In a high interest rate environment, the kind of debt used to purchase a property is one of (if not the most) important factors when it comes to risk mitigation. Most of the money used to finance multifamily properties comes from a loan. But the kind of loan used to buy a multifamily property is much different than the ones homeowners use to buy their dream house.
Below, we’re dissecting two specific kinds of loans - bridge loans and agency loans. Although each option is often utilized by multifamily investors, they each have distinct pros and cons.
And the risk of not understanding these key differences can lead to a loss of profit, investor capital, and the asset itself.
So let’s get into it.
Bridging The Gap - With Bridge Loans
According to Multifamily.Loans, a bridge loan is a “short term financing tool for any kind of multifamily…real estate.” These loans are typically for a few months to two or three years. Multifamily investors will usually use a bridge loan in order to stabilize their asset so they can refinance into long term, agency debt (more on agency debt later). In order to do this, investors will use the funds from the bridge loan to improve the property’s condition through renovations, replace non-performing residents with new ones, and add amenities such as a pool or laundry facility. Since bridge loans are short term, they’re popular among “value-add” investors who are often considered the “fix and flippers” of the large multifamily space.
Bridge Loan Advantages
Bridge loans offer more flexibility to investors. As we alluded to earlier, agency loans (funded by Fannie Mae and Freddie Mac) usually only want to provide financing on properties that are considered “stabilized.” Value-add multifamily investors make their money on finding properties with much needed improvements. These deals have lots of profit-potential, but due to things like deferred maintenance and non-performing residents, these agencies don’t consider them “stabilized,” and won’t lend on them. Bridge lenders, on the other hand, are willing to lend on value-add properties. Bridge loans are favorable options for investors with a sound business plan to increase the value of their property.
Bridge loans have a shorter closing period, allowing for more efficiency and time conservation.
Bridge loans give investors more leverage, which means investors need to raise less money in order to close.
Both agency loans and bridge loans are non-recourse, meaning investors aren’t personally liable.
Bridge Loan Disadvantages
Bridge loans are shorter than agency loans, with most bridge loans being 3 years or less. This means that investors have a short window of time to stabilize their property before they need to refinance. This means there is more risk involved than an agency loan, because investors can face a problem if their loan comes due and they are not in a position to refinance.
Bridge loans typically include higher interest rates, making them more costly than agency loans.
Agency Loans 101
Agency loans are backed by Fannie Mae and Freddie Mac, two government-sponsored enterprises. Fannie Mae and Freddie Mac were chartered in order to offer “reliable and affordable supply of mortgage funds across the country.” Fannie Mae was chartered in 1938, and Freddie Mac in 1970.
Both provide a range of financing products. “As of 2023, Fannie Mae and Freddie Mac support around 70 percent of the mortgage market, according to the National Association of Realtors.”
Agency Loan Advantages
Multifamily investors like agency loans because they are known for their low interest rates. Since agency loans are long term, and Fannie Mae and Freddie Mac only offer financing on properties they consider stabilized, there isn’t as much risk as with the kinds of properties bridge lenders would approve a loan on. Investors have more time to implement their business plans and generate a return before they need to sell or refinance.
Agency Loan Downsides
It is more difficult to qualify for an agency loan than a bridge loan. Agencies conduct a thorough review, and expect sound financials, a strong general partnership with experience in similar projects, and 660 or higher credit scores. The net worth of the borrower must also be equal to or higher than the loan amount, and must have at least 10% of the loan in liquid assets.
As far as the property goes, it should be stabilized. This means the property needs to be at 90% occupancy for 90 days. Closing with these agencies can also take longer than with a bridge loan.
As you can see, there are pros and cons to both agency loans and bridge loans. An agency loan is ideal for an investor who wants to refinance their current property or wants to buy a stabilized property to hold long-term.
Bridge loans offer financing to properties that don’t fit the conventional criteria the agencies look for, and they allow for a faster closing process.