Apartments are a Resilient and Proven Asset Class
Fundamentals of Multi-Family Financing – 2017 By Michael Becker & Paul Peebles
Apartments are a Resilient and Proven Asset Class
Coming out of the 2008 Great Recession, multi-family properties (i.e., apartments) became one of the most popular asset classes. As a result, multi-family recovered faster and has performed better than most other real estate investment niches over the last several years.
However, long before the Great Recession, multi-family properties had been a staple for both individual investors and institutions like REITs and insurance companies.
For individual investors, owning income producing residential real estate is a proven way to create financial freedom. It’s a timeless asset which serves an essential human need, so it’s in demand in both good times and bad.
The natural progression for most real estate investors is to start with single family houses and then grow up into larger multi-family properties. This progression allows the investor to leverage other people’s money, credit, experience and efforts to acquire bigger properties and enjoy larger, more stable streams of income.
There are several reasons why multi-family is considered by many to be “best in class” within the investment real estate world…both for investors in the property AND investors in the paper (the mortgages that fund the property).
Housing is an Enduring Universal Need
Not everyone works in an office, belongs to a health club, eats in a restaurant, stays in a hotel, operates a factory or stores their personal treasures in a storage bay.
But EVERYONE needs a place to sleep at night. And because most people prefer walls and a roof, housing will always be a basic need for everyone.
With tighter home mortgage lending standards, there are fewer people able to qualify to purchase a home of their own. And with a weak jobs market and slow (if any) real wage growth, saving up for a down payment is a slow, if not impossible task. The result is more people are renting.
Another factor growing the renter population is the size and lifestyle of the generation known as the Millennials. There are nearly 80 million of these children of the baby boomers, and they’re starting life with student debt, little savings and little desire to buy a home. They saw many of their parents lose equity, and in some cases, lose homes during the crash. They’re in no hurry to buy and are happy to rent.
As for those former homeowners who lost their homes during the Great Recession, they too have joined the renter population. In fact, home ownership in the United States is now at its lowest rate since 1995.
Even empty nester baby boomers factor in to the mix. For those who don’t have adult children or elderly parents moving in with them, downsizing from a home into an easier to care for apartment is a way to free up equity for investment and simplify their lives.
Add to this a population which is growing through immigration…often on the lower end of the pay scale…and it’s clear there are more and more people needing affordable housing. Apartments meet this need.
Apartments are Diversified Cash Flow Machines
A common goal for many investors is to create enough cash flow to meet or exceed personal monthly expenses. Rich Dad Poor Dad author Robert Kiyosaki calls this “getting out of the rat race.”
Once you get there you’ve achieved financial freedom. Owning an asset, like an apartment complex which produces monthly cash flow, is a great way to help you achieve that goal. Owning an apartment is like owning a business. You will be rewarded by managing your asset more efficiently than your competitor.
Like you, your lender is depending upon the property cash flow because they know the average borrower can’t support the property without rental income in excess of expenses. That’s why the lender is very interested in the quality and experience of the management.
Cash Flow Creates Equity
This is one of the most important distinctions between houses and apartments. It’s also one of the most important concepts to understand as an apartment investor. Single family valuation is based on competing properties of similar size, age, and quality construction that have been sold recently in the same submarket.
While a house may be bid up by a homeowner to a price far in excess of what rents will support, that can almost never happen with an apartment.
In other words, value is a product of income. The more income, the more value. So even though investors may bid more for the same income (causing the ROI or cap rate to fall, just like bonds), there’s far less pure speculation in apartments. Apartment investors and lenders are VERY fixated on positive cash flow.
Apartment operators can typically raise their rents once per year as leases expire, subject to local market conditions.
As rents increase, the value of the property increases with it. As mentioned, apartments are valued off of a multiple of net operating income.
Net Operating Income (NOI) is Gross Rents Received less Expenses. The NOI is what is used to make your mortgage payments.
As in any business, lowering expenses and increasing income will increase your net operating income.
Something as simple as moving the trash bill from the landlord to the tenant can increase the value of your investment by several thousands of dollars. This is because a small increase in income per unit can be a substantial amount for an entire complex.
