One of the methods to go into multifamily investments is to have multifamily loans, and there are lots of ways to figure out the best option. James Eng, Senior Director of Old Capital, enlightens us about multifamily debt and what you need to do to apply for one. James outlines the three questions you need to answer that will help identify what type of loan the property and you as an investor qualifies for. Moreover, he walks us through Fannie Mae and Freddie Mac and what we need to know about them, and the other loan options available if we do not qualify for those two government financing lenders.
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Getting Started on Multifamily Debt with James Eng
Our guest is James Eng. Thanks for being on the show, James.
Thanks for having me, Whitney.
It’s a pleasure to have you on the show. James serves as the Senior Director for Old Capital. I’m sure most of you have heard of Old Capital. He’s actively involved in financing commercial real estate with a focus on multifamily in Texas. He has financed over $500 million in multifamily property. He’s invested as a limited partner in 21 multifamily properties totaling over 6,000 units. It’s obvious you have lots of experience in the industry from different angles, James. It’s a pleasure to have you on. Give the readers a little more about your background and your focus.
I was born and raised in Houston, Texas. I went to school at the University of Texas in Austin and then I made my way up here to Dallas. I’ve lived in all of your major metros except San Antonio down here in Texas. I like the growth down here, the population and the employment growth and in the past couple of years, I’ve been intimately involved on the multifamily side in terms of financing and then also investing here in Texas. I appreciate you having me on.
Thank you and what do you do? What is your focus? Who are you working for? Just so our audience understand what your specialty is.
Starting in 2015, I joined Old Capital and the focus was on originating multifamily debt. That can be Fannie Mae, Freddie Mac or CMBS. It could be a bridge loan or a bank loan, all those different types. Essentially, people come to me and say, “I’ve got 100 units under contract. I need to figure out the financing. What’s the best option for me?” I hold their hand and walk them step-by-step through the process and make sure that they close in the timeframe given and usually, that’s 45 to 60 days. I utilize all my resources to help them find the best debt and then also help build their team out. Whether they need a property management company, whether they need a general contractor, all those pieces we help put together for people.
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For somebody that is not familiar with buying commercial property or large properties, you just said a bunch of names there that they’re going to say, “Who are those people?” Give us a more basic level and tell us what’s Fannie Mae or Freddie Mac, those names. Tell us what that is and why that’s important.
I think the easiest thing and I put out a white paper on this, but it comes down to three questions. Number one, when you’re looking at a property, what is the occupancy of the property? If it is 90% or above, it is considered stabilized. That’s the first question I’m going to ask you, number one. The second question is going to be, what is your sponsorship groups, net worth and liquidity? Number three is, do you have prior multifamily experience? The answer to those three questions are going to tell me what type of loan the property qualifies for and then what type of loan you as an investor qualify for. Fannie Mae and Freddie Mac are government agencies. They are lending on stabilized properties and they want you to have a multifamily experience. To qualify for a Fannie Mae loan, the property needs to be 90% occupied for the last 90 days and then you as the investor group, need to have a net worth greater than the loan amount and then you also need post-close liquidity.
Cash and marketable securities, non-retirement of at least 10% of the loan amount. If you’re able to hit both of those, then you can qualify for a Fannie Mae loan. On Fannie Mae, it’s probably 75% on the property and 25%, you as the borrower. If it falls outside of that box so it doesn’t qualify for a Fannie Mae and it doesn’t qualify for a Freddie Mac, then that’s when you’re going to walk into a bridge loan or a recourse bank loan. If your occupancy is lower or you don’t have the experience or you’re looking at doing your first deal then it’s probably a bank loan at the very beginning.
I appreciate you going and walking through that. Our audience never heard of that type of debt before, also known as agency debt. That’s awesome and they can have an understanding of, “Can I go get that? Do I qualify?” What you’re going to ask them before you even have the conversation. You mentioned if somebody comes to you with a property and you’re going to help them figure out the financing. Pretty much you’re going to go through those questions. How do you help them find the best debt? What else is going to help us to know the best type of debt that we should use?
