Skip navigation
Ensuring a Safe and Sound Federal Banking System for All Americans Site Map | Text Size: S M L

BankNet

BankNet
Resources for bankers

HelpWithMyBank.gov

HelpWithMyBank.gov

Get answers to banking questions

Job Seekers

Job Seekers
Join one of the best places to work

Community Developments Investments (May 2015)

An Interview With Shekar Narasimhan: Financing Small Rental Properties

This photo shows the upper three stories of a brick apartment building.
Source: Shutterstock
This photo shows the upper three stories of a brick apartment building.

Shekar Narasimhan, Managing Partner, Beekman Advisors

Shekar Narasimhan, Managing Partner at Beekman Advisors, McLean, Va, provides strategic advisory services to companies and investors involved in real estate, mortgage financing, affordable housing, and related sectors. He serves on many boards, including those of Enterprise Community Investment and the Community Preservation and Development Corporation. He is on the executive committee of the National Housing Conference and is a fellow at the Joint Center for Housing Studies of Harvard University. In the past, he served on the Mortgage Bankers Association of America Board of Directors, and was elected the first Chair of the Fannie Mae Delegated Underwriter and Servicer Advisory Committee.

To share more information about how to best finance the small multifamily rental market, the Community Developments Investments staff recently sat down with Mr. Narasimhan to talk about financing for small multifamily rental properties. Here is a portion of the conversation.

OCC: Can you please tell us your thinking about the availability of financing for small multifamily properties and where any gaps exist?

Narasimhan: First, let me say that this small multifamily rental property market seems to be getting much of the credit it needs from portfolio lenders and is not capital starved. But I would like to point out that there is still a need for a secondary market for small multifamily loans. When you look at it purely from the perspective of a lender, access to a secondary market at some point in time, to be able to offload assets that don’t meet your asset liability requirements or have a duration mismatch or have seasoned and can extract profits from it, is a very, very valuable thing to have. The other reason is that under certain circumstances, securitizing loans can result in lower regulatory capital requirements for the lender.

For example, let’s say you have a three-year seasoned small loan that has met certain requirements: say a 10-year duration, 25-year amortization, and it has performed well for three years in a row. If that loan can get a Federal Housing Administration (FHA) insurance wrap, it could be kept by the lender in portfolio. The insurance would then reduce the regulatory capital requirements from, say 100 percent to 20 percent or something like that, depending upon structure. The institution may then decide to keep these newly insured loans for the duration, or alternatively, it would have the ability, if the loan didn’t fit the lender’s profile on its liability side, to be able to offload the insured loan in the secondary market. This could be done because there’s a ready market for government guaranteed paper.

[Editor’s note: Under the regulatory capital rule certain multifamily mortgage loans receive a preferential capital charge of 4 percent (risk weight of 50 percent) pursuant to the provisions pertaining to statutory multifamily loans in the regulatory capital rules. Other multifamily mortgages receive 8 percent capital charge (a 100 percent risk weight). The risk weighting would depend on whether the FHA “wrap” would qualify as an eligible guarantee under the capital rule. If the “wrap” did qualify, it is likely to be treated as a conditional government guarantee, which would reduce the capital charge to 1.6 percent (risk weight of 20 percent).]

OCC: How are Fannie Mae and Freddie Mac factored into the small multifamily market?

Narasimhan: Many have suggested that Fannie Mae and Freddie Mac, or their successor entities, should play a larger role in financing small multifamily properties. I guess my perspective has been that square pegs don’t fit in round holes, and this is a square peg. This is also the reason why we should clearly define what we’re trying to achieve on the capital side. And I would argue that what we’re trying to achieve is the ability for these loans to be sold in the secondary market at some point in some manner rather than create a cookie-cutter securitization product. This would support the free flow of capital. As a lender, I can replenish my balance sheet. I can reduce my reserve requirements. I can address an asset liability mismatch. I don’t necessarily need to be able to standardize each loan to securitize them through a CMBS [commercial mortgage-backed security] conduit or through a federally guaranteed agency that puts it into a mortgage-backed security.