Even more exciting is that an increase of income can lead to a substantial increase in equity (value).
For example, if you own a 50 unit apartment building and you increase the income (without incurring any additional expense) by $20 per unit, you have created an extra $1000 per month. At a 10% cap rate, you have created an additional $120,000 in value. A small movement to income can have a large impact to value.
Even better, the extra $1000 per month can be used to help extract the new equity to repay investors, yourself or to use as a down payment on another property.
Apartments Can Help You Hedge Against Market Fluctuations
The other side of rising rents is a soft market, so you never want to cut your cash flow too thin. Fortunately, your lenders will require a cushion. In many ways, your lender is like your partner.
In a soft market, you can lower your rents slightly to keep your building full. While lower rents are unpleasant, vacancies are terrible and expensive. It could cost you more to re-lease a vacant unit.
If you have a diverse mix of units, you may find your smaller, more affordable units become more popular and you can keep a good tenant simply by downsizing them.
When the market recovers, you’ll be able to ratchet your rents back up again. Unlike commercial leases, which may be 5 or 10 years long, residential leases are typically 6 months to a year. This means you can respond more quickly to changes in the market; both up and down.
Apartments are Tax Efficient
Depreciation expense is one of the few gifts the government gives us. It’s essentially a non-cash expense apartment owners use to shelter their income and reduce their tax bill.
Apartments are considered residential and enjoy a slightly faster depreciation schedule than commercial properties. This means more deduction per year to offset the income tax on your positive cash flow.
Another tax advantage of apartments is scale. With large apartments it can make sense to invest the time and money for cost-segregation (a process of itemizing different components of the structure in order to use an accelerated depreciation schedule).
The bottom line is less tax and more after tax income. Apartments Hedge Against Inflation
Apartments are real estate and can be classified as a “real asset”. This means that if the dollar continues its 100 year trend of falling in value over time, apartments will retain their value (increase in dollar terms).
Also, rental rates tend to move up with inflation. As previously mentioned, because apartment leases usually carry a term of one year or less as opposed to other commercial real estate asset classes that carry terms of 3-20 years, you have the ability to more quickly adjust and capture rising rents.
Apartments are Operationally Efficient
All businesses look for economies of scale. When you can set up standards and systems, and spread expenses across a larger revenue base, you can create additional profit margin. Apartments have scalability.
Let’s look at some examples:
Apartments allow you to finance more units with one loan. So while apartment loan costs are more than a typical house loan, you only need one to finance even hundreds of units.
The same can be said for the time it takes to find, negotiate and close the transaction. Building a portfolio of 20 single-family houses is a lot more work than simply buying a single 20 unit apartment building.
Once you own and are operating the property, you only have one tax bill, one insurance policy, one roof, etc., to deal with.
Of course, later if you decide to sell or refinance, you will only have one transaction to get through. If you’re doing a 1031 tax deferred exchange, it’s much easier with a multi-family building versus the nearly impossible task of executing multiple concurrent single family transactions.
Lastly, when it comes to professional property management, many apartments will be large enough to justify (or in some cases require) a full-time on-site manager and maintenance staff. This means your property and your tenants will be getting more and better attention than is practical with a collection of single-family homes.
Now that we’ve covered some of the many benefits of owning apartment buildings, let’s discuss how apartment financing works.
How Apartments Get Financed
Real estate investors get excited about potential, but lenders are much more concerned with current reality. When it comes to financing apartments, there are two basic categories of properties:
Stabilized Properties
Stabilized properties are easier to get financed. A stabilized property can typically be described as one with 90%+ of physical occupancy for greater than 90 days. Lenders (the investors funding the loan) are usually looking for a specific rate of return or a yield on their investment. They like to see the past two year’s cash flow to determine possible future cash flow available to repay their mortgage. Imagine that the lender is looking at the operating
statement in a rear view mirror. They want to analyze what has happened in the past year or two to give them a good idea on how the property will be operated in the future. Higher leverage from the lender can be the reward for a stabilized property.
Non-Stabilized Properties
As the name would imply, these are properties, sometimes referred to as a “broken property” that don’t meet the aforementioned criteria of income stability.
