By Terry Painter/Mortgage Banker Member of The Forbes Real Estate Council
Author: “The Encyclopedia of Commercial Real Estate Advice” Publisher: Wiley
In Short, it takes these 5 components to finance an Apartment Building:
1. A Great Property – that has 2 or more of these upsides: a good location, under market rents, already cash flows the loan, or rents can be increased with inexpensive value adds.
2. The Property Value and Income Supports the Loan
3. The Property is in Good Condition
4. The Borrower is Qualified – has good credit, enough cash, and enough net-worth
5. The Borrower has the Best Professionals
What Lenders are Looking For
Keep in mind that lenders only make money if they close loans. So they will always want to talk to you, and they will always want to get you off the phone fast if you or the property do not qualify. They already know that most financing requests are not going to qualify for their loan programs so their first task when you call will be to disqualify you.
As a commercial mortgage banker, I have closed hundreds of apartment building loans over the past 24 years. When I get an inquiry from an investor looking for multifamily financing, I first ask them some questions to determine the quality of the property – its location, occupancy, income and physical condition. Next, I screen the borrower for cash, net worth, and experience. If it is a purchase, I always ask them how much cash they have to put down, and what their net worth and liquidity is. I’m not going to make a loan to them if they will be stone broke after closing.
One thing that really motivates me to work with a borrower is when they have the property financials together at the beginning – a current rent roll and last 2 years income and expense statements, and their recent personal financial statement as well. I will need to determine the net operating income and cap rate based on actual numbers, not fiction. Often, listing brokers try and sell commercial properties based on their potential numbers—not actual—and inexperienced borrowers pass those fictional numbers on to us. I, nor my underwriters will never fall for that. It always impresses me when a borrower tells me that they have walked all the units and what the general condition of the property they are buying is.
Here’s a tip on getting a busy loan officer to really go that extra mile for you. Use your enthusiasm to sell the deal to them. Excitement is contagious. I can’t help but get caught up in a deal when the borrower has enthusiasm, and I will often bend over backwards to help them make the deal happen when they draw me into it with their excitement. Be clear ahead of your first talk with a lender on what excites you about the property. Next, here are the five components that it will take to qualify for an apartment building loan.
The 5 Components Required to Qualify for An Apartment Building Loan
1. A Great Property – The property is in a good low-crime neighborhood and has many value add upsides such as: under market rents, or rents that can be increased with inexpensive cosmetic improvements. Lenders will pull a crime report to make sure it’s a safe area. Most of all what makes this a great property will be that it already cash flows the loan, or with inexpensive value adds, it can be brought up to the level of similar properties in the sub-market that are preforming well.
2. The Property Value and Income Supports the Loan – Lenders get bent out of shape when borrowers overpay for a property—or if it is a refinance, insist that the value is much higher than it likely is, and on top of this the cash flow doesn’t support the loan size they are expecting. Take the time to research similar size and quality multifamily properties on LoopNet, or with a local commercial real estate broker. Lenders seldom go beyond their Loan to Value limits. Although they might lend up to 75% LTV, they will only be able to do so if the net operating income and DSCR support that size loan. Mostly, the net operating income has to support the size loan the borrower can afford based on how much they can put down. This is something you should run numbers on before you talk to the lender.
3. The Property is in Good Condition – When you are purchasing a property, this is something you won’t know for sure until you get a property condition report. There are banks and bridge lenders that do rehab loans for properties that need a lot of upgrades; but it’s difficult to obtain them if the borrower does not have prior experience rehabbing an apartment building. Ideally conventional lenders want the property to be in good condition or not need more than about $6,000 in improvements per unit to bring it up to speed.
4. The Borrower Qualifies – The borrower should already have the down payment together before they apply for the loan. Lenders hate it when the borrower tells them “I don’t have the cash now, but I will be raising it”. Or, “I have several investors lined up that will have more money soon”. The borrower should have good credit (most loan programs require a credit score of 680 or higher) the required net worth (ask the lender) and some post-closing cash (ask the lender on this too). The borrower will be screened for experience as well.
5. The Borrower has the Best Professionals – If you don’t have experience, a good property management company is essential and will help grease the loan getting approved. Also, a good real estate attorney and a contractor that has a good reputation is a must if the property needs work.
What Borrowers Should be Looking For from a Lender
Borrowers should be screening me as well to make sure that I have a loan program that fits what they are looking for. In my book, “The Encyclopedia of Commercial Real Estate Advice”, I tell borrowers that they should take charge of the loan process by actively participating. This means knowing ahead what your ideal loan terms are. What LTV, interest rate, amortization, prepayment penalty and loan term do you want? Next you will be calling different loan programs to research what each offers and the qualifications required. Be sure to ask each loan officer that you call these 7 prequalification questions to make sure you qualify ahead of applying. All it takes is for one of these to not qualify and your loan won’t be approved. OACH!