Let’s say a listing broker sends you a deal and you get the offering memorandum, you get the trailing twelve financial. You get the rent roll and you analyze the deal. You say, “This deal makes sense on paper. You send it over to me.” I’m going to take those items and show it to two or three, maybe four lenders and then they’re going to come back and say, “This is the leverage that I can do. This is the interest only. These are the terms that I would be able to offer on this deal.” We’re going to shop that deal with lenders that we have a previous relationship with and they typically respond in 24 hours. From there, we’re going to get you back to the investor the best terms possible. Whereas you might do a general partner in this multifamily syndication game, they might do one or two deals a year potentially maybe more. We are doing probably four to five deals a month with these lenders. The response that we get is significantly faster. They’re going to put out the best terms possible because they know that we’re not only going to bring them this deal but potentially more deals behind it.
I’ll give you a scenario, somebody that’s just getting into business, which I know quite a few of the audience are trying to get into the syndication. They’re not going to have the liquidity and they’re not going to have the experience with commercial properties. Maybe they’ve had small multifamily. Let’s talk about that. What qualifies as the experience?
Experience is you signing on a Fannie Mae or Freddie Mac loan. If you’re a key principal on a deal, a loan guarantor on somebody else’s deal, that’s one way of qualifying. Another way is if you do a recourse bank loan on a multifamily property and you’ve held that property for at least a year then that is considered multifamily experience. They also want it to be a comparable size. If you do a ten-unit deal and then all of a sudden you say, “I’m moving up to 200 units.” That’s a little bit too big of a jump. They want you to go up the ladder slowly. They’ll say, “Maybe you go from 10 units to 40 units, to 70 units, to 200 units and work your way up the ladder that way.
That sounds great, work your way up. I’ve heard that for a bit. James, I don’t want this to take forever. I want to get right to the big properties. I want to jump right in there. I know this is what some of the audience were thinking. Help me to figure out how to do that. If I find a 100-unit deal or let’s say I’ve only had a few single-family homes or I flipped some homes but now I’ve decided syndication is the way I want to go and I need some agency debt, what are my options?
You need to find a partner who will sign with you on a Fannie Mae loan. That partner can be more than one person but at least one person needs that multifamily experience. When we add up the sponsorship group’s total net worth and liquidity, that’s what we’re going to be looking for. Let’s say it’s a $10 million deal, $8 million loan, they’re going to need all the KPs who are signing to have a total net worth of $8 million. After the down payment, you’re still going to need $800,000 across all the key principals.
I’ve got to find some partners. It could be many partners. If it’s $10 million, I could have two different people with $5 million of liquidity.
They add up the net worth and they add up the liquidity. The net worth, you fill out an Excel template and send it in and you sign that it’s authorized. You’re signing away that this is correct, but the liquidity, they get actual bank statements for the last two months and make sure that the liquidity is there.
That’s understandable but then let’s say those two people have no experience. They’re just wealthy individuals that want to be in on this deal. I can bring a third person if I needed to that has experience.
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They almost look at it as like one person but you might have four people to fill in all those gaps in the sponsorship group. What’s great is let’s say on your first deal, you don’t have multifamily experience, but you sign with somebody else and then you’re on deal number one and you closed in January 2019. Four or five months later, you are now qualified to do the deal on your own. If you have the deal and you have a multifamily experience, you might need to just bring in net worth and liquidity using someone else’s balance sheet to do your next deal.
Let me clarify, even if I don’t have the liquidity or the balance sheet, I can still sign on the debt as long as somebody else does, right?
If I already have this set up and for the audience that has never done a deal before or never done an agency debt, if they’re putting this team together and they find somebody with the experience and the liquidity, they can get the debt, they should sign on it as well. Is that what you’re saying?
