Seeing your development project come to fruition is immensely satisfying. Once construction is completed and the building is tenanted, your final step is to get permanent financing for your multifamily real estate. This may be in the form of conventional commercial mortgage refinancing. It could also be the point at which you and/or your partners exit the investment by selling it.
Shop Around for Permanent Financing for Multifamily Real Estate
Refinancing a mortgage is a common practice. But that’s not to say it’s easy. The short credit history of your development could cause complications when refinancing a construction loan and could impact your interest rate substantially. The lender will likely order a property appraisal and will certainly ask you to produce documentation of all your financial activities. In lieu of credit history, the underwriters will likely place heavy emphasis on the local market conditions and look at indicators such as DSCR (debt service coverage ratio)—a measure of your ability to pay back your loan—and your equity in the project (the portion owned by you and your partners, debt-free).
You will find no shortage of lenders willing to consider the permanent financing of your multifamily real estate project. Local banks, national banks, and non-traditional lenders, such as finance companies and online lenders, are all potential sources of funding. Their offers could differ substantially, so it is critical that you comparison shop.
Keep in mind, too, that you are the lender’s customer and you may be able to negotiate some of the loan’s conditions. You will be living with those conditions for many years to come. Spread over a long period, a few basis points on your interest rate will mean a lot of money. Balloon payments and prepayment fees will also have greater meaning than they did in the previous rounds of financing.
You may choose to use a commercial mortgage broker in your search. Mortgage brokers help you find the right lender. They use different techniques and may be subject to very little regulation, so do your due diligence before agreeing to a relationship. A broker’s primary value is performing the legwork you’re too busy to do. In other words, a broker may not find opportunities you wouldn’t eventually come across on your own, but the time savings could be huge.
Time for a 1031 Exchange?
You might not want to own the completed development asset. After all, a multifamily housing community provides ROI differently from a development project. So, if you continue to own the project after its completion, you are essentially changing investments. Development typically creates a profit relatively quickly and should provide a higher rate of return than a completed multifamily property. Ownership of a multifamily property generally provides a steady cash flow for as long as you own it, but at a lower rate.
The profit you make by selling at this point is known as the terminal capitalization rate or exit cap. The exit cap is determined by the property’s expected net operating income and growth potential, interest rates, investor demand, and the availability and terms of financing. In addition, local market conditions and construction costs, which may be highly impacted by the cost of labor, can have a decisive influence on that rate.
Selling your development has tax consequences. So, you may want to consider a 1031 exchange for tax optimization. By exchanging your development property for another investment property, you can defer capital gains taxes—and continue to defer them as long as you maintain the cycle of exchanges. A 1031 exchange is complex, with many property rules and steps, holding requirements, and strict deadlines. It requires the services of a qualified intermediary and you will likely want to seek professional investment advice at a number of points during the procedure.
At CWS Capital Partners, we are a fully integrated multifamily real estate investment management firm that offers everything from due diligence and multifamily real estate valuation to transaction support and property management. We specialize in assisting our clients with 1031 exchanges, acquisitions, repositioning, and development. We also own and manage luxury multifamily investment communities in major markets around the country and employ a team of experts who can help you hone your investment strategy.
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The information provided here is for your general informational purposes only. It should not be considered a recommendation or personalized advisory advice. CWS has made this third party information available from authors it believes are knowledgeable and reliable resources. However, its accuracy or completeness cannot be guaranteed and sentiment may change due to legal or economic conditions.
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