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A Large Look into Small Balance Loans

In 2014, the Federal Home Loan Mortgage Corp. entered the small balance loan arena, backing $4.6 million loans in the first year. By the end of 2017, Freddie Mac funded a total of $6.9 billion in small balance loans (SBL) business.

Though the balances on these loans are, as the name suggests, small, their popularity is clearly anything but. “These loans have a broad appeal among investors. Institutional types are doing small balance loans, as are mom-and-pops,” commented J. Scott Croul, senior managing director of Small Balance Loans with Red Capital Group, LLC. Additionally, more borrowers are likely to be jumping into the SBL space, due to its streamlined, low cost requirements, better debt coverage, reduced paperwork and competitive interest rates.

“Freddie Mac’s SBL product brings a highly efficient capital source to all markets across the nation” Croul noted. “This was a space that was largely underserved and once dominated by local and regional banks. Now there are roughly 11 national lenders that offer the product, and enable Freddie Mac to provide a consistent source of capital to all markets and fulfill its mission to support affordability of the US housing market.”

How Small is “Small?”

The Freddie Mac SBL program offers financing ranging from $1 million to $6 million nationwide, with certain major markets qualifying for loans up to $7.5 million. These markets include larger metros, such as Los Angeles, Dallas, Chicago and Washington DC, as well as secondary markets that include Stamford, CT and Minneapolis. Freddie Mac’s counterpart, the Federal National Mortgage Association (Fannie Mae) also offers small loan balance financing through its Small Mortgage Loan (SML) program, which goes to $3 million nationwide, and up to $5 million in certain eligible markets.

Though slight differences exist between the programs, their goals are the same. Specifically, the loans target stable, structurally sound multifamily properties with five or more units that in most cases, fall into the affordable housing/workforce housing categories. Said Croul: “They aren’t going after the luxury space, but are targeting Class B and Class C quality assets.” He added that the small loan balance products are targeting  formerly underserved markets, and are not limited to major markets or large apartment operators. Target borrowers could range from the retiree who owns one or two multifamily properties, to “the guys who, that is their business,” Croul said. “All they do is specialize in multifamily investments.”

The SBL Pros and Cons

Though lower-balance loans are available on the conventional side, the SBL programs carry less stringent parameters for due diligence, as well as a more streamlined process when it comes to closing the loan. Less documentation, negotiation and customization are involved, meaning faster approval and less cost.  Furthermore, both the Freddie Mac and Fannie Mae programs will hold the interest rate until it is fully locked, without the sponsor having to pay extra.

When it comes to an SBL, the emphasis tends to be more on the property than the property owner. This isn’t to say, however, that checks will be signed to just anyone who want to buy a couple of Class B apartment buildings. “They’ll look at the sponsor’s experience first,” Croul explained. “If the sponsor doesn’t have experience, they’ll look at the property’s management and the market, and consider the strengths and weaknesses of both.” Similar to single-family home-buying, Fannie and Freddie want credit scores and the borrower’s financial statements. In fact, liquidity should be no less than 9 months debt service, and net worth need to be at least equal to the loan amount.

Finally, the loan documents are, for the most part, set in stone, with few changes and no customization permitted. “Standard changes are allowable but, for the most part, the idea is to have a fixed set of documents that lead to a low-cost, high-volume business,” Croul said.

Large Interest in Small Loans

Croul went on to say that Freddie Mac’s $6.9 billion in SBL lending last year speaks volumes as to the program’s success so far. Even better news is the potential for growth in this highly-fractured sector. One analysis points to a potential $50-billion-a-year industry, whereas another indicates that SBL activities could well top $80 billion.

Croul is also encouraged by the belief that a large portion of the market still remains unaware of the GSEs SBL products. And, for Freddie Mac, while $6.9 billion in small business lending is huge, it’s only a small portion of the $73.2 billion the GSE financed in 2017. Fannie Mae, overall, provided $67 billion in multifamily and other rental financing, with $2.3 billion in small loans. “If Freddie can duplicate their 30% market share on the conventional side in the SBL segment,” Croul pointed out, “they would triple their SBL volume.”

For comments, questions or concerns, please contact Amy Sorter

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