They have to sign on it as well because what happens is, as a general partner, the more things that you have, if you have the deal, you have the net worth and liquidity, and you have the multifamily experience, you don’t need anybody else to sign with you. It can just be you. Your percentage of the deal, whether you’re doing a preferred return or you’re doing a percentage of the equity, however, you’re structuring the deal, you’re going to get more of the deal the more pieces of that puzzle that you bring to get to the deal. That’s going to help you and your negotiation with potential partners. If someone’s coming in and they have multifamily experience, and they have net worth and liquidity, then they might take half of the deal from you.
I felt like you’ve made so many good points already. Somebody that’s getting into their first deal, they’re working so hard to put this team together. If nobody tells them, they might not think, “I should be signing on this as well. Even though I don’t have the balance sheet, I can still sign.”
You can still sign, get some experience and it will be a lot easier on your next deal.
What’s going to set us up for success when we come to you with that information? How should it be packaged? What should that look like? Let’s say I have those team members lined up that has experience and balance sheet, what does that need to look like when I come to you?
Typically, we ask people to send over the personal financial statement and potentially a resume or a schedule of real estate if they have anything currently. We’ll review their balance sheets to make sure they qualify for the loan as a group and then also, once you send me your T12, rent-roll and offering memorandum on a deal. The other two things that I’m going to ask you for are your year one pro forma, your budget for the first year. What do you think rents can get to? When you go in, what do you think expenses can run at? Also your rehab budget, how much are you going to spend on the property? Is it $3,000 a door, $4,000 or $5,000 a door? Let’s figure out what your rehab budget is and from there then I can get you the most accurate term sheet.
As far as our relationship with somebody like you, if it’s packaged a certain way, does that matter? Do we need some relationship or reach out to you maybe before we have a deal?
Usually what I do is people will reach out, we’ll review their personal financial statement. We’ll go through loans a little bit more in detail so that when they get a deal from a listing broker, they can at least at a high level check it and say, “What type of loan does this even qualify for to start?” They can start underwriting deals. Let’s say toward the deal, they like the deal and they’re going to submit an LOI next week, then that’s typically when they’ll send me the information. We’ll size the deal up and then we’ll have a term sheet to go with their offer. They’re going to submit an LOI that shows, “This is the purchase price, this is my earnest money,” all the terms of the deal. They’ll have our term sheet with the debt. I like to have general partners put how they’re going to raise the equity also in that package. If they have bank statements or anything like that, they could show that the key principals have the equity to close this deal. That to me, as a seller, that’s super strong. You’re showing me that number one, you can qualify for the debt. Number two, you can raise the equity or even if you syndicate the equity and you have a couple of hundred thousand left, the key principals can write a check and the deal’s going to get closed.
I want to be ahead of the game. If I’m presenting something to you, I don’t want you to have to come back to me twelve times asking for more things. I want to have all that prepared as possible so we can move as fast as possible. What are the problems that you see come up or maybe some ways that somebody ask or applied for a debt and it didn’t happen and why?
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I think sometimes when people are reviewing their personal financial statement, sometimes we get that late in the game. They don’t tell us about maybe some bad credit. With Fannie Mae and Freddie Mac, you need a credit score of at least 650 to sign on these loans. If you have any prior bankruptcy or litigation currently against you, you need to tell the lender upfront. When we send you the loan application, there are questions in there that ask specifically the key principals on the deal, “Have you ever declared bankruptcy? Do you have any litigation currently against you?” It’s always better to be upfront about that versus the lender running the search and coming up and then them coming back to you. I would say that’s probably number one on the borrower side. On the property side, usually as long as the occupancy and the property is stabilized, we haven’t had an issue. Sometimes the seller gets the deal under contract and they say, “I’m out of here. I’m going on vacation. I’ll see you in two months, hopefully, the money shows up.” The property’s occupancy goes from 90% to 85% to 80% and all of a sudden Fannie Mae can’t lend on the property.
