If you're new to multifamily investing you will most likely want to know as much as possible about the world of financing. Winston Rowe & Associates, a national no advance fee commercial real estate advisory and finance firm is there to help.
Apartment and multifamily investors seeking additional information about Winston Rowe & Associates creative, out of the box commercial real estate financing solutions can contact them at 248-246-2243 or visit them on line at http://www.winstonrowe.com
While each apartment building transaction is unique and underwritten on its own merits it's worth knowing that there are a few basic requirements commercial lenders use.
The underlying asset is among the first on the lender's list to review. This is the security the lender uses for taking the risk of lending you money. Therefore, the building you own or looking to buy represents the source of repayment for the commercial loan.
Believe it or not with very few exceptions lenders do not like distressed properties and REOs.
These kinds of properties come with a myriad of problems such as high vacancies, management and tenant’s issues, title, lack of maintenance and or upgrades, local economy, and in many cases inability to service debt. As a result, hard money may be one of the very limited financing options.
For conventional transactions great emphasis is placed on the property and its condition. In case of foreclosure, the lender wants to be sure it has a marketable property. This is the reason for which the lender will typically not allow the borrower to choose the appraiser. The commercial appraisal is detailed and it utilizes three variables to derive the property value: income approach, replacement cost, and sales comparison method.
The income approach carries the utmost important factor in determining the collateral approval. A building could be fancy, well-maintained, and in a great location, but if the income is not there to support the value the collateral does not pass the test.
The Cap Rate:
Among other factors worth mentioning are the age and condition of the property, the vacancy rate, and the area market capitalization rate. The "Cap Rate" is a ratio used to determine a property's value based on its generated income. It's computed by taking the rental net operating income (NOI) and dividing it by the property's fair market value (FMV) or sales price. The lender will then compare the property's Cap Rate with the general area's rate for similar properties.
The red flag arises when the ratio is lower than the norm, therefore a higher cap rate is certainly desirable. Conversely, a very high ratio raises another red flag. Rest assured that an underwriter would question why a property has such a high ratio. Are there any underlying issues that could potentially affect the property in the future? Remember that an underwriter has a detective's eye, he/she is looking for what could go wrong before looking at the positives.
If you're looking at buying an apartment building something tells me you'd want to first look at the Cap Rate. Often a high ratio means a better deal for you. If the area's Cap Rate is approximately 8% and the property you're looking to buy has a 5% ratio you must justify why you're buying it.
What is it that compels you to pay the higher price? Remember also that the appraisal will put a heavy emphasis on the lower ratio.
Now, let's do some quick calculations as an example. We'll assume that you're trying to determine between two previewed properties. The first property has a NOI of $35,000 and an asking price of $600,000. The second property has a NOI of $15,000 and an asking price of $150,000. Which one would the Cap Rate suggest is a better investment? Obviously, the second property since the Cap Rate is 10% ($15,000 / $150,000) versus 5.8% ($35,000 / $600,000).
On the other hand, if you're the proud owner of an apartment complex and you want to figure out its estimated value, you can do this by first learning what the area Cap Rate is for your location. Let's say the area Cap Rate is 8% and your property's NOI is $42,000. You can then easily determine your value at $525,000 ($42,000 /.008).
The Cash Flow:
Cash flow plays a significant role when underwriting a multifamily loan. Within the industry the cash-flow analysis is known as the Debt Coverage Ratio ( DCR). Such ratio measures the property's net income ability to cover the annual debt service. The lender will analyze the property's rent-roll - and the financials - and determine the annual income and expenses. After that it determines if the annual cash flow can service the new debt.
The DCR is calculated by dividing the property's annual NOI by the property's projected annual debt service (based on the new loan). Annual debt service includes the principal and interest payment only. Taxes, insurance, and the rest of the expenses have already been deducted when determining the NOI. Lenders are looking to see a minimum of 1.25 ratio, meaning that for every $1 of debt service the property must generate a minimum of $1.25 in net operating income. So, let's say a building's NOI is $35,000 while the annual P&I is $27,000 (or $2,250 monthly).
The resulting DCR is 1.29, a ratio within the guidelines. However, a mere increase of a half percent on the rate could bring down the ratio below 1.25 thus putting the loan in jeopardy of being denied.
Most loans funding today are recourse loans. It means that lenders are not satisfied with the collateral only and you, as the borrower must provide a personal guarantee; which implies that your credit and financial strength will be scrutinized. Keep in mind that even if title to the property is vested in the name of a corporation, LLC, or some other form, lenders still require personal guarantees from their owners or members.
Underwriting trend is rather conservative so lenders expect you to prove a great credit history, sufficient apartment building experience, and a decent net worth with a generous amount of liquid funds.
When it comes to the capital invested or equity owned most programs want to see the borrower's equity at twenty percent or more. Your net worth should look impressive. Fannie Mae, for instance, wants to see the borrower's net worth be at least the loan amount requested.
Finally, the apartment building is the primary source of collateral and loan repayment, therefore it carries more weight when compared with the borrower during the loan underwriting process. Still, the strength or weakness of the borrower will ultimately impact the approval or denial of the loan.
A loan package meeting these basic requirements creates the foundation for a successful loan approval. However, keep in mind it doesn't necessarily mean that a transaction that meets the criteria is automatically approved for a loan. Still, not meeting any one of the above requirements will most likely end in denial of your commercial loan request.
The Lending industry is quite chaotic and unpredictable, especially in today's economic environment. Banks will like your deal today and hate it tomorrow. Most commercial loans are originated today as Portfolio Loans.
This means the lender keeps the loan in their portfolio for the entire term. So, if they find today they have too many retail centers in their portfolio, they will decide - over night and without a warning - to shift to apartment buildings.
At Winston Rowe & Associates, their primary objective is to provide the most reliable and efficient means of sourcing both debt and equity for your commercial real estate loans.
Winston Rowe & Associates has an excellent knowledge based investor resource for commercial real estate valuation and market analysis located at: