Loans for Multifamily
Many investors in real estate take a common path. The first properties they invest in are usually single-family homes used for flipping or renting. When they reach a particular point in their investment career, they opt to diversify into multifamily buildings in search of larger profits. Financing for a single-family house vs. an apartment building can vary greatly. Consequently, the purpose of this piece is to serve as a primer on multifamily financing.
Here are the details of what we’ll discuss:
- A Review of Multifamily Properties
- Multifamily Loans followed by Residential Financing
- Multifamily Loans with Commercial Financing
- Conclusion
A Review of Multifamily Properties
Apartment buildings that house numerous families are the primary focus of the multifamily commercial real estate niche. Multifamily buildings can be two- to four-plexes. However, from the standpoint of lenders, these properties are classified as residential and hence qualify only for residential financing.
Instead, apartment complexes with five or more units are considered commercial property. As a result, commercial lending is the most common kind of debt financing used by investors for such properties. It is by no means an exhaustive list, but it does cover some of the most prevalent kinds of multifamily dwellings:
- Garden-style apartments
- Mid-rise apartments
- High-rise apartments
- Student housing/dorms
- Senior and assisted-living
In the next two sections, we’ll explore multifamily loans secured using 1) residential financing and 2) commercial financing.
Multifamily Loans followed by Residential Financing
Residential Financing: Overview
Borrowing in your name is required for most residential mortgages, including those used to purchase duplexes and fourplexes. John Smith, and not 123 Main Street, LLC, will be the one to take out a mortgage on one of these buildings. Because it is used to acquire a mortgage on a primary residence, most real estate investors have a basic understanding of residential financing.
It is unusual for conventional lenders to provide mortgages to businesses for commercial premises. Additionally, the loan-to-value (LTV) standards are often much lower when lenders permit applicants to utilize an LLC rather than the borrower’s name. Only one of the national banks we looked into offered this service, and it came with a 60% LTV minimum.
NOTE: Unlike traditional lenders, hard money lenders are willing to give short-term financing for single-family houses in the name of a corporation, generally to aid a flip.
Loan terms and amortization schedules for residential mortgages on multifamily properties are typically the same as those for single-family homes (e.g., a 15- or 30-year fully amortizing loan).
Using Residential Financing to Apply for Multifamily Loans
Lenders for a multifamily loan using residential finance will require guarantees concerning your financial condition. To put it another way, a lender will care most about whether or not you will be able to make your monthly loan payments. It means you’ll have to provide documentation of your income (such as W2s, 1099s, tax returns, etc.) and a detailed accounting of your debts to prove that your DTI falls within limits set by the lending institution.
Lenders may consider projected rental revenue for duplexes and fourplexes as part of the DTI calculation, albeit this is conditional on several variables. Is the property already occupied by tenants who have signed leases? Second, have you worked as a property manager before or contracted with a company that has? If you qualify, a lender may count as much as 75% of your projected rental income toward your DTI.
The comparable market method is used in residential property appraisals to finance multifamily dwellings. To determine a fair market value, appraisers will look at previously sold properties comparable to the subject property. This methodology makes it highly unlikely that you’ll be able to use the income-based appraisal approach (often seen in business finance) to justify a higher valuation. This, however, is subject to the case’s specifics and the lending institution’s demands.
Multifamily Loans with Commercial Financing
Commercial Financing: Overview
Commercial financing comprises giving businesses money to buy things like apartment complexes with five or more units. The previous scenario would continue with a multifamily loan for the apartment building in the name of 123 Main Street, LLC rather than John Smith. They are borrowing as a company that shields the owners from personal responsibility for any debts that become due. Most lawsuits can only go after the LLC’s assets, rather than the individual owners’, barring negligence or numerous other criteria that allow “piercing the veil” of an LLC. Nonetheless, most lenders, especially first-time investors, will insist on a personal guarantee for commercial mortgages, even with this shielding from personal liability.
The loan lengths of commercially financed multifamily loans are typically shorter than the amortization periods associated with such loans. For instance, it is not uncommon for borrowers to refinance or make a balloon payment at the end of a 10-year loan since the amortization duration is 25 or 30 years.
Obtaining Commercial Financing for Multifamily Loans
Lenders for commercial multifamily loans are generally concerned with the asset’s rental income, operational expenses, net operating income, and debt coverage ratio. Lenders want guarantees that the property will generate enough income to satisfy the monthly payments when underwriting these loans.
If you want to apply for one of these multifamily loans, you’ll need to provide the lender with a pro forma. The financial terms of a transaction are spelled forth in this sample document. Included in pro formas will be the bare minimum of the following:
- • Contributed capital sources and uses (i.e., the equity put into a deal)
- A detailed acquisition schedule and, if necessary, construction/renovation expenses
- • Property rent rolls (projected or real, depending on the property’s stabilization state)
- A balanced operational budget
- Projected debt coverage ratio (to ensure that a property’s NOI meets its debt payments with a certain margin of safety)
Moreover, commercial mortgages have LTV restrictions from the lending institution, varying from 65% to 85%. The income technique is used in business multifamily evaluations, but it is not used in residential mortgages. The capitalization (or “cap”) rate is a market- and a property-specific factor used by appraisers to split the NOI of a property.
With this method, appraisers can assign a value to a property even if no comparables exist. And from an investor’s point of view, this evaluation method allows for more leeway in either A) raising rents, B) cutting operating costs or C) doing both to boost a property’s worth.
Conclusion
There are a lot of additional issues that come up for real estate investors as they move into apartment buildings. Particularly, applying for multifamily loans necessitates familiarizing oneself with the intricacies of commercial finance, which differs greatly from residential financing.
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