OCC: So you’re saying that this small multifamily loan product is a square peg, not fitting the round holes of the government-sponsored enterprises (GSE). Please tell us more about your thinking here.

Narasimhan: An idea I’ve had for a very long time is that banks want and need to make these loans. Probably the right loan for this marketplace is actually a 10-year fixed-rate loan with a 25-year amortization. Most of the property owners do not need or want a much longer duration. After 10 years, banks tend to need to recycle capital. After 10 years, the properties themselves need renovation or capital improvements, probably because of the age. What if you could create an instrument so that after three years of seasoning this loan on your books, you could take it to [the] Federal Housing Administration? FHA, of course, would automatically give you 100 percent government guaranteed insurance. You insure that loan and ideally make it into a Ginnie Mae security. Or, after a period of seasoning where the loan actually performed and you maintained the servicing, and you then could keep that loan on your books or you could offload it directly into the secondary market with that government insurance or that government wrap. But you’re not forcing the bank or institution to sell. You are reducing their risk weighting for regulatory capital and you’re enabling them to continue to serve the same borrower base. That’s what I mean by access to the secondary market. The ability to sell a loan can be differentiated from the ability to create pools of loans, to create a security and sell it. Most smaller financial institutions are never going to have the ability to create pools of loans.

OCC: So, is it really just a question of a lack of longer-term, fixed-rate financing that the small multifamily property sector needs?

Narasimhan: You put your finger on it. One product in the market is offered by J.P. Morgan Chase (which was formerly a WAMU [Washington Mutual] product), and it was a five-year instrument, fixed rate for the first five years, with one five-year rollover option.

We in the affordable housing community (especially nonprofits and advocates) have our own value system about how we think the market should operate. We think that a longer-term, fixed-rate mortgage would be better for these properties. We think non-recourse is better. When a commercial bank makes this loan, it tends to do it as a relationship borrowing exercise, which makes complete sense. The loan will tend to be at a floating rate and have the advantage of optionality in prepayment terms. So the bank is giving the borrower a lot of optionality. The securitization market requires less optionality, non-recourse, reserves being pledged, and, you know, significantly higher fixed underwriting costs.

So we, in the affordable housing community, have tried to push our value system on these loans, and it doesn’t make sense. This is more driven by people saying, “We have a section of the market that is diminishing in size,” which it is. “There is more attrition of units here. This is a valuable resource. We should do something about it, and we think the answer is to somehow figure out a way to do 10-year, fixed-rate loans for this market, and it’ll become more stable.” I think that may be the right product for this market if you could do a 10-year fixed-rate loan which could have limited prepayment optionality and then is open for prepay or very limited prepay restrictions after five years. But I don’t know anybody who’s going to buy that particular loan product in the securitization market. It doesn’t fit, and it doesn’t price very well. So that’s why I keep saying the disconnect is we think we know an answer, but I’m not sure we’ve thought through what the problem is.

OCC: But the downside of a 10-year, fixed-rate product for our community banks is duration risk. And perhaps we need to acknowledge that some parts of this small multifamily market are not going to be served with longer-term financing since they are too small for the GSEs and thus not securitizable. Would you agree?

Narasimhan: Right. So, let me make two points here. One is the proposed FHA risk-sharing pilot, [which] requires 50 percent risk taking by a qualified community development financial institution [CDFI] will have difficulties becoming operational if the loan cannot be securitized with Ginnie Mae. Under the program [described elsewhere in this publication] if the CDFI makes a loan under the program, they get FHA insurance. And if the loan defaults, the CDFI would pay 50 percent of the claim.

However, legislation is needed in order for these loans to be able to be securitized with Ginnie Mae. I don’t believe that legislation is likely to pass, at least in the near term, and there wouldn’t be liquidity for the loan itself. These are not going to be held in a nonprofit sector, particularly by CDFIs, either because of the risk-sharing or because of the duration risk and because of the fact that they’re not liquid instruments.