Distressed assets are usually non-stabilized. These properties have functional and physical items that need to be corrected. Many distressed properties suffer from low occupancy, lower net operating income, and physical ailments that need to be corrected. Does the property need to change managers or install a better quality of tenant? Does the property need updating to compete? Buyers of non-stabilized properties are putting “humpty dumpty” back together again with corrective action. Investors sacrifice immediate cash flow today; for a future capital gain and/or larger cash flow tomorrow.
Where Does the Money Come From?
When you purchase an apartment complex choosing the correct lender is critical. In a typical apartment purchase the bank puts in 70-75% of the total cost so in many respects “the bank is your partner” in the deal. They will make or break your ability to purchase the property.
There are two primary channels through which apartments are financed: traditional banks and/or a government sponsored agency lender (Fannie Mae or Freddie Mac).
Traditional Bank Lending
Traditional banks are just what they sound like- private institutions that take in deposits (from Grandma) and make loans. They might be large national banks, local community banks or credit unions.
Traditional banks are generally preferred over agency lending in the following circumstances:
• You are new to multifamily investing. Fannie Mae will only loan to individuals that have previous multifamily ownership experience. They do not want you learning on their dime. Fannie Mae will not put you in the apartment business unless you team up with additional partners that have past or current Fannie Mae apartment experience. That partner must sign on your loan documents.
• The property itself has some level of distress typically due to some physical issues that need to be cured and poor historic financial performance of the property. Fannie Mae typically only lends on stabilized properties in relatively good physical condition. Fannie Mae hangs its hat on stabilized cash flow streams.
Loans to Newbies
When you are initially getting into ownership of apartments, lenders will typically take a more conservative stance. They generally want owners to have more skin in the game for their first deal. They’ll also want a larger margin for error if something goes wrong.
Bank is your Partner
In commercial lending, the Bank is your greatest partner. You are putting in 25-30% of the equity needed in the transaction; but the bank is putting in 70-75% in debt. You are the operating partner- with measured upside and operational daily control of the asset and your bank is the silent partner-with hope on getting their principal balance returned with nominal interest. The bank is willing to “put you” into the apartment business as a new borrower. They are willing to take a prudent risk on you and your first transaction. Fannie Mae will not put an inexperienced borrower into a transaction.
Personal Guarantees (“Recourse” Loans)
Loans to newbies typically require personal guarantees from all guarantors (signers). From the bank’s perspective, the more personal balance sheets backing the deal up, the better. The bank is not only taking a collateral interest in your property, but also in your personal balance sheet in case of a possible future deficiency balance. A deficiency balance is created if the bank has to foreclose on the property and sells the asset to a third party for an economic loss. That loss has to be cured (paid off) with your personal assets.
Cash Reserves
“Post-closing liquidity” (lots of cash in the bank after the deal is done) is critical for loan approval. The lender doesn’t want you to put ALL your money into the deal. They want you to have cash in reserves in case there is an unexpected expense. For newbies, the lender may require reserves between 20-30% of the loan amount to be held. The lender wants to see bank or investment statements that support your personal liquidity. Those reserves cannot be equity in other real estate investments or IRA’s or 401k’s. Lenders want to see cash, stocks or bonds in your name. If there is an unexpected loss, the lender wants you to be in a position to pay for that expense, not them.
Professional Management
Lenders will also want a third party professional property management company hired for larger properties. From the lender’s perspective, handing an inexperienced operator a large property to manage, is akin to giving a young child the keys to a very expensive car. Hiring a local professional property management company should help educate you on what is important in Fair Housing, accounting & bookkeeping, and city inspections.
Due Diligence
Know what you are buying- when you buy an apartment. Your purchase contract should have a few qualifying timing markers that should aid to protect you. The most important are: 1) Physical Due Diligence 2) Financing Contingency. Physical Due Diligence is having you and a multifamily inspector review the physical deficiencies of the property. This first step should happen immediately after the contract is executed. Your rehab budget is based on this report. Example items that must be reviewed are condition of sewer lines by a camera scoping the lines for breaks, electrical panels, roof condition, appliance and fixtures. You will want to engage your property management company to review all leases, rent rolls and tenant files for credit and criminal background. This auditing task is very important in clarify your tenant base.