The Seven Pre-Approvals for Financing an Apartment Building
1. Borrower Quality – Credit score, net worth, liquidity, and post-closing cash needed. Also, what experience do you need and is it okay if you manage the property yourself? Do you need to live close to the property?
2. Property Location – Many banks only lend close to where they have branches. Ask the lender if they lend where the property is located
3. Property Income – What Debt Service Coverage Ratio (DSCR) do they require? How long has the property you have maintained this DSCR? Ask them what their interest rates and amortization are so you can make sure the property can achieve the minimum DSCR required.
4. Occupancy – What is the minimum occupancy the property can have to qualify? And how long does this need to be at this level prior to applying for the loan?
5. Tenant Quality – Will they allow section 8 vouchers for low-income tenants? Do they have any restrictions for students or military tenants?
6. Lease Quality – Do they allow month to month tenancy? Or do most or all of the tenants have to sign a 6 month or year lease?
7. Property Quality – Will they lend on the property if it is not in great condition? Will they include funds in the loan to improve the property? If so, how much per unit?
The good news is that if you follow these guidelines you will not only know which loan program you want, but which one you qualify for. Better yet, you will know if you and the property will qualify for that financing.
To finance an apartment building you need to complete 7 tasks: analyze the income of the property, analyze market rents, estimate the appraised value, analyze the condition of the property, analyze your financial strength, research lenders, and apply for the best loan that you qualify for.
7 Basic Steps to Finance an Apartment Building/Complex
1. Analyze the Income of the Property - You will need to have a current rent roll showing current property income and the past 12 trailing months income and expense statement. Subtract total expenses from Income to determine the net operating income. Now you will need to know the loan amount. If you have not spoken with a lender or mortgage broker yet estimate 75% of the value. Now take your annual net operating Income and divide it by your estimated annual mortgage payments. This will give you a ratio called a debt service coverage ratio. This number will need to be approximately 1.25. To learn more about debt service coverage ratio, check out: https://apartmentloanstore.com/content/debt-coverage-ratio, or watch this video: https://www.youtube.com/watch?v=oyvKXh3x2Mo
2. Analyze Market Rents – The easiest way to do this is to find 3 – 5 apartment buildings in the same sub-market as the subject property. These need to be of similar age and quality as the subject property. You can find the websites for these and see what rents they are getting. Or you can talk to a multifamily property manager, or your commercial realtor. It is helpful to know market rents so you can determine if the rents of the subject are too low and have room for future increases. Also, if the rents of the subject property are the highest in the market this can cause you to get a lower than anticipated appraised value.
3. Estimate the Appraised Value – First, Determine the Capitalization Rate (Cap Rate) of the subject property. To do this take the annual net operating income of the property (Gross Annual Rental Income less Annual Expenses) and divide this by the purchase price or the value that a real estate professions estimates. Find out what cap rates similar properties have sold for in the past year and use this cap rate to estimate the value of your property. Second, Ask a real estate professional for help in researching similar properties that have sold within 5 miles of your property. Calculate the price per unit these for these properties and apply it to the number of units of your property. Again, you will need to find similar size and quality properties to yours for this to be accurate...
4. Analyze the Condition of the Property – Keep in mind that even if you qualify for the loan and the property has more than adequate net income to qualify as well, the quality of the property might be a problem for your lender. If it is in a bad or dangerous neighborhood this can be a problem for the lender. If the property is in bad condition and needs extensive repairs, this too can be a problem for the lender. It is important if you are purchasing an older property to walk through all the units and determine the condition for yourself.
5. Analyze Your Financial Strength – First, start out by pulling your own credit report. You can go to Credit Karma and do this for free: https://www.creditkarma.com
Pulling your credit yourself will not lower your score. Find out what the minimum credit score is for the loan programs you are interested in. A Good credit score is 680 and above and most of the best rate multifamily loan programs require this. However, at Apartment Loan Store we have some great rate programs that can accept an average credit score as low as 660. Excellent credit is 740 and above. If your credit is impaired, call one of our friendly loan specialists to find our about loans for apartment buildings with bad credit: https://apartmentloanstore.com/content/apartment-loan-bad-credit
Secondly, you should fill out a personal financial statement with a schedule of real estate owned. You can initially give this to a lender or commercial mortgage along with your credit report to get pre-qualified. Call a commercial mortgage broker or bank to determine what net worth to loan ratio is required, and how much cash you will need to take out the loan. Keep in mind that all loans today require post closing liquidity. This means you cannot be broke after the loan is closed. Typically you will need to show that your and your partners have the down payment plus at least 12 months mortgage payments in post-closing cash. Thirdly, you may need sufficient personal income to qualify. Find out what this requirement is. Commercial banks often require you to have more than one source of income for you to qualify for a commercial investment property loan. If you show insufficient income on tax returns, call one of our loan specialists. We have many stated income loan programs that do not collect tax returns, many of which have excellent rates.
