By Harrison Pinkus, Interra Realty
Though many multifamily investors have been able to close transactions in today’s less-than-ideal economic climate, high interest rates remain a challenge for some. However, there is one strategy that can propel a deal over the hurdle of high interest rates and across the finish line: assuming the seller’s loan.
With plenty of investors looking to acquire assets despite elevated rates, loan assumptions offer a win-win opportunity, as long as the buyer and seller surround themselves with a knowledgeable team of brokers, attorneys and lenders. The biggest advantage for buyers is a lower financing rate than what is currently available on the market. Buyers also benefit from lower closing costs and no appraisal. Meanwhile, loan assumptions at a lower rate provide sellers with the leverage to command a higher asking price for their property.
Loan assumptions are by no means the only route to closing a deal in today’s environment. After all, investors can always move ahead with a purchase now and finance at current rates with a plan to refinance later if rates improve. But, since the buyer must be able to acquire debt financing and carry a higher rate for a year or more regardless of how the transaction is structured, assumptions provide a route that can make a good deal better.
As a multifamily real estate broker, I have seen an increase over the past year in transactions that include a loan assumption. For example, my firm, Interra Realty, recently brokered a pair of such deals in Chicago: the $1.9 million sale of a five-unit property in the West Town neighborhood as well as the $1.9 million sale of a Lincoln Park asset.
The West Town property had a 4.09 percent rate with approximately four years remaining, while the Lincoln Park asset had a 4.31 percent rate with less than four years remaining. In both cases, the buyers assumed the existing loan of the seller, providing them with loan rates that were well below what the market would be able to provide at the time of the sale.
Many investors have never closed a deal that included an assumption, preferring instead to rely on their existing lender relationships. Due to higher rates, however, more buyers are open to the possibility. For those looking to include an assumption on their next deal, there are a few factors to keep in mind.
As the buyer and seller negotiate the purchase price, they will also need to consider the terms of the assumption, factoring in the outstanding balance, any adjustments for prepaid expenses such as property taxes and insurance, and usually a liability release for the seller. The lender will prepare an assumption agreement outlining the terms and conditions of the assumption, highlighting details such as the interest rate, remaining term, loan balance and other relevant details.
However, not all loans are assumable. While a property carrying debt from a regional bank or other lender may be eligible to transfer to a new owner, most of these mortgages contain “due-on-sale” clauses requiring the borrower to satisfy their loan obligation in full upon change in ownership.
Fannie Mae or Freddie Mac, on the other hand, allow for the transfer of their debt, as those agencies were created in part to promote liquidity in the housing market. As a result, the vast majority of assumptions occur on loans that originated from Fannie Mae or Freddie Mac, as was the case on our West Town and Lincoln Park deals.
For investors who haven’t dealt with agency debt before, the process may seem protracted. Fannie Mae and Freddie Mac have robust vetting processes and will likely require an extra level of due diligence on the potential buyer if they do not have a prior relationship. After assessing the buyer’s creditworthiness, income verification and ability to repay the loan, the agencies typically give a lot of weight to whether or not the buyer currently owns or has previously owned real estate.
While working with agency debt may extend the process, deals that involve loan assumptions are, by necessity, more collaborative. It is not uncommon for the buyer, seller, their brokers, their attorneys, the lender and/or the loan servicer to be in frequent contact with one another as it is in everyone’s best interest to close these deals as quickly and efficiently as possible.
The long-term strength and stability of multifamily makes it an in-demand investment in any economic climate. For owners currently on the fence, loan assumptions can be a powerful incentive to offer a property for sale. This is especially true if they have several years remaining on their debt since potential buyers would be willing to pay a premium in order to lock in a long-term loan with a favorable rate.
With today’s high rates, it’s no surprise that loan assumptions are making their way into more and more multifamily transactions. However, it is paramount that buyers and sellers work closely with their brokers and real estate attorneys to ensure the process is executed correctly.
Harrison Pinkus is a director with Chicago-based brokerage firm Interra Realty. This article originally appeared in the October 2023 issue of Heartland Real Estate Business magazine.