The second step is the Financial Contingency. This is the timeframe that it should take to apply for credit and receive your loan commitment from the lender. Quality third party reports- bank due diligence – are required from the lender and can take several weeks to complete. A new apartment buyer is sometimes surprised at the number and expense of all the reports the lender will require. But in a big property, there are lots of things to look at and what might be an inexpensive problem in a single family home can be a significant expense in a large building. These reports should include Appraisal, Property Condition Assessment Report, and a Phase I environmental report.
Prior to the end of the due diligence period; on either the Physical Due Diligence or Financing Contingency; if you encounter any physical or financials issues on the property that cannot be resolved- you should be able to cancel the contract and have your earnest money returned.
Create an Entity
Almost all lenders will require you to create a Single Asset Entity to be the borrower. Your asset is typically held in a Limited Liability Corporation. Typically, you will not create the new LLC until your offer for purchase is accepted. The LLC is the borrower; the managing member and the other guarantors of the LLC will sign for loan documents on behalf of the borrower.
Value Added Lending “Humpty Dumpty Loans”
These programs are specifically designed for properties which are either non-stabilized or are in need of minor to moderate renovation or some other value added strategy. You are putting the property back together. Moderate renovations can be funded at acquisition so the property can be positioned to secure permanent financing in the future.
Here are some typical guidelines for this type of financing from a traditional bank:
Traditional Bank Lending (Bridge)
• Loan Amounts: $400,000 to $10,000,000+
• Loan to Value / Loan to Cost: 65% to 75% (loan based on acquisition price + rehab needed)
• Term (maturity): Up to 7 years
• Amortization: 15, 20, or 25 years (largely dependent on the age and condition of property)
• Rates: Fixed & Adjustable
• Interest Only Payments Possible: Up to 1 year during rehab
• Rehab budget: Needed before appraisal
• 24-month monthly pro-forma operating statement: Needed before appraisal
• Debt Service Coverage (DSC)1: Not lower than 1.0X
• Recourse: Yes, personal guarantees are required by the banks
• Origination fee: 1% of loan amount + Appraisal/ Phase 1 environmental study
• Escrows: Not typically required, you will be responsible for paying your own taxes, insurance and capital projects
As previously stated, the lender is looking for the guarantors (sponsors) to have strong personal balance sheets to provide the lender with additional security. A lender will typically look for Post-Close Liquidity from the guarantor(s) of 20-30% of the loan amount or more. The lender wants to know that if something financially happens to the property (insurance claim not paid, lower than expected operating income, etc.) that the guarantors can still be able to operate the property without a capital call from the bank.
Most Banks will require a depository relationship. (Personal and Operating accounts)
Banks require that you provide quarterly reporting on operational performance of your apartment with a current rent roll. They will also require you to update your personal financial statement annually and submit your most current personal tax return. This is a business loan; so regulators want to monitor how your ‘business’ is going.
One great benefit in getting a traditional bank loan is that it earns you ownership/ management experience with Fannie Mae and Freddie Mac for future loans.
Rules of Thumb for Bank Financing
Not all Lenders are the same; some Banks are not real estate lenders
Not all Lenders like Apartment loans
Not all Lenders like older properties that need to rehabbed and repositioned
Not all Lenders like non-recourse loans; most will not even offer non-recourse loans
Not all Lenders will like the part of town that you want to invest in.
Not all lenders will give you maximum leverage to acquire and rehab with your loan.
Not all lenders will amortize apartment loans greater than 15 years.
Your large bank loan officer is not the decision maker; help him/her build a case for their credit committee to approve the loan. Loan officers are sales people and problem solvers, but they don’t have signing (approval) authority.
1 DSC is a ratio of Net Operating Income versus Principal & Interest. So of a property brings in $12,000 per month of NOI and the lender require a minimum 1.0x ratio, the largest the Principal & Interest payment could be would be $12,000 per month. If the lender required a 1.2x ratio, the PITI payment could only be $10,000 per month ($12,000 /1.2 = $10,000)
Help mitigate the lenders risk. Examples: You may need to add another guarantor or have the lender temporarily hold additional collateral in the form of a CD pledge. If you are new to apartment ownership, hire a very qualified property management that manages similar properties in the local area. Lenders trust you, but they really trust a qualified property management company that already manages properties in the same submarket. The lender wants to see two things: 1) strong resume on management experience 2) a comprehensive monthly pro forma on how they will operate the property.