6. Research Lenders – Contact at least 3 – 5 lenders and ask them to ball park the loan terms and qualifications for your transaction. Or you can call us at Apartment Loan Store and we can give you the terms for the loan programs you qualify for. Here are the items you need to know:
A. What is the maximum Loan to Value (LTV)?
B. What Debt Service Coverage is required?
C. What is the post closing cash requirement?
D. Will they lend at the subject property address?
E. What are their current interest rates and how long can they fix the rate?
F. How long can they amortize the loan for?
G. What is the term of the loan?
H. What experience is required for the borrower(s)?
I. What is the minimum credit score requirement?
J. What is the personal income requirement?
K. What are the loan expenses?
7. Apply for the Best Loan(s) you Qualify for – You can submit a loan submission package to your top loan programs, or we can do this for you. Your objective is to get a letter of interest from the lender that shows the loan terms and pre-qualifies you for the loan. Be wary of lenders or brokers that charge upfront or due diligence fees. These programs are likely scams. You should not have to put money down on a loan until you get a letter of interest, and the funds should go towards the third party reports or legal expenses that the lender actually incurs. Here are the items you will need to apply for the loan:
A. Personal Financial Statement on all key principals (borrowers) including schedule of real estate owned.
B. Current Rent Roll on the subject property
C. Previous past 2 full years and past trailing 12 months income and expense statement.
D. Copy of your current three bureau credit report. The lender might want to pull your credit, but this will likely lower your credit score. Especially if you are applying to multiple lenders.
E. Photos of the exterior and interior of the property
F. A brief loan summary selling the transaction
G. Last 2 years tax returns and current business financials if you are self employed. (Might not be needed for all loan programs.)
The 4 Basics of Investing in an Apartment Building/Complex
1. Be familiar with multifamily investing. This is a business that needs experience
2. Be familiar with multifamily lending or call us at Apartment Loan Store
3. Research and Choose the loan program that best suits you
4. Know how to choose an outstanding lender
The exception to having essential knowledge involving the 4 basics (above), is if you have a partner who is experienced in multifamily ownership, and you have no experience. This way the investment has a much better chance of success than if you have no experience. However, it is essential that you have some basic knowledge of the 4 basic things above if you work with a partner. Why? Because you need to be involved in the decision making process being part owner. If there is an essential decision to make, and you have no knowledge of apartment investing and apartment lending, you might go along with a decision that is not in your best interests.
1. Be Familiar With Multifamily Investing
First, if you are going the multifamily investing route, you need to know why it’s the best type of property for you to own. Just because a friend recommends investing in multifamily property, it doesn’t mean it’s the right choice for you. We are going to look at some advantages of owning apartment buildings/complexes versus the other types of commercial properties or residential properties.
It is important that since I represent Apartment Loan Store, a company that specializes in multifamily investment, I admit that I have a bias in favor of multifamily investing. But there are some excellent reasons for this as well.
Let’s compare the choice of residential property investment and four different types of commercial property investment with investing in a multifamily (5 units plus) property:
The Four Different Types of Commercial Property Investments
i. Residential rental properties (1 – 4 units)
ii. Office and retail properties
iii. Industrial properties
iv. Multifamily properties (Which are 5 or more units).
First, let’s start with looking at the choice of residential property investment. In making a comparison between apartment building ownership and residential property ownership, a major advantage of apartment building ownership is leverage. If you get a 20 unit apartment building you have one loan. If you get 20 residential properties, you have 20 loans. Think of the savings in time and expense. Also, in applying for 20 loans, the lending institution may decline multiple loans for whatever reasons, whereas with a multifamily property, there is just one loan to accept or decline. Another leverage advantage of multifamily property ownership is you have a large savings in expense and convenience from having all the units in one location. This is called economy of scale. Instead of over time having to replace 20 roofs, you might just need to replace 2 roofs. Another example is, you could have one air conditioning/heating system in an apartment building versus having 20 air conditioning/heating systems to take care of for 20 residential properties. Yard maintenance, repairs and maintenance, as well as management fees will be lower one a 20 units apartment complex vs 20 residential homes.
As far as comparing multifamily ownership to other types of commercial property ownership, there are a number of advantages for multifamily ownership. As a rule, multifamily loans are easier to get. Most often, there is less risk than in owning retail, office or industrial property. Banks don’t like risk - they tend to be conservative. If you own retail, office, or industrial, you have the risk of it possibly taking many months to fill the lease of a client who does not extend their lease. What if you have a vacant one unit retail property, and it takes a year to lease it? As far as owning industrial property you have more environmental and legal concerns than you generally do with multifamily property.
