Freddie Mac hopes to do $3 billion of these small loans in 2007, according to Nashwa Moussa, director of small loan executions for Freddie Mac.