So now let’s take a look at what a typical “first timer” traditional bank loan looks like.
EXAMPLE: Typical 1st Transaction (Bank Loan):
• $900,000 Purchase Price
• $100,000 Rehab Needed to Secure Higher Future Rents
• $1,000,000 Total “all in” Costs
• $750,000 Loan Amount (max LTC 75%)
• $250,000 Down Payment Needed (25%)
• 60 Months Term
• 25 Year Amortization Max
• $225,000 Post Closing Liquidity Required is 20-30% of loan amount (Cannot be 401k’s or IRA’s) This type of Post-Closing liquidity is NOT HELD by the bank. The bank wants to know that you have immediate access to your personal funds
Simple Underwriting: Calculation of NET RENTAL INCOME (NOI)
GROSS RENTAL INCOME – the lesser of (i) actual rents in place, or (ii) market rents for occupied units, plus market rents for vacant units based on a current rent roll (multiplied by 12)
Plus
To the extent deducted as an expense, rents for other non-revenue units (including model units), owner-occupied units, and employee units
Equals
GROSS POTENTIAL RENT (GPR)
Minus
Economic Vacancy (not less than 5%) based on the current rent roll (multiplied by 12), including physical vacancy, concessions, and bad debts.
Equals
NET RENTAL INCOME (NRI)
Plus
COMMERCIAL INCOME (parking revenue, laundry, vending, etc.)
Equals
EFFECTIVE GROSS INCOME
Calculation of OPERATING EXPENSES
Use Line-by Line stabilized property expenses. Stabilized properties typically will have these variable expenses- combined utilities (gas, water, electric) trash removal, pest control, continuous maintenance and repair, interior & exterior decorating, cleaning & supplies, third party property management, on-site property management payroll, janitorial & maintenance payroll, general & administrative, professional fees (legal and accounting)
Minus
Real Estate taxes is based on the actual future tax bills
Minus
Insurance is based on a new 12 month policy
Minus
Replacement Reserves equal to $300/ annual per unit
Equals
UNDERWRITTEN NET OPERATING INCOME (NOI)
Calculation of DSCR (DEBT SERVICE COVERAGE)
UNDERWRITTEN NET OPERATING INCOME (NOI)
Divided
Annual debt service for the mortgage loan amount. Debt service must be calculated at current interest rate or acceptable interest rate floor. Must be greater than 1.25X for stabilized properties.
Things to watch:
Some, owner-operators of small apartments fail to include many operating expenses (management fees or maintenance payroll) into their financial statements. These operators forget that even though they are doing the actual work on the property and not including the costs… bank underwriters must use that true expense. So, if the annual expenses on a small property look too low… the seller is not including several legitimate expenses.
Permanent Agency Non-Recourse Loans with Fannie Mae or Freddie Mac
As previously mentioned, Fannie Mae or Freddie Mac financing are primarily for stabilized, cash flowing apartments. They both prefer borrowers that have current or historical ownership or management experience with apartments.
Each has specific underwriting guidelines for these two separate loan programs.
Typical Agency Loan Guidelines:
Fannie Mae:
Loan Amount: $750,000 – $25,000,000+
Experience: Borrower must have PRIOR multifamily experience
Loan Term: Fixed-rate terms 5, 7, 10, 12, & 15 years. 7/6 ARM
LTV/ LTC: Max 80%. Possible to include rehab into loan amount
Lower leverage in designated Fannie Mae Pre-Review Markets within US.
