The Difference Between Bank and Agency Multifamily Lending
When financing the purchase of a multifamily property, most investors seek a loan from either a bank or government-sponsored lending agency such as Freddie Mac® or Fannie Mae®. While both banks and agencies are heavily regulated, there are some crucial differences between their lending products that are important to understand before proceeding with a loan.
Perhaps the most significant contrast between bank and agency multifamily lending is the difference between a recourse and non-recourse loan. Banks primarily only offer recourse loans, while government-sponsored enterprises (GSEs) exclusively offer non-recourse loans.
Recourse vs Non-Recourse Loans
The difference between recourse and non-recourse lending comes down to what assets can be seized by the lender in the event that you default on your loan.
For example, a recourse loan enables the lender to recover their investment from your personal assets if the value of the underlying asset, i.e. the property, is not enough to cover the debt. This means your home, any other properties, any money in your bank accounts, or any other asset are subject to seizure to pay off the remainder of the loan. In a full recourse contract, a lender can even garnish your wages in order to recoup their investment.
Conversely, the underlying property is the only collateral that can be seized by the lender in a non-recourse loan. While this is not the only term worth considering, a non-recourse loan is obviously the better choice compared to a recourse loan with the otherwise same terms.
Multifamily Lending - Bank Underwriting Requirements
Underwriting is the process used by lenders to calculate the interest rate and terms of a loan. It typically involves some analysis of the asset and the financial standing of the prospective borrower.
In multifamily lending, banks tend to scrutinize the borrower far more than the underlying asset when underwriting a recourse loan. This makes sense, given your personal wealth and assets are effectively being put up as collateral in a recourse loan.
Prospective borrowers are required to provide tax returns for the past two years, and must meet the bank’s requirements for debt-to-income-ratio. All debts are taken into consideration, including car loans, personal loans, and credit cards, as well as any debts associated with other investments. Other than an appraisal, the property is not typically analyzed to the same extent.
It’s worth noting that banks can and sometimes do offer non-recourse loans. However, they offset any additional risk by increasing the interest rate or adjusting the other terms of the loan in their favor.
In short, when underwriting a recourse loan for a multifamily property, banks tend to focus on the borrower rather than the asset. The opposite is true for GSE agencies underwriting a non-recourse loan.
Multifamily Lending - Agency Underwriting Requirements
The two leading GSE multifamily lending agencies are the Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association, more commonly known as Freddie Mac® and Fannie Mae® respectively.
As you’d expect, GSE agencies underwrite non-recourse loans based primarily on the value of the underlying asset. When the property is appraised, the agencies require an independent engineer to attend with the goal of inspecting the operations of the property and identifying any maintenance issues. If issues are discovered, they are often required to be resolved before the sale closes. Additionally, the agencies may analyze the renters that reside in the property, and the financial standing of the borrower - your net worth, liquidity, and real estate experience - must also meet minimum standards.
Multifamily lending agencies also typically require a minimum loan amount of $1 million. Due to the added appraisal costs when borrowing from an agency, there is a higher administrative cost per loan when borrowing from an agency over a bank. For loans less than $1 million, this isn’t practical.
Additionally, GSE agencies fund their loans through securitization, ie. the sale of their loans to third-party investors. This process incurs additional administrative and legal costs that are passed on to the borrower.
Granted, these fees (appraisal plus securitization costs) could instead be viewed as the fixed cost of securing a loan with more favorable terms than available from a bank. When viewed from this perspective, the benefit to the borrower increases with the size of their loan.
The Pros & Cons of Bank vs Agency Multifamily Loans
Investors inclined to minimize risk to their personal assets and/or attain favorable terms for a higher leverage loan are natural candidates for an agency loan. However, while they are generally more favorable, agency loans are not suitable for all transactions. Given the higher administrative costs, it’s not ideal (nor typically available) for an amount less than $1 million. Additionally, the emphasis on the current state and value of the asset means that you are unlikely to meet agency requirements when purchasing a property in poor condition.
Conversely, while banks are more inclined to finance small loans or assets in disrepair, the recourse loans they offer present greater risk to the borrower. First-time multifamily investors should be cautious about borrowing for a property that will inevitably incur additional repair costs before generating revenue, especially if they are assuming personal risk.
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