That has been an issue for us on some deals. Also, I would say, make sure that you have an environmental report done. The typical report is called a phase one environmental. That tells you the historical use of the property and then also the surrounding areas, whether it’s a gas station or a dry cleaner. You don’t want any of that coming through your property in terms of chemicals and you have to look at the groundwater and see which way it’s flowing. The last thing I would say that has surprised some investors is flood plains. Flood insurance has gotten expensive especially down in Houston because of all these hurricanes coming off the coast. Understanding if your property is in a flood plain, how does that impact your insurance requirements because Fannie and Freddie will have insurance requirements if it’s in a flood plain. It could be double or triple the cost of your standard insurance policy.
Are there limits to the number of agency loans that we can have?
Agency loans are non-recourse. What that means is they cannot go after you personally for the difference if they ended up foreclosing on the deal. You can essentially have as many non-recourse loans as you want. There are carve-outs where if the general partner commits fraud. Let’s say you got a fire on the property and you don’t apply insurance proceeds to the property, just keep the money. If you don’t do your financial reporting. There’s a list of ten or fifteen things that are in the loan agreement that says, “As long as you do everything that you say you’re going to do then this loan is non-recourse.” In the industry, we like to call these bad boy carve-outs. If you’re a bad boy, the loan can turn recourse. Be careful with that.
We mentioned a couple of different types of debt. I was thinking about agency debt versus a local lender, a credit union or something like that. Why would somebody use one of those over agency debt or vice versa?
On Fannie and Freddie, the typical terms that we’re doing are ten-year loans and it has 30-year amortization. It could have three years of interest only up to five years interest only and their leverage is close to 75% to 80%. Those are the best terms that you’re going to get anywhere and it’s all non-recourse. If a deal qualifies for Fannie and Freddie, it almost always wins. The biggest negative to agency loans is they have the largest prepayment penalty. Fannie Mae loans have a thing called yield maintenance and what that means is you are paying the interest payments for the remaining term all now. They take the present value of all those payments. Let’s say you get a ten-year loan and a lot of people have a five-year hold. The next five years you still have to make those payments but they’re taking the present value of those payments. It can be a rather high prepayment penalty. That’s on the Fannie and Freddie side. On the recourse bank loan, their leverage is typically 75% max. They usually are doing one year of interest only and then the amortization is anywhere from 20 to 25 years. That materially impacts your cashflow.
Most people, the only reason that they’re doing a recourse bank loan is it is not qualifying for Fannie or Freddie or the loan is under $1 million. The lowest Fannie loan that I’ve seen is $750,000. Nobody wants to go through all the paperwork to do a $750,000 Fannie Mae loan. Most likely if you’re buying a property that only needs $1 million loan, you probably are not going to hold that property for that long. Most of the time you’re going to buy it, fix the problem, rehab it, then sell it on one or two years and you just don’t want yield maintenance on that. Banks can give you what’s called a step-down prepayment. It might be a 3-2-1. That’s a percentage of the loan. Whereas yield maintenance could be 20% of the loan amount for the first couple of years. Most people are doing smaller deals or non-stabilized deals. They will use recourse loans and then people who are buying stabilized deals, larger deals, they’ll do the non-recourse Fannie and Freddie.
I was thinking about that prepayment penalty. It’s a big negative if you have to pay that fee. I was thinking, just like a lot of guys do, they’re planning on holding for five years but they might have a ten-year debt. A big selling point is you have this loan that’s low interest or five years from now the interest rates are probably going to be higher. You hope that they’ll assume that note but that would keep you from paying that penalty.
