Coast to Coast: Small-loan specialist Arbor Commercial Mortgage provided a $3.85 million Fannie Mae loan for the 49-unit East Village Apartments in New York.
Courtesy Arbor Coast to Coast: Small-loan specialist Arbor Commercial Mortgage provided a $3.85 million Fannie Mae loan for the 49-unit East Village Apartments in New York.
Coast to Coast: Arbor Commercial Mortgage also closed a $2.3 million loan for the 32-unit Palms Patio in San Diego, in the fourth quarter.
Courtesy Arbor Coast to Coast: Arbor Commercial Mortgage also closed a $2.3 million loan for the 32-unit Palms Patio in San Diego, in the fourth quarter.

 

The small-loan market heated up in a big way last year, and that momentum has carried over into 2012.

Fannie Mae's small-loan program continues to dominate the market, offering some of the best rates available for deals of $5 million or less. Last year, Fannie captured $2.4 billion of the small-loan market, about the same volume it did in 2010.

And that consistency is telling. The overall market for multifamily debt grew in 2011, but Fannie Mae's small-loan volume didn't. That's because more balance sheet lenders, mainly national, regional, and community banks, jumped off the sidelines and pecked away at Fannie's market share.

Among those competitors, Chase Commercial Term Lending continues to be one of the most active small-loan lenders, especially in major markets on the West Coast and in Chicago. And throughout the nation's prime markets, many community banks are flexing their balance sheets again. In some metros, in fact, including New York City, local banks are routinely beating out Fannie Mae.

And though most life insurance companies favor large loans, there are a few, including Symetra, StanCorp, and Protective Life, that have an appetite for deals below $5 million.

“A lot of lenders got back into the game last year,” says Rick Warren, managing director for New York–based Centerline Capital Group. “We saw competition come back very strong in the small-loan space—a lot more competition than I think anybody had anticipated.”

Rate Race

If you're looking for a seven- or 10-year small loan, Fannie Mae is probably your best bet. Banks overwhelmingly prefer five-year deals, and the ones that use their balance sheet for loans of seven years or longer are the exception. And banks that are willing to do longer-term loans often price up for it, sometimes as much as 100 basis points (bps) or more above what Fannie Mae would offer.

Indeed, Fannie's rates are hard to beat. The company was quoting full-leverage 10-year small loans in the low– to mid–4 percent range in mid-February, with five-year loans about 100 bps below that. But banks in many major metros can get close to Fannie's five-year pricing, close enough to entice borrowers with more proceeds.

“If a borrower in a strong market is dead set on full proceeds and wants a five-year deal, they're probably going to a bank,” says Rick Wolf, a vice president at New York–based DUS lender Greystone. “But if it's lower leverage, I can beat them almost all the time right now. And if they want 10-year money or even seven-year money, we're in the hunt.”

Fannie Mae lenders use an underwriting floor—an artificial constraint for sizing loans—that's more stringent than what banks use. And Fannie has a surprisingly long list of “pre-review” markets, where borrowers can achieve only relatively low-leverage loans.

“Fannie Mae's pricing is clearly better, but, in some cases, proceeds become more important than the rate difference,” says Keith Van Arsdale, president and CEO of Dallas-based small-loan specialist BMC Capital. “And in those pre-review markets, like the Ohio markets, Florida, and Arizona, the most Fannie Mae is going to do is 65 percent.”

Underwriting Trade-offs

Responding to the increased competition, Fannie Mae recently made some changes across its multifamily division that had some impact on loans of $3 million to $5 million.

Fannie reduced its underwriting floors, allowing many loans to be sized more generously. And the company designated a handful of markets, such as Boston, New York, and Washington, D.C., as “strong markets”—a list that was completely empty for a long time. Deals in “strong markets” can achieve the most proceeds and the lowest debt service coverage ratio.

“[Fannie is] becoming a little more flexible; it's a flight to quality,” says Warren. “When you're competing against banks and life companies that cherry-pick the quality deals, you have to counter that with a product that puts you on a more level playing field.”

What's more, Fannie Mae began offering nonrecourse to a greater spectrum of small-loan borrowers, as well as more interest-only periods, last year. These are two places where Fannie can shine—banks aren't as generous with nonrecourse and interest-only provisions.

But there are some inherent limitations to Fannie's program. Many borrowers are willing to take a slightly higher rate from a balance sheet lender because they don't want to be bound by the prepayment penalties that Fannie requires. And banks, life insurance companies, and credit unions aren't bound by the same programmatic rules as are Fannie Mae lenders.

This difference is particularly stark when assessing creditworthiness. Fannie Mae wants a borrower to have a net worth of more than the loan amount. If a borrower wants a $3 million loan and has a net worth of $2 million and another $500,000 in the bank, the company would probably turn them down.

Fannie Mae also requires a FICO score of 680, a rule from which the company won't budge. “We have clients that are good borrowers, and they're at 670,” says Van Arsdale. “And we can secure loans for them all day long through life companies or a bank.”