Types of Debt Financing

In this article we will review the types of debt financing available for multifamily apartment community investments.

There is a range of debt financing products that can be used to acquire apartment communities. In the traditional financial markets, debt is also known as a bond. If you think in terms of securities, you have a bond that you can purchase, or you can have a stock that you can purchase.  The stock would be equity ownership in a company. The bond is not ownership but is the debt obligation or credit that the company would owe as a debtor or creditor.

In Commercial Real Estate structured finance, the total capital used to finance a project, debt and equity, is referred to as the capital stack.  The capital stack in private equity may be referred to as the cap table.  The capital stack is zero to 100 percent of the capital used to acquire a multifamily apartment community.

Let’s further discuss the types of debt products that can be used for property acquisitions.

1. The first, in simple terms, is bank financing. Banks, large and small, like lending on commercial real estate to shore up their balance sheet.  Banks make money on the interest charged on these loans.  Banks are relationship driven.  They want to have deposits on hand from the person or companies using their products to finance acquisitions.  Bank debt is in most cases full recourse.  This means that the general partners of the project partnership will have to personally guarantee the loan via their net worth and liquidity.  Banks are conservative and want to ensure the capital they are lending is backed by collateral other than the real estate being financed.  This is to ensure that if the project doesn’t go as planned, the general partners are incentivized to correct the ship rather than giving up and letting the bank step in.  Banks are not in the real estate business; they are in the deposit and lending business.  Bank debt is very flexible given they are relationship driven.

2. The next would be bridge financing. Bridge is short term financing. It can be two to five years, typically around three years. Bridge financing sources could be banks, or it could be a debt fund. A debt fund is a group or a company that raises capital strictly to provide debt products on commercial real estate. Most bridge lenders are what we call balance sheet lenders. This means they are a financial firm, an investment firm, a bank, or some type of financial institution that holds the loan on their balance sheet.  Some bridge debt providers will sell their loans to the secondary market.  This is a benefit to the marketplace because the debt instrument is yielding interest and is backed by real estate.  Bridge lenders and their products lack the flexibility banks have and are transactional.  Their goal is to lend, make fees on the capital they are lending and receive interest payments on the capital they lend.  The more they lend, the more they make.

3. Another type of debt is called mezzanine debt. It sits between the senior lender and the bank or bridge debt. The goal with mezzanine financing is to get more leverage. As an example, you have 60 percent leverage, and you’re trying to push the leverage to 75 percent, that's where mezzanine financing would be used. It's a little higher interest rate, and there's no participation by the lender in the upside. They just sit in the middle of the capital stack.  Mezzanine debt providers specialize in this type of product and don’t tend to venture outside of this product type.  Mezzanine debt is used on heavier renovation projects and new development given the large value creation that will occur from the project.

4. The most common type of debt for multifamily apartment communities would be GSE or Government Sponsored Entity.  Fannie Mae and Freddie Mac are agencies of the Federal Government with mandates to lend on workforce housing.  The Government understands the need for investment into apartment communities by the private markets and they are willing to provide low-cost debt financing to incentivize investors to buy and sell apartment buildings.  Agency financing is very attractive, low rate, government backed and best of all is non-recourse.  Non-Recourse means it’s strictly asset based with no liability to the sponsorship group if the project doesn’t go as planned.

5. There's also private debt. You can have private capital that you borrow for debt financing from a private lender.  It’s very rare and requires a high net worth individual or company that is seeking to provide debt products.  The interest rates tend to be higher than the market but provide the project flexibility that other lenders may not.

6. There are hard money loans for deals as well. These loans are short term, high interest, and expensive.  It’s common in single family investing but is challenging in apartment community investing because of how expensive and finite the timing of the terms can be.  These two things can make the project have more risk and is only recommended on heavy renovation projects and for sponsors with experience and a finance background.

7. Lastly, another form of debt financing is participating debt. Participating debt means a company that lends on multifamily and other CRE assets as debt, but they also participate in the upside of the deal, how an equity partner would in other scenarios.  This is attractive to real estate sponsors, or general partners, because they don't have to give up an enormous piece of the upside to equity partners. Participating debt products mainly come from life insurance companies.  It can be higher leverage.  Life insurance companies are risk averse and tend to be more Core thesis focused.  They want to lend on good real estate and to lend to experienced sponsors and companies.

As you can see, these are some of the types of debt products that you can use to acquire multifamily apartment community investments.  There are others but this list summarizes the majority of products used in the marketplace.

Subscribe for alerts about our latest offerings and to receive periodic market updates.

Start building your wealth today.