My other thought is that we should look more carefully at the 538 program that Rural Housing Service runs (see sidebar 3, below). The 538 program is the rural rental program. It’s also largely small loans. It’s a program with a 90/10 pari passu risk-share [90 percent of the loan is covered by a government guarantee, 10 percent is retained by a lender]. Reminds me of the old Freddie Mac 95/5 program, for single-family mortgage loans made by S&Ls.

OCC: Anything else you want to cover that we haven’t talked about yet?

Narasimhan: Only to assert that this small multifamily market needs to become more professionalized. This will have a terribly positive effect on the small multifamily space by proving wrong all the people I’ve talked to who say, “No, no, it can never be made efficient.” But those are the same people that said you can never do single family rental housing either. So if it works, which I strongly suspect it will, given the players and given the impetus and given the fact that this is core housing for the United States, it will help preserve this very important housing stock that is desperately needed. If the stock did not exist, it would create even more rent increases than we have seen, and people would then have no choice but to rent a large garden apartment in the suburbs. And that’s why I keep suggesting the same thing, which is to give lenders access to the secondary market. Let them be the drivers of the decision. Give them the template for getting there so that when they load up, they can take appropriate action.

Some of these banks have billions of dollars of these loans. At some point in time, they will notice the extent of these loans and hear their boards and your [OCC] examiners say, “You’re loaded up.” They need an exit strategy when this time arrives. So I would say the rationale for a secondary market is very solid. The rationale for using banks as the front lines to originate and service this product and make money off of it is fantastic.

For more information, e-mail Shekar Narasimhan.

HUD’s New Multifamily Risk-Sharing Program

Theodore Toon, Director of the Office of Production, Office of Multifamily Housing Development, U.S. Department of Housing and Urban Development

Small buildings house a disproportionately large share of the nation’s low-income renters and provide housing at rents more affordable than large buildings.1 Yet this segment of the market is disproportionately underfinanced, even through U.S. Department of Housing and Urban Development (HUD) programs.2 In addition, a disproportionately small percentage of the Federal Housing Administration (FHA) insured loans have been for small buildings. In FY 2012, just 5 percent of loans in the FHA new construction/substantial rehabilitation program (section 221[d][4]) were for small multifamily properties, and just 16 percent of FHA’s loans in the refinance/moderate rehabilitation program (section 223[f]) were for small properties.3

Small buildings are home to more than 30 percent of the nation’s renters, approximately 20 million households.4 Many of these properties are “naturally affordable,” meaning that rents without rental assistance are typically more affordable to low- and moderate-income families than the rents in larger buildings.5 By supporting the financing of these kinds of properties with mortgage insurance, the FHA ensures that more affordable housing is available for these renters and their families and that rents can remain affordable into the future.

HUD’s Office of Multifamily Housing has a long-standing history of supporting the development, preservation, and operation of market rate and affordable housing. In the past, HUD has supported affordable housing with FHA insured loans, and in some cases, with grants and subsidies to owners or tenants (often referred to as “assistance”). But now, HUD is embarking on a new strategy, focusing on financing for small multifamily buildings of between five and 49 units each. In late 2013, HUD published a Federal Register notice for public comment, announcing its intent to implement a Small Multifamily Building Risk-Share Initiative. This initiative expands support for small building financing, utilizing existing authorities within HUD’s FHA. Corresponding legislation has been proposed by the Obama administration that would allow these risk-share loans to be securitized in Ginnie Mae mortgage backed securities. HUD received over 40 comments, which it has been aggregating, and expects to publish a final Housing Notice in 2015.

The majority of small multifamily properties are owned by individuals, and many others are owned by small businesses. Small owner entities, rather than institutional investors, own 77 percent of small buildings. In many cases, small multifamily properties are small businesses, creating jobs and opportunity in all kinds of communities. Generating more accessible financing streams for these owners preserves and creates more affordable units of housing—a priority for the Obama administration. With the lack of access to low-cost long term fixed rate financing, new investors are rarely drawn to play in this space, and owners are less likely to have access to conventional financing to make needed repairs and improvements.

