The image that emerges from this research is that of two market segments. Larger multifamily properties have various sources for financing, greater choice of loan type, and more competitive interest rates. By contrast, smaller multifamily properties primarily depend on local depositories for financing and thus have less choice in the type of loan and often carry higher interest rates. Barriers to Financing Small Properties The standard underwriting process, used extensively for loans on commercial properties, typically mandates the use of a recent appraisal by a State-certified appraiser, environmental reviews, and attorney opinions and certifications. The high fixed costs associated with this process make standard underwriting prohibitively expensive for smaller multifamily properties. Many small property owners do not keep sufficient documentation of property income and expenses to meet standard commercial underwriting requirements. The revenues generated by these loans for underwriting and servicing, which are based on a percentage of the loan balance, are too low to make these loans profitable for many commercial mortgage originators. One factor that does not seem to be a barrier to serving this market is credit risk associated with small loans. In fact, recent studies on multifamily loans show that borrowers with smaller loans are less likely to default. Depository institutions, the principal sources of financing for small multifamily properties, use a hybrid of residential and commercial underwriting. Depositories rely as much on the creditworthiness of the borrower as the value of the asset securing the loan. By making loans only to creditworthy borrowers and by requiring personal recourse, depositories are able to rely on a much less costly process to evaluate the property. This approach also frees borrowers from providing the extensive documentation of property income and expenses required by secondary market investors. Recent Market Trends The market for small multifamily financing has evolved in recent years. As secondary market conduits have grown in importance in commercial mortgage financing in the 1990s, these firms are exploring opportunities to expand their markets. They are finding that small properties are a largely untapped, increasingly attractive market. To better tap this niche, Fannie Mae and 12 other conduits have introduced loan packages for smaller multifamily properties. It appears that the majority of small multifamily borrowers are still largely left with depositories as a source of funding, and there are also some favorable trends in this niche. Depositories appear to be expanding their lending operations. LaSalle Bank, for example, has taken its small multifamily program to all 48 continental States. Other residential lenders are developing new lending programs with fewer underwriting barriers to smaller properties. The expansion of lending programs aimed at this smaller property market has made a sizeable contribution to the availability of financing. However, given the scale of these new programs relative to the size of the market niche (several hundred thousand properties), there is still room for substantial expansion of lending activities, particularly in small markets and rural areas. The report concludes that it is hard to evaluate the impact of expanding lending programs on interest rates for smaller loans. Many lenders noted that rates continue to be higher in the small property segment because of higher costs of underwriting and servicing these loans and because lack of deep competition makes higher rates feasible. However, if lending programs targeting this niche continue to grow, interest rate premiums that are not attributable to higher costs or risks would decline over time. An Assessment of the Availability and Cost of Financing for Small Multifamily Properties is available for $5 from HUD USER. Use the order form.
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