2. Be Familiar With Multifamily Lending
You need to know the rules of the multifamily lending game. How does it work? What are the loans and terms? A most important thing to know is if you have the financial strength for a multifamily loan? Here are some determining factors to see if you have the financial strength for a multifamily loan.
i. Can you put at least 20% down? Some lenders will fund 80% of the property value which is an 80% loan to value loan. But, on the high end, it’s going to be more like 25% down needed. You may end up needing to put 70% or 65% down. One major factor is cash flow. For example, a lender may be willing to do up to 80% loan to value, but the cash flow of a particular property may only support a 70% loan to value loan.
ii. Is your net worth at least the size of the loan? This is a requirement that lenders have. If your loan amount is $1,000,000, you need to have at least $1,000,000 in equity, savings, investments, retirement accounts, value of businesses, value of personal belongings, etc.
iii. Do your credit scores from the 3 bureaus average out to be at least 680? Most lenders have this minimum credit score requirement. If your credit scores are below this, you may need to get credit repair.
3. How to Choose the Type of Multifamily Loan Program That Best Suits You
There are different types of loan programs. It’s important to become familiar with them so you make the best choice for yourself. Here are some highlights of some multifamily loan programs that have great rates.
I. Fannie Mae Loan Program
- Loan to value of 80% is the maximum if purchase or refi has no cash-out
- Loan to value of 75% is the maximum if refi has cash out.
- 30 years amortization
- Rate is fixed for a range of 5 years to 30 years.
- $750,000 is the minimum loan size, and size of loan is limitless.
- If approved, loan can be assumed for a fee of 1%
II. Freddie Mac Loan Program
- Rate is fixed for a range of 5 years to 30 years.
- Loan to value of 80% is the maximum if purchase or refi has no cash-out
- Loan to value of 75% is the maximum if refi has cash out.
- $1,000,000 is the minimum loan size, and size of loan is limitless.
- 30 years amortization
III. Commercial Mortgage Backed Security (CMBS) Loan
- $2,000,000 is the smallest loan size
- 5 years, 10 years, and 15 years are the choices for fixed rate.
- Maximum loan to value of 75%
- Rates are very low
IV. Life Insurance Company Loan
- Usually no less than $5,000,000 loan minimum and can go up to $75,000,000 or more
- Rates are super low
- No more than 65% loan to value
- Amortization period of 25 years or 30 year
V. HUD (FHA) Loan
- No less than $2,000,000 loan size, no maximum size of loan
- Loan to value not to exceed 83.3% for a purchase and also for a refinance with no cash out.
- Loan to value not to exceed 80% for a refinance with cash out.
- 30 years to 35 years is length of fixed period.
- Super low rates. However mortgage insurance premiums have to be paid with the mortgage.
- Closing costs and fees are greater than other programs, but you get a very low rate for a very long time. So for your property you might not have to get it refinanced in the future.
VI. Regional Bank Loan
- Loan to value not to exceed 75%
- Most often, 3 to 10 years is the period of time the rate is fixed.
- Usually there is a 30 year term.
- Minimum loan size not to go below $500,000. Most often, loan size not to exceed $10,000,000.
- Some of the lowest rates available for those wanting a fixed rate of 3 or 5 years
- When the fixed rate period is up, rates will adjust
Know how to choose a good lender
This is easily one of the most important steps. Why? Because a superb lender will help guide you in your multifamily loan so that it is a very rewarding and financially sound process. A poor quality lender could cause your loan process to be one that costs you financially, timewise, and in “number of headaches.”
It is recommended that you follow these steps to find an excellent multifamily lender:
As in so many other fields, some lenders are crooked. They will take deposits from clients and disappear. I experienced this once, and after that, I became much tougher in my due diligence.
I. Get referrals from people you know, trust and have had successful experiences with a particular lender. Still do your own due-diligence – talk to references, etc.
II. Go to an apartment investment association meeting, and get the contact information of multifamily lenders they work with. Still do your own due-diligence – talk to references, etc.
III. Make sure that you select a lender with quite a few years of experience. You might pick a very good lender. But if you are given a new lender to work with, even if that lender is sincere, that lender is more prone to mistakes. Mistakes can be costly.
IV. If you contact lenders on your own, do deep due diligence. Check with the Better Business Bureau, Do a scam check online, etc.
Once you get ahold of a reference of the lender, ask detailed specific questions including:
-What the lender specifically did they liked
-What the lender did not do very well.
-Is the lender very honest?
-Is the lender very knowledgeable?
-How quickly did the lender return phone calls?
-How focused is the lender on getting the loan done on a timely basis?
-Did the lender give you very good rate and terms?
-Very importantly, ask if the lender took time to educate them.
-Did the lender take the time to answer questions?
By: Terry Painter/President Apartment Loan Store and Business Loan Store