# Pre-Stabilization Multifamily Financing

- Link: https://johnmorelli.us/exploring-pre-stabilization-multifamily-financing/
- Published: 2024-10-22T22:47:40+00:00
- Author: John Morelli

As multifamily developers face persistently high interest rates across most debt
products, they are increasingly looking for ways to exit high-cost construction 
loans before properties reach full occupancy. However, qualifying for a permanent
loan can be a challenge when the asset isn’t stabilized or fails to meet proforma
rent expectations. This predicament has become more frequent, leaving developers
in a tight spot.

A solution for many developers is construction take-out loans before stabilization,
also known as “lease-up” loans. These loans can help reduce borrowing costs sooner
than waiting for property stabilization. This type of financing is a viable option
for newly built or renovated multifamily properties and can eliminate the need for
a bridge loan, particularly when the developer faces an approaching loan maturity.
That said, some lenders require properties to be at least 50% leased or occupied
before they’ll consider financing, even during the lease-up period.

Let’s explore how different lenders approach the timing, loan sizing, and pricing
of lease-up loans.

##### Agency Loans

For agency lease-up loans, lenders will begin quoting when the property’s net operating
income (NOI) achieves a 1.0x interest-only [debt service coverage ratio](https://insigniafs.com/debt-service-coverage-ratio-dscr/)(
DSCR) and 60% occupancy. Typically, closing can occur once the occupancy reaches
75% to 80%. [Loan sizing](https://insigniafs.com/loan-sizing/) is based on a 1.25x
DSCR using stabilized NOI with a 30-year amortization. Interest rates range from
seven to 15 basis points above the permanent rate, with terms of five, seven, or
ten years. The rate can be locked in before closing. However, a credit enhancement
might be required, though waivers can be difficult to obtain, particularly if the
loan is full-term interest-only.

##### Banks

Banks usually quote lease-up loans once a development reaches around 50% occupancy,
but require a Certificate of Occupancy. Closing typically occurs when occupancy 
hits 75% to 80%, provided there is leasing momentum. Loan sizing follows a 1.25x
DSCR on a 30-year amortization, using a minimum underwriting rate of 200 basis points
above the U.S. Treasury rate. The final interest rate is typically SOFR plus 300
basis points, or a fixed rate of 200 to 225 basis points above SOFR. Bank loans 
often start with a floating rate and later transition to a fixed rate, with deposits
ranging from 5% to 20%, depending on the bank.

##### CMBS

CMBS lenders are less concerned with initial occupancy for quoting but will only
close loans once the property is above 90% occupancy. The loan must meet a 1.2x 
interest-only DSCR, with interest rates starting at 225 basis points above the Treasury
rate. The rate can be locked in at closing, and loan terms are typically five, seven,
or ten years, similar to agency loans.

##### Debt Funds

Debt funds require a certificate of occupancy before providing a loan quote. Their
typical minimum DSCR is 1.25x on a 30-year amortization with a rate of 6.5%, based
on stabilized NOI, which usually materializes two to three years after lease-up.
They price loans expecting refinancing through Freddie Mac or Fannie Mae. Rates 
start at 250 basis points above the Term Secured Overnight Financing Rate (SOFR),
with initial terms typically spanning three years, plus two one-year extension options.
Debt funds often provide higher loan proceeds and allow earlier execution during
the lease-up period.

##### Life Companies

Life companies also require a Certificate of Occupancy to quote loans and may require
a master lease at closing to cover any NOI shortfall. Their loan sizing is 1.25x
on a 30-year amortization, with interest rates starting at 165 basis points above
the U.S. Treasury rate. Borrowers can lock in a rate up to 90 days before achieving
a 1.0x DSCR. Typical loan terms are five, seven, or ten years, although flexibility
is possible for shorter or longer durations.

##### Executing Lease-Up Loan Strategies Effectively

Each lender type offers different terms for lease-up loans, but these loans can 
be attractive for developers looking to exit expensive construction financing ahead
of stabilization. It’s important to consider loan sizing metrics, pre-stab terms,
and pricing when deciding which lender best suits your needs.

Additionally, understanding how lease-up loans work can help you implement leasing
strategies more effectively. This might involve reducing vacancies, offering tenant
concessions like free rent, and optimizing rental pricing. While lease-up loans 
come at a premium due to the higher risk lenders take, developers should evaluate
if paying slightly more upfront, in exchange for exiting higher-cost construction
debt, makes financial sense for their project.