The tricky thing about assumptions is, let’s go back to the example of you bought a $10-million deal and you got an $8-million loan. You’ve done a fantastic job on the deal and now it is worth $16 million and the loan is $8 million still. The person who’s buying your deal, if they assume your loan at $8 million, the leverage is only 50%. $8 million divided by your $16 million. For most people, that doesn’t work for them and so given that the interest rate is lower that might be great, but they probably want a 75% to 80% loan on the deal. They’d probably want a $12-million loan. Fannie Mae has a program for this and it’s called a supplemental loan. Fannie Mae can do a supplemental loan when someone else is buying your property. They can re-leverage it to 75%. You can keep the $8-million loan in place and then add a $4 million supplemental. The thing that you have to watch out for is with five years left or less, they don’t do supplementals anymore. You have to be very careful. Let’s say you go to list of property, you want to make sure that when you go to the list, there are at least six years left in maturity if you think anyone is going to assume this deal. The cut-offs that you have to be careful of, seven years left to maturity and five years left to maturity. Those two cut-offs change what the supplemental can be. You have to watch those timelines if you think you’re going to sell on an assumption.
I appreciate you elaborating on the assumption, that’s great. I’m sure a lot of people have never heard that before in parts that I’ve heard. What’s been the hardest part of the syndication business for you? I know you’ve been on the lending side and the passive investor side.
I talked to a lot of general partners and there are two things that the a general partner has to do. They have to find deals and then they have to raise equity. Finding deals right now, we’re in first quarter 2019, the finding deals part is not as competitive. In the fourth quarter of 2018, interest rates ran up significantly. The ten-year debt was at 5.25% that has significantly reversed. Right now, we’re closing loans. The loan can be anywhere from about 4.5% interest rate, and so that has shifted dramatically. Your leverage is improved. The cashflow is there. There’s less competition for deals and interest rates are still low. The number one thing right now is the ability to raise equity and getting people comfortable with the returns. A lot of people in Dallas, when I started in 2015, everybody thought that was the top of the market. I could have been sitting here for four years not investing in any deal because I thought it was the top. The people who bought deals in 2011-2012, they were completely spoiled by their returns. They might have made a double, 2x or 3x on their equity in three to four years.
You’re having to go back to those investors right now and tell them, “We’re not going to double your money. We’re going to get a 70% return. You give me $100,000 and I’m going to give you $170,000 over the next five years.” Some of the equity is saying, “I’m going to stay on the sidelines then, that’s too low of a return for me.” Some of their guys that they counted on in 2014 or 2015 for equity, those people aren’t there anymore. You’re having to constantly meet new people, educate them on the benefits of multifamily, then convince them that this is the best time to be investing in multifamily. To me, it’s that ability to raise equity. The investors who have been able to do that have been able to do the best in terms of buying deals. They’re confident in their ability to raise the equity and the debt markets right now have been very forgiving. The interest rates have come down and you’re locking-in ten-year money at 4.5%.
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We’re working on a deal and I think we’ll go agency debt as well. I was very surprised at the interest. You’ve mentioned getting investors comfortable with the returns. Do you have any advice on how to do that or what that should look like?
There are a couple of ways. Always start with your track record and I did a podcast on this. Warren Buffett put out his latest letter to his shareholders. On the very first page, it shows S&P 500 versus Berkshire Hathaway over the last 50 year. Berkshire Hathaway’s annual return was 20% and S&P was 8% or 9%. He doesn’t even have any texts on the first page. All it says is, “Here’s my column of results, here’s the S&P 500.” To me, as an investor, as a passive, the first thing that I’m looking for is what’s the track record? Who was the track record and the general partner? Have they done this before? Have they syndicated a deal? If I go drive by their properties, how does it look? Is this something that I want to invest in? If you don’t have that, you need to go borrow that and get that from somebody else. Number one is the track record and then the second is how much of the return? That’s 70% return that we’re talking about over five years. How much of the return is coming from cashflow and how much of the return is coming from your residual sale?
