- Freddie and Fannie’s second loan products offer helping hand
- Second Mortgage advantages
- Berkshire targets second loan business
When loan underwriting becomes more conservative or equity investment just falls short of the need, apartment owners turn to secondary financing to make their deals work, especially in the case of rehabs, when increased rents have yet to be realized. In 2001, new sources of second loans or mezzanine financing became available thanks in large part to Fannie Mae and Freddie Mac.
Both firms now allow borrowers using first mortgages that they own to use secondary financing as well. Fannie Mae and Freddie Mac also offer supplemental loans that can be used to take out the secondary financing when projects are generating sufficient cash flow.
The catch is that the mortgage firms will not buy second loans on properties they have financed for a year or more after they buy the first mortgages on the properties. To fill the gap, several Fannie Mae and Freddie Mac lenders are now offering “mezz loans” with the expectation that their loans can be taken out by a Fannie or Freddie second mortgage after the properties stabilize.
Freddie and Fannie’s second loan products offer helping hand
Both the Fannie Mae and Freddie Mac second loan products help borrowers obtain more loan proceeds than they can get from the mortgage conduits that originate loans for the commercial mortgage backed securities market. With a typical conduit loan, a borrower gets an 80% loan but has trouble realizing the increase in equity when the property’s value rises. It’s hard to sell the property, because buyers would need too much equity. It’s expensive to refinance because yield maintenance is required.
The Fannie Mae second loan program allows borrowers to get back up to 80% of value as their projects increase in value, if their first mortgage is through Fannie Mae. “The world is littered with people who have conduit loans who are upset about being stuck with those loans now and don’t want to do it again, so they are choosing Fannie Mae. It’s driving business,” said Charles Frischer, vice president of Capri Capital.
With its Second Mortgage product, Freddie Mac can purchase second mortgages on seasoned first mortgages that it owns. The firm also offers a split mortgage option, where the borrower simultaneously takes out a first and second mortgage.
The first mortgage must have a seasoning period of at least 12 months, except in the case of the split mortgage option, and must have a minimum remaining term of five years from the date of second mortgage loan closing. To be eligible, project must have occupancy of at least 92% for three consecutive months before the sale of second mortgage.
The maximum loan-to-value ratio of the combined first and second mortgage may not be more than 80% of Freddie Mac underwriting value; 75% for loan term of five years or less. The minimum debt coverage is 1.30x on a combined basis; 1.25x for split mortgage.
The minimum New Loan Amount is $1 million and the maximum is $10 million, but the loan may not exceed 50% of the original unpaid principal balance of the first mortgage. Loan proceeds will generally be based on increases in net operating income growth rather than on decreases in cap rates and interest rates from original underwriting.
Maximum term is 25 years; 30 years for split mortgage, with maximum amortization or 25 years; 30 years for split mortgage.
Second Mortgage advantages
Freddie Mac says the advantages of its Second Mortgage product include:
- Reduced documentation at full application for most loans;
- Additional financing without the prepayment premium that a refinancing would trigger; and
- The ability to maximize proceeds at settlement of a split loan without subjecting the entire debt to a full yield maintenance period.
Berkshire targets second loan business
One of the lenders aggressively targeting the growing mezz debt market is Berkshire Mortgage Finance. The firm is uniquely positioned to make these loans since it is focused on the apartment market, owns apartments and has construction lending capabilities, said Kurt Reimann, senior vice president and managing director. The firm had completed two deals as of Sept. 1 and expects to do $100 million to $125 million over the first 12 months of the program.
Typically, Berkshire expects that borrowers will combine mezz debt with a Fannie or Freddie first loan. The first loan is based on existing rent rolls with a 20% equity requirement, so developers undertaking rehab need equity of 30% to 40%. With mezzanine financing in place, the borrower can cut its equity requirement in half, he said.
Berkshire typically makes mezz loans at fixed rates, with no amortization for terms of three or four years. As to pricing, it looks for a return of 13% to 14% but structures the pay rate at a level that makes the deal feasible. The difference between the loan rate and the pay rate is accrued.
Berkshire provided a $4.25 million mezzanine loan to facilitate the acquisition and rehabilitation of Mill Ponds Apartments, located in suburban Chicago.
The transaction was structured in conjunction with the assumption of an existing Berkshire-Fannie Mae first mortgage for $10.27 million. The mezzanine loan was fixed at a rate of 14%, with an initial pay rate of 10% and interest charged only on disbursed funds.
Approximately $2.95 million was provided at close of escrow, with an additional $1.3 million for rehabilitation costs, to be disbursed over a two-year term. While the mezzanine loan provides for a four-year term, it was structured to allow the borrower the option of partial prepayment of principal.
Mill Ponds Apartments is a 216-unit property located in Naperville, Ill., the second most populated city in the greater Chicago area. The property was built from 1988 to 1990 and consists of six three-story, walk-up buildings. Project amenities include a swimming pool and clubhouse that will be renovated to include an exercise facility. The subject apartments have historically been in high demand, experiencing close to 100% occupancy.
Berkshire Mortgage Finance is a full-service, national mortgage banking firm with a self-originated servicing portfolio in excess of $12 billion. Headquartered in Boston, the firm has divisional headquarters in Bethesda, Md., and Irvine, Calif. Branch offices are located in Atlanta, Chicago, Dallas, Nashville, Phoenix, San Diego, Seattle and Walnut Creek, Calif. Berkshire provides real estate financing nationwide, specializing in multifamily properties.