Other than Fannie Mae and Freddie Mac to some degree, the federal government is largely absent in this space (see the article in this edition entitled “Secondary Market Options to Finance Small Multifamily Properties” by Sharon Canavan).This is one reason that HUD introduced the concept of a Small Multifamily Building Risk-Share Initiative that is a proposed extension of the FHA’s existing Multifamily Risk-Sharing program authorized under section 542(b) of the National Housing Act. This initiative would allow 50/50 risk sharing with community development financial institutions, mission-motivated lenders, or lending consortiums that originate and service mortgages on properties that have between five and 49 units or loan balances under $3 million. The ultimate goal is to provide better access to financing to create more affordable rental housing for Americans.

For more information, e-mail  James Carey, Office of Multifamily Housing Production.

1 American Housing Survey, 2010.

2 William Apgar and Shekar Narasimhan, “Enhancing Access to Capital for Smaller Unsubsidized Multifamily Rental Properties,” March 2007.

3 HUD data.

5 American Community Survey, 2010.

5 Ibid.

This photo shows a NeighborWorks America trainer in front of an asset management classroom of adults, using his arms and hands to illustrate a point to the class. Source: NeighborWorks America.
NeighborWorks America provides training for small property owners on asset management.

Asset Management Training Opportunities for Rental Property Owners

David A. Fromm, Senior Curriculum Manager, Training, NeighborWorks America

Asset management has become a recognized housing industry term for the function provided to owners by skilled, experienced housing professionals who provide a critical connection between owners’ goals for their properties and the various operational challenges that confront owners. As has been discussed elsewhere in this publication, owners of small multifamily properties often seek to manage properties themselves. NeighborWorks America, in conjunction with Enterprise Community Partners and Local Initiatives Support Corporation, provides asset management training which may be useful to owners of small multifamily properties.

An Asset Management Designation

In 1994, NeighborWorks America joined with Enterprise Community Partners and Local Initiatives Support Corporation to create the Consortium for Housing and Asset Management (Consortium). The Consortium recognized that nonprofit asset management, like for-profit asset management, is difficult work and requires managers to be particularly skilled and sophisticated. Over time, to support all industry managers, the Consortium developed a designation program, the Certified Housing Asset Manager (CHAM). This CHAM program trains and recognizes professional capacity and benefits both professionals and their organizations. In addition, NeighborWorks/CHAM sponsors an annual conference focusing on cutting-edge asset management issues for property owners. These resources are available to help owners provide high quality, sustainable, and affordable rental housing that is a true community asset, whether the asset consists of small apartment buildings, usually defined as having five to 50 units, or much larger developments.

NeighborWorks America has also developed a series of other asset management courses designed to meet the developing needs of our national network of members, roughly 240 nonprofit organizations spread across the country. These courses are also available for independent small property owners. The courses teach owners how to apply the basic concepts of asset management to their housing portfolios no matter how large or how small. Owners of small, medium, and large housing properties are trained to understand and apply the basic principles of asset management to meet the established ownership goals for a property.

The Curriculum

Overall, the NeighborWorks asset management curriculum identifies opportunities and systems for owners to provide proper oversight of the property manager through implementation of industry-accepted property performance standards. The curriculum teaches the basics of real estate financial analysis for owners to analyze the current financial status of a multifamily property and identify options for improving the property’s financial performance. The curriculum includes a range of techniques to measure the profitability of multifamily real estate and options for refinancing a property’s debt.

Through case study analysis and discussion of best practices, participants learn to identify and examine the different property management options available to best meet their organization’s needs. Approaches to keep multifamily affordable rental stock healthy and energy efficient are provided. Special modules cover the specifics of managing real estate owned (REO) properties. REOs are usually owned by an investor, usually a bank.