A lot of times you’ll see a five-year cashflow and you put in $100,000. First year it might be 5% then 7% then 8%. At least half of the return maybe will come from cashflow and half will come from residual sale. On a bridge deal where they’re doing $10,000 or $20,000 a door in rehab and kicking every tenant out, it’s like $100,000 goes in, zero, zero, zero, then $200,000 at the end. That might be a higher return. It might be a 2x on your equity multiple but there’s significantly more risk in that deal when you’re comparing them. As an LP, I think it’s good to have at least the cashflow taken care of for your first couple of deals. As you get a little bit more adventurous on your heavy value-add deals, then you can do a couple of those. I’ve been in two of those deals where the cashflow is zero for the first eighteen months or so and then they’re hoping to refinance or sell the asset and get a large return on those deals. The only reason I got comfortable with those deals was because of the track record of those general partners.
I appreciate your sharing that. What’s the one thing that’s contributed to your success?
I think the one thing is the ability to put together skills. I started in finance then I moved to underwriting. I’m more on the origination side of financing transactions. Each one of the roles that I had, whether it was corporate finance, whether it was underwriting, whether it was loan origination and investing, the skill sets have built upon each other. Each one of those made me a better investor. That’s how I like to look at projects and things that I do is, is this building new skills and new relationships. That’s how I determine on how to take on projects. That is, especially right now, our ability to do this interview and understanding the technology piece. A lot of people in real estate do not utilize the technology that’s available. We have used that at our firm to grow our brand and my personal brand is the technology piece that a lot of people should be using in the industry.
How do you like to give back?
We did a three-on-three basketball tournament for a nonprofit called City House. They help kids zero to seventeen who essentially come from either abused homes or foster homes. They give them a place to live, grow up, go to school and be normal kids. We raised about $12,500 for that group and we made it part of the industry. We have listing brokers there, property managers there, general partners and we’re playing good old three-on-three basketball and raised money for that group. A lot of people in the industry want to get back but they don’t know what organizations they should be working with. We interviewed four or five organizations and this group rose to the top. They have a shelter called My Friend’s Place and it’s about ten years old. The money that we raised is going to rehab that whole facility that’s about 10,000 square feet. We’ll do new flooring, paint, carpet, all the stuff we do with apartments. We’re doing it on the shelter that they have here in Dallas.
Thanks for sharing that. Thanks for being a part of that and contributing. James, you’ve provided so much value to the audience and to myself. I can’t thank you enough for being on the show. Tell our audience how they can learn more about you and get in touch with you.
There are a couple of ways. Our company’s podcast is Old Capital Podcast. That is huge. We do at least once a week on there interviewing general partners, property managers, listing brokers and everybody in the market. If you want to reach out to me, my email is JEng@OldCapitalLending.com and if you just search my name, you’ll find my LinkedIn, YouTube videos and all that type of stuff. That will be the best place to reach out to me.
Thank you so much, James and I appreciate our audience being with us every day. I hope you’ll also go to Life Bridge Capital and connect with me, then go to the Facebook group, The Real Estate Syndication Show so we can all learn from experts like James and ask questions and grow our businesses together. I hope you’ll do me a favor and share the show. We will talk to each of you.
Thanks a lot, Whitney.
- Old Capital
- Fannie Mae
- Freddie Mac
- City House
- Old Capital Podcast
- James Eng on LinkedIn
- James Eng on YouTube
- The Real Estate Syndication Show Facebook Group
About James Eng
James Eng serves as a Senior Director for Old Capital. Mr. Eng is actively involved in financing commercial real estate with a focus on multifamily in Texas. He has financed over $500MM in multifamily properties. Before joining Old Capital, Mr. Eng underwrote over $750MM in loans over 8 years for the acquisition or refinance of commercial properties at GE Real Estate. Prior to his work at GE Real Estate, he completed GE’s Financial Management Program (FMP) at GE Capital with rotations in Connecticut, Colorado, and Texas across multiple businesses. He received his undergraduate finance degree from the McCombs School of Business at The University of Texas at Austin. He is currently invested as a limited partner in 21 multifamily properties totaling over 6,000 units.