Janover Ventures CEO Blake Janover Discusses Multifamily Financing: Part 2

The Janover Ventures CEO Was Interviewed On William Weidner’s Realty Speak Podcast

Last month, Janover Ventures CEO Blake Janover went on William Weidner’s Realty Speak podcast to discuss the current state of the multifamily financing market, as well as to talk about how he got his start in the multifamily business. Listen to the podcast here, or read this condensed version of the interview for some of the highlights.  

In part one of this interview, they discussed Blake's early business experiences, the lessons he learned in the aftermath of the 2008 recession, the definition and importance of a commercial real estate capital stack, and the difference between a direct lender, a broker, and an advisor in the multifamily business. They also talked about the potential upsides of working with an advisor, and the awesome benefits of HUD/FHA-insured multifamily debt, including the HUD 223(f) and HUD 221(d)(4) loan programs.

In the second part of this interview, they discuss:

• How recourse works in multifamily lending, and why borrowers should always aim to get a non-recourse loan
• The importance of carve-outs for non-recourse loans, and why multifamily borrowers should always retain counsel
• How prepayment penalties work
• The benefits and drawbacks of CMBS loans
• Fannie Mae vs. Freddie Mac multifamily loans for small-balance borrowers
• How closing costs work for multifamily loans
• The most important questions a borrower should ask before they start searching for a lender

*The following interview has been edited for length and clarity.

So these HUD loans, are they non-recourse or recourse and what does that mean?

Generally speaking, HUD/FHA multifamily loans, CMBS loans, and life company loans are all non-recourse, with carve-outs. I’ll explain what that means in a moment.
If a loan is recourse, the key principals of the borrowing entity (usually a special purpose entity), sign personal guarantees. This means that if they default on their loan, the personal guarantee is triggered and the lender can take the principal’s personal residence, car, jewelry, and the contents of their bank account, and may even be able to garner their wages.

A lot of people signed personal guarantees before 2008, and a lot of really successful people ended up losing everything, so naturally, since 2008, people have been a lot less willing to sign them.

In contrast, for a non-recourse loan, there’s no personal guarantee. If lender has to take back the property, they will be responsible for making themselves whole. However, pretty much all non-recourse loans come with carve-outs, which make a loan recourse in the case that the borrower commits one or more “bad” acts, such as fraud, material misrepresentation, or not paying their taxes.

Today, a lot of lenders are slipping in more carve outs, or addenda to carve outs, which, in practice, can make a non-recourse loan into a full recourse financial instrument. Some of these addenda could technically put you into default for doing something very minor, like sending in your P&L statement late. That’s why it’s really important to retain counsel that’s specifically experienced in negotiating carve-outs.

Unlike in a residential mortgage, where you just come in and sign the papers, for a commercial loan, you have the right to retain counsel. Then, they can come look at the paperwork and make sure everything meets your expectations. Is that correct?

You don't have the right-- you have the responsibility to your investors and yourself to make sure that the loan documents coincide with the term sheet or commitment which you signed.

For Fannie and Freddie, you typically don’t have to worry about this, but for the CMBS market, there’s sometimes some cowboy-esque activity. Not to throw shade on CMBS lenders, since many of them are great, and CMBS, as a product, is unbelievable. In particular, it’s great for loans between $2 and $10 million, particularly if the key principals don’t meet the net worth and liquidity hurdles that are often required for other kinds of multifamily financing.

In essence, CMBS loans are incredible but it’s important to realize that they aren’t in a box-- so every lender has its own policies, loan docs, credit committees, and so on.

Coming back to the subject of recourse, some banks make it so that you’re technically triggering a carve out no matter what you do, but they won’t act on this unless they really have to. Sometimes you’ll agree to this because you have to-- because you don’t have any other good choice when it comes to financing. You also might do it because you have a great relationship with your lender. But no matter what, never go into a situation where you're borrowing a bunch of money blind.

Talking about the legal implications of borrowing-- do you assist with discovery?

No, we’re not attorneys, and we’re not accounts, and we can’t assist with tax advice. That being said, I’m always happy to look at something and say “Hey, that doesn’t look right, you may want to push back on it.” We really add the most value when it comes to business considerations, such as loan terms, prepayment penalties, recourse, and the like. We certainly don’t get into legal minutiae, but we can look to see if something seems appropriate if a client has a specific question.