Access to the Training

To meet the needs of our network members as well as to provide opportunities for training to the broader market, NeighborWorks America offers four National Training Institutes a year where participants can network and learn with peers at various locations across the country. In addition, sponsors may request specific locations and times for training events. We deliver place-based training events held anytime throughout the year depending on the request of the sponsor.

In addition to these events, we offer self-paced eLearning and virtual classroom courses that provide the opportunity to learn from the convenience of a home or office. (Only certain courses are available in this format.) And we are beginning to expand these online learning opportunities by building skills efficiently and cost-effectively through NeighborWorks eClassroom Express webinar training sessions.

As lenders to owners of small multifamily rental properties, banks may want to refer borrowers who may require additional training as asset managers to the NeighborWorks training program. Likewise, investor owners may want to increase their asset management skills by participating in this training.

For more information, e-mail David A. Fromm. Visit NeighborWorks for more information on accessing training.

USDA Section 538 Guaranteed Rural Rental Housing Loan Program

Description: This program seeks to increase the supply of affordable multifamily housing in rural areas through partnerships between the U.S. Department of Agriculture (USDA) Rural Development program and major lending sources, including national banks and federal savings associations. The program provides federal credit enhancement, in the form of 90 percent (maximum) guaranteed loans, to encourage lenders to make new loans for affordable rental properties that are located in rural geographies and that meet the program’s standards.

Lender eligibility: Lenders must be approved by the USDA to participate in the 538 program. Eligible lenders are typically already approved HUD/FHA, Fannie Mae, or Freddie Mac multifamily lenders, or Ginnie Mae. Or they could be state or local housing finance agencies. Members of the Federal Home Loan Bank System and other lenders also may be able to participate if they have demonstrated satisfactory multifamily lending experience and financial strength.

Project eligibility: 538 program funding can be used for multifamily projects with five or more units. The project must be located in a rural area. Loans can be used for (1) construction of new rental housing or (2) acquisition and rehabilitation of existing rural rental housing when there is at least $6,500 of rehabilitation per unit involved. In connection with construction of new rental housing, the loan proceeds can be used for a variety of purposes, including land acquisition costs, landscaping, parking, and appliances. When the funds are used to rehabilitate existing housing, the proceeds can be used to cover loan fees and costs (including USDA fees), professional services, market study costs, developer fees, and construction interest. Acquisition or rehabilitation projects covered by the 538 program would include revitalization of existing rural rental housing projects under the USDA Rural Development’s Section 515 loan program (which provides affordable rental housing to seniors, people with disabilities, and families).

Affordability restrictions: The USDA Rural Development program includes required tenant affordability criteria that must be established as a deed restriction for the full term of the loan, even if the loan is prepaid. First, tenants may not have incomes in excess of 115 percent of the area’s adjusted median income (determined when the tenant is admitted). Second, the average monthly rent plus utility allowance cannot exceed 30 percent of the area’s adjusted median income. Third, the maximum rent plus utility allowance cannot exceed 30 percent of 115 percent of the area’s adjusted median income.

Loan size: This program does not establish a minimum loan size. Maximum loan size is the lesser of (1) for for-profit borrowers, up to 90 percent of the project’s appraised value or 90 percent of the total development cost and (2) for nonprofit borrowers, Indian tribes, or public borrowers, up to 97 percent of the appraised value or 97 percent of the total development cost.

Lender benefits: Lenders may use their own forms, loan documents, and security instruments. Importantly, a secondary market exists for 538 guarantees through Freddie Mac, Fannie Mae, and Ginnie Mae. Additionally, the guaranteed portion (up to 90 percent) of the loan is protected against loss by a federal guarantee. Further, the guaranteed portion of the loan does not count against the lender’s legal lending limits and can help lenders satisfy their Community Reinvestment Act requirements.

For more information, visit

10.438—Section 538 Rural Rental Housing Guaranteed Loans
Articles by non-OCC authors represent the authors’ own views and not necessarily the views of the OCC.