Recourse: Non-recourse with standard exceptions for fraud and misrepresentation
Collateral: Multifamily with a minimum 5 units
Occupancy: 90%+ Physical Occupancy for 90 days & 85%+ economic occupancy
Amortization: Up to 30 years
Minimum DSC: 1.25 – 1.30x
Interest only: Possible, but not guaranteed
Borrower: Single-asset entity only
Tax & Insurance: Higher leverage loan requires tax, insurance and replacement reserves escrows
Assumable: Yes, new sponsor needs to be qualified
Prepayment: Yield Maintenance or step down prepayment penalty is available
Supplemental: “Cash out “or new subordinated debt is available (2nd lien); after 12 months
Reserves: Replacement reserves are underwritten at a minimum $250 per unit per annum
Green Program: Yes, a lower loan interest rate (up to 33 basis points) would be available if property qualifies for utility (water or electric) cost reduction. Additional report required.
Freddie Mac Small Balance Loan:
Loan Amount: $1,000,000 – $6,000,000
Loan Term: Fixed-rate terms of 5, 7, or 10 years. Hybrid ARM loan terms of 20 years, with initial 5,7,10 years fixed and modifies to adjustable rate for remaining term.
Recourse: Non-recourse with standard carve-out provisions required.
Experience: Freddie Mac will require 3rd party property management, IF borrower does not have historical ownership or management experience.
Minimum DSC: 1.25 – 1.30x
Amortization: Up to 30 years
Interest Only: Yes, up to a possible 3 years in specific markets
Collateral: Multifamily, minimum five residential units.
LTV: Max 80% in large markets, Max 75% in small/ very small markets
Borrower: US Citizens typically, Possible for Non US Citizens with additional guidelines. Must be held in a single-asset US entity (sole asset)
Occupancy: 90%+ physical occupancy over the trailing 3 month period.
85%+ economic occupancy (actual collected amount as % of gross potential income) Subject property has not experienced volatile historical occupancy swings; and No history of serious crime at the subject property.
Tax & Insurance: Real Estate tax escrow deferred for deals with 65% LTV or less. Insurance escrow deferred. Replacement reserve escrow deferred.
Assumable: Subject to approval and 1% fee
Prepayment: Declining schedules (step down) and yield maintenance available for all loan types.
Rehab: Cannot include rehab improvement expenses into loan
Supplemental: “Cash out “or new subordinated debt is NOT available
Clarification Points:
• Fannie Mae doesn’t want the property to have been recently leased up simply to qualify for the loan. They want a history to show the occupancy level is real and sustainable. No bank depository account required.
• Non-Recourse- All Key Principals (“KP’s”) sign a “Bad Boy carve-out”. Fannie Mae and Freddie Mac require the experienced individuals in the group sign and certify they will run the property ethically and not commit fraud. As long as there is no fraud, if the loan goes bad they can’t come after the individuals. If the borrower commits fraud for items like falsifying financial statements, insurance fraud, etc. (“bad boy” behavior), they CAN come after individuals PERSONALLY for money lost in a default situation.
• Pre-Payment- Yield Maintenance (this is a fee equal to the amount of interest the lender would have earned if you didn’t pre-pay the loan, so it “maintain the yield” to the lender on their invested funds) Freddie Mac Small Balance has a step down prepayment based on % of loan. For example on a 10 year loan, it would be 5%/5%/4%/4%/3%/3%/2%/2%/1%/1%.
• Applying for the correct type of loan upfront is critical. Example: If you know that you will hold the property for 2-3 years only; applying for a 10 of 12 year Fannie Mae loan would be ill-advised. Fannie Mae has a significant prepayment penalty on this type of a permanent loan if it is paid off early and is not assumed. Perhaps a Fannie Mae 7/6 ARM would be a better choice. The 7/6 ARM is an adjustable rate with greater prepayment flexibility and significant cost savings. Apply for the right type of loan based on your exit strategy.
• Credit score must be >650 (no BK’s or foreclosures)
• Typically, 3rd party reports are required for appraisal, environmental & property condition engineers report
• Typical loan origination is 0-1%
• Typically it will take between 45-60 days to close transaction.
• Fannie Mae Application Fee (legal & third parties included) is $20,000
• Freddie Mac Application Fee (legal & third parties included) is $12,000
Rules of Thumb for Agency lending
Key Principal (“KP”) Requirements:
• Prefers KP’s to live in same area as the property
• Prefer prior multi-family ownership
• Prefer 3rd party professional management
• Show pride of ownership in current properties – Take good care of your asset.