Blake, you mentioned prepayment penalties? What are they, what are the different types, and what can a borrower can expect?

With non-recourse securitized-type debt, if you want a 10-year fixed-rate or 20-year fixed-rate, loan, expect prepayment penalties to come with the package.

I’ll use the example of the Freddie SBL program, which is a really popular program for multifamily borrowers. You can take yield maintenance by default as your prepayment penalty. Think of it as call protection; if you’re a lender, your yield is protected. As a lender, at any point, you’ll earn the spread over the corresponding treasury (if the borrower decides to repay the loan early).

However, as a borrower, if at any point, if you want to navigate to a step-down prepayment penalty, you can. A step down might be set up like this: 5,5,5,4,3,2,1.

Could you explain more about that?

Sure. A 5-year loan with 5-year step down could go like this: a 5% penalty in the first year, a 4% penalty in the second year, a 3% penalty in the third year, a 2% penalty in the second year, and a 1% penalty in the fifth year. In the last 90 days, there’s generally no prepayment penalty.

What about defeasance?

Defeasance is common in CMBS, but today, we’re doing a lot more yield maintenance. It’s important to realize that most debt today is assumable for a reasonable fee, usually 1%. If interest rates increase in the future, and you have a 40-year loan at a 4% interest rate, and now rates are 8%, a new buyer can create a tremendous amount of arbitrage by assuming that loan. Plus, Fannie Mae provides supplemental debt at market rates, so borrowers can actually layer it on top of their senior loan to make up for the rest of the leverage.

Now I want to talk about small balance loans from Fannie Mae and Freddie Mac, and the differences between them. Small balance loans range from $750,000 to $7.5 million. Saying it out loud sounds offensive, especially since something like $5 million is really a lot of money.

But until a couple years ago, borrowers would need to take out a $20 or $50 million loan to get this type of financing.

Everyone else just went to their banks and got a full-recourse 5/25 loan. Now, these smaller borrowers have access to financing in the same ways that really big investors do. Like I just mentioned, with Fannie, you can go as low as $750,000.

With Freddie Mac, their Small Balance Loan (SBL) Optigo product is also great (they’re calling all multifamily products Optigo now), though their credit box is kind of narrow. Freddie SBL is better in larger markets, like Los Angeles, New York City, Miami, Portland, and Austin. In those markets, you will get the most competitively priced, non-recourse, high-leverage debt possible.

That being said, Fannie Mae has a really special product too, which is most powerful in secondary and tertiary markets. Freddie really moves based on markets first, while Fannie is almost market agnostic. However, some markets are pre-review for Fannie, which means it’s a little harder to get good terms there (often because Fannie has had bad experiences with foreclosures there in the past). Fannie will provide small balance, 30-year fixed and fully amortizing debt, even for a 30-unit, C-Class property in a tiny market, with an old roof, and that debt will be in the mid-4s, with 80% leverage--  most people don't know this.

Part of our mission as a company is getting that message out there. If you’re looking for $1-3 million in debt, you are an entrepreneur and you deserve to know what’s available to you. You should be able to reinvest your proceeds to do whatever you want and remove the personal guarantees. Because there’s no one out there with 300, 400, or 500 units who’s personally guaranteeing their properties.

In essence, there's more out there than you know; maybe there's a path of lesser resistance-- and a way to reduce your risk while increasing your profits. That’s what we want to help people discover.

We’ve heard the words costs and closing costs; do you have a real case scenario that you can share with us today about the different costs, including upfront costs, and post-closing costs that a borrower will deal with during the lending process?

Different lenders have different upfront costs. With Fannie and Freddie you can usually expect to pay between $8,000 to $12,000 in upfront costs. That money is usually put towards a PCNA (or project capital needs assessment, a type in-depth property inspection), an Appraisal, and a Phase I Environmental Report. Lenders will never pay out of pocket for these reports, though smaller lenders, like local banks, may do less and cost less.

For bigger loans, like Fannie Mae DUS, you can expect about $30,000 in upfront costs. For CMBS, though, the biggest potential pitfall is legal costs. Always ask your CBMS lender to use small counsel in a small state; otherwise legal fees cold run $30,000 or $40,000. I’ve even seen them go to $150,000. No matter what, no lender will do a loan without taking money upfront.