• Total KP’s net worth to equal loan amount (aggregated from borrowers)
• KP’s to have at least 10% of loan amount in post-close liquidity
• Fannie Mae will not use IRA’s or 401k’s for liquid assets.
Get Your Fannie Mae “Gold Card”
Your “Gold Card” is your ticket to Fannie Mae financing. Fannie Mae financing is the preferred method for investors wanting to syndicate apartment transactions. There are three primary ways to get the multi-family experience required to get your “Gold Card”:
1. Do your first multi-family transaction with a traditional bank loan and have at least 24 months of ownership.
2. Be a key principal (loan guarantor) in another Fannie Mae borrower’s transaction – you essentially earn your experience through someone else.
3. If you are the managing member or general partner, have another experienced & qualified KP sign with you.
Getting Started
If your head is spinning a little, don’t worry. You don’t need to memorize all of this. In fact, it can change. These are simply guidelines so you have a basic understanding of the options available and what you need to do to qualify.
The key is to work with an experienced commercial loan broker who can look at your specific deal and walk you through the process.
Now let’s discuss what the things you will need to pull together when you are ready to do your first or next apartment loan.
Pre-Approval/ Pre-Qualification
Apartment lending qualification is very different from single family home loan qualification. In home lending, a lender can issue you a pre-approval based on your personal income, credit report, amount of liquidity, etc. This written approval is based on the borrower’s strength to qualify….and not as much on the property and location of the home.
With apartment lending- the quality, condition and location of the asset are the most important factors in underwriting. A pre-approval is not going to be available because 2/3rds of an apartment lending decision is based on subject property. The lender needs to have a complete picture on a number of critical underwriting variables. Examples: Where is property located and age? What are historical cash flows for the last 2 years and year to date? How much deferred maintenance does the property currently have and what is rehab budget necessary to cure? Who is going to manage the property? What does your monthly proforma show; what is your future expected operating expenses and total income?
1/3 of an apartment lending decision is based on you. What is your liquidity? What is your net worth? What is your past apartment experience and level of ownership or management? Do you receive consistent personal income outside this transaction? Are you going to have additional guarantors, with a sufficient balance sheet that will stand with you?
Bottom line, the lender can give you an indication on how much you can qualify for, but because the age, condition and location of the asset is so important in an underwriting approval, a written pre-approval before the asset is selected is not worth very much. Speak with your commercial mortgage broker on how to structure the transaction for approval. They will give you a verbal insight on how much you can qualify for based on the total picture.
Checklist of Items You’ll Need to Provide Your Commercial Loan Broker:
✓ Updated signed personal financial statement
✓ Liquidity verification (bank and/or brokerage statements)
✓ Last 2 years of personal/corporate tax returns
✓ Real estate resume- detail your real estate experience. “I bought a home, fixed it up, and sold it.” Tell the story of your successes in real estate. It’s like you’re applying for the job of running the property.
✓ Schedule of Real Estate owned (what do you currently own; loan balance, value, contingent liability or non-recourse; annual NOI, annual debt service, etc.)
✓ Broker’s Offering Memorandum on the property you are looking to purchase
✓ Property’s historical monthly operating statements (last two years and YTD)
✓ Current rent roll
✓ Five digital pictures of the interior/ exterior of the property
✓ Your analysis of transaction; share your monthly PROFORMA for the next 12 months. How are you going to operate property?
The Value of an Experienced Commercial Loan Broker
Whether you are an experienced multi-family operator or new to the business, financing a multi-family property is not simple. Having an experienced commercial mortgage broker on your team can be the difference between getting funded or being rejected. An experienced commercial mortgage broker will be your most valuable partner, because you will have thousands of dollars and your reputation at risk if you are not able to execute on financing and close.
A good commercial mortgage broker will review your personal financial package, the apartment complex in question and your business plan, and will help you efficiently find the best financing available for your situation.
Your commercial loan broker also keeps everything moving. When you get into a contract to purchase you are obligating yourself to hit key deadlines for inspections, appraisals and other milestones. Missing any of those deadlines can jeopardize your transaction. A great broker will work with you and your agent to stay on top of all the moving parts.