That being said, you want to work with a real lender who doesn’t want to take your money; who you send your money to matters. You may not want to send a $10,000 deposit to XZY lender located in the middle of nowhere; you might not hear from them again.

I’m excited for your to tell us about those closing statements and to teach us more.

Sure. For this, I’m going to use the example of a $26 million construction loan. Here goes:

• Lender’s Commitment Fee: $200,000 (it sounds like a lot but it’s actually less than a point)
• Doc Stamps: $93,000
• Intangible Tax: $53,000
• Title Premium: $59,000
• Title Premium for Endorsement: $6,000
• Additional Lien Searches: $3,000
• Additional Taxes: $81,000
• Borrower Legal: $40,000
• Advisory Services: $300,000
• Insurance: $160,000
• Lender’s Due Diligence:
• Insurance Review: $5,000
• Phase II Environmental: $10,000
• Appraisal: $6,500
• Zoning Report
• Construction Risk Assessment: $6,000
• Lender Legal: $100,000

There are a variety of other, miscellaneous fees, but if we add up everything together, we get about $1.2 million overall.

If I take $1.2 million and divide it by $26 million, I get 4.6%, and, while I was cringing at first, in reality, that’s not so bad.

Yeah, it’s not, and a lot of these aren’t necessarily direct closing costs, they’re also things like insurance and taxes.

I want our listeners to keep in mind that different states have different taxes that may be charged in a loan transaction, depending on whether it’s a sale or refinance, and in New York, we have something called mortgage tax, which doesn’t typically apply in other states. I won’t get into it all, but title insurance is also different in different states. So these are a few important things to keep in mind.

Definitely, and if you’ll give me just a few minutes, I’d also like to go over another transaction, a $4.4 million construction loan in New York state. This was a small  bank loan. The closing costs included:

• Insurance: $7,000
• Survey: $2,000
• Origination Fees: $88,000
• Doc Tax: $4,500
• Appraisal: $5,500
• Title and Mortgage Tax: $20,000

The origination fee was pretty expensive here, and I’ll tell you why. This lender typically had a 2% origination fee, but in lieu of the lender charging no prepayment penalties, they added an additional fee. Having no prepayment penalty was really important to the borrower in this situation.

Doing the math, it looks like that origination fee came out to about 2.8%.

Yes, in this case, the borrower didn’t have any real estate tax bill to pay, and didn’t escrow insurance. The total percentage of costs as it related to the loan amount was lower.

Going back to the first closing statement, we talked about a $300,000 advisory services fee. Whose fee was that?

On larger transactions, you’ll see various advisors engaged, from insurance to underwriting and so on. In this particular scenario, the fee was for advisors engaged by the family office who invested the limited partnership money into the SPE (special purpose entity). Part of it went to borrower advisory fees as well. These larger construction transactions required the services of a wide variety of folks, and the services in absolute numbers aren’t cheap, but as we talked about before, expressed as a percentage of total project cost, they are, in fact, quite reasonable.

I think we calculated the total expenses at 4.5%, and including all those services, it is pretty reasonable.

Especially when the partnership is planning on getting an 8-figure return on their investment.

That’s what it’s all about; I put this much in and get that much out tomorrow. We could go on forever, but that’s all we have time for. Before we go, could you give our listeners the top three questions they should ask themselves (not anybody else), before they start to search for a lender.

So the first question is: what are my goals, risk tolerance, and what’s my business plan? Is it a long hold? Is it a flip? Is there a Capex component? What do I want? How do I want to get there?

The second question is, do I know all the products available to me and which ones are appropriate? So I make sure that I can address all of them in my search, be it CMBS, bridge, life company, etc.

And the third question-- probably the most important: did I call Janover Ventures?

I like that third question, Blake, that’s good. A little shameless self-promotion going on there.

No shame here, Bill, no shame.

And of course, that’s perfectly fine. And that being said, you provided our listeners today with a tremendous wealth of intel. I’m sure the Realty Speak listeners are very excited about what they heard today. I’m very excited about what I heard today. And thank you, thank you so much. How can everyone get in touch with you?

You can email me directly at [email protected]. If you look me up on LinkedIn (Blake Janover), I’m pretty active there. And, you can visit our website, www.janover.ventures.