Of course, an experienced loan broker has seen a lot of deals, stays on top of the latest loan programs and guidelines and can alert you early if there’s something problematic in your deal. It’s hard enough to find extra cash, another guarantor or a fast turn-around on an important bid or inspection…but if no one sees the problem until late in the process, it’s even more stressful. Your commercial loan broker’s experience can make a world of difference.
Helping Your Commercial Mortgage Broker Help You
Here are a few simple tips that will improve your chances for approval:
• Work with industry experts. A good broker will want to help you no matter what kind of deal you’re undertaking. But a residential broker (someone who arranges funding for 1-4 unit residential properties) is much different than a commercial mortgage broker. When you are seeking funding for apartments, you will need the expertise of someone who specializes in apartment financing.
• Engage your commercial mortgage broker EARLY in the process. It’s recommend to engage your commercial mortgage broker when you are submitting your letter of intent (LOI), and to discuss the basics of the deal and your proposed timeline to make sure it’s realistic from a financing perspective. Make sure that the commercial mortgage broker sends you his “sizing spreadsheet” of the transaction. You will want to make sure that your commercial mortgage broker has run the debt coverage analysis based on past and pro-forma operating statements of the asset. “Measure twice and cut once.” Make sure he or she agrees with your analysis. You don’t want to get too deep into a contract that isn’t realistic from a financing perspective.
• Be organized and prepared. Before you start seriously start looking to acquire a property, gather up your financial package including your real estate resume, signed Personal Financial Statement, Liquidity Verification and Tax Returns.
• Prep your story and team. Once you have agreed to purchase a property you should be able to tell the story to the lender on why you like the property and believe it’s a good investment, how you plan on operating the property, and be prepared to show them your financial pro-forma. The lender wants to see your strategy and specific tactics on how
you are going to make this investment successful. Share with your lender the successes of your past investments. If you have been successful in rehabbing and stabilizing properties in that submarket, make sure you bring that to the lender’s attention.
• Be responsive. It’s very important to be responsive to your Lender’s requests, and to provide them with accurate and ALL of the information and documentation they ask for. The best lenders are busy. If you are not responsive or only provide part of the info requested without providing an explanation, they will move onto the next loan file and put yours at the bottom of the stack. Those delays can cost you your deal. Be responsive!
If you do these simple things you will GREATLY increase your chances of getting loan approval.
If you have any questions or feedback, please feel free to contact us.
Good luck!
Mike Becker Paul Peebles
Senior Director National Underwriter
Old Capital Lending Old Capital
mbecker@oldcapitallending.com ppeebles@oldcapitallending.com
oldcapitallending.com 817 488 0440
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Michael Becker serves as a Senior Director for Old Capital Lending. Mr. Becker is actively involved in financing commercial real estate and has extensive experience in all aspects of the transaction process, including underwriting and marketing, financial analysis, due diligence, and preparation of marketing materials as well as processing and closing. He has closed multifamily, office, industrial, medical, raw loan, hospitality, and shopping center transactions throughout the southwest. Before joining Old Capital, Mr. Becker was the top loan producer for 3 consecutive years in his division at Wells Fargo and has extensive prior experience in the community banking space. He is a lifelong resident of North Texas. He is a graduate of The University of North Texas. He is married and has two young children.
Paul Peebles has been arranging real estate financing for borrowers and institutional clients since 1987. Mr. Peebles, our National Underwriter at Old Capital, underwrites and structures all transactions handled by Old Capital through an array of sources including conduits, banks, life companies, Fannie Mae, Freddie Mac, HUD and private money lenders. His knowledge of the capital markets and his long term and deep relationships with the decision makers at the various capital sources is a competitive advantage for the client. He has closed over a $1 billion in real estate transactions. Mr. Peebles is a “deal maker.” Prior to Old Capital, Mr. Peebles was affiliated with Merrill Lynch Capital Markets, World Savings Bank and ITT Commercial Real Estate. He is a graduate of University of Iowa. He is originally from Western Springs, Illinois. He is married and has one daughter. 2017 v.1