Multi-Family Financing by Andrew Bogdanoff

by 07 Mar 2009
Multi-family dwellings, or apartment houses as they are referred to by lay people, are familiar territory for most of us. Quite simply, multi-family commonly refers to an apartment complex that houses many people and requires a lease (minimally month to month and more regularly a year-long obligation) rather than the daily commitment that represents most hotel stays. From garden types to high- or mid-rise complexes, the concept is the same; to have many people living within the same property. Given their popularity, it should come as no surprise that multi-family loans are one of the cornerstones of commercial lending, representing one of the three most popular loans in today?s market. It has often been called the ?lender?s favorite? because in a good location, multi-family residences tend to have a high occupancy level and are relatively simple to manage. Lenders are generally comfortable with multi-family loans in good and bad economic times alike, making them a loan option that every mortgage originator should be familiar with. Two Defined Rules There are two rules to be aware of when beginning the process of requesting loan(s) for a multi-family property. The first is a key component called the debt service coverage. This formula is a simple division equation that can make or break the loan. When reviewing the debt service coverage the lender will divide the net operating income of the property by the amount of the annual payment of principle and interest. Generally, lenders like to have a debt service coverage ratio of 1.2 to 1. This milestone ratio is met, for instance, when a property has a net operating income of $1.2 million and an annual payment of principle of only $1 million. If the debt service coverage falls below the desired 1.2 to 1 ratio, the lender will require more of a down payment from the borrower in order to ensure that the mortgage payment can be made if unexpected circumstances arise, such as an increase in utilities costs or a decrease in the occupancy rate. In short, if this ratio can?t be met, the lender will only agree to loan a lesser amount so that the lower payment can assuredly be met. The second rule pertaining to multi-family loans relates to the net operating costs. Once determined, the net operating costs are divided by the monthly payment to determine the size of the loan. As a rule on multi-family properties, only 80 percent of the purchase price of a property can be borrowed. Lenders subtract a number of costs from the gross rents in order to understand the net operating costs, starting with the vacancy allowance. This ?allowance? is a projection of the number of units that will sit vacant based on industry averages for particular geographic vicinities. The lender then moves on to examine other operating expenses such as utilities, real estate taxes, payroll, insurance, and other costs the landlord must pay over the course of the year. The net operating examination is not yet complete, however, until a maintenance reserve is also evaluated. Lenders assume that over the course of the year there will be some maintenance problems such as broken washing machines, roofing repairs or even the need to repave the parking lot. These classic operating expenses do not occur on a regular basis but do require a contingency fund to cover the costs Pre-Loan Examination In addition to the definitive rules regarding debt service coverage and net operating costs, lenders will conduct a pre-loan evaluation that examines a number of items, including: o Property appraisal ? Like all appraisals, this will represent the value of the property. The lender will loan up to 80 percent of the appraisal or purchase price, whichever is lower. For instance, assume a borrower can purchase a property for $10 million that actually appraises for $15 million. He might want to borrow $12 million (80 percent of the appraisal cost), but he would be turned down. Remember that the lender would only give him $10 million, which is the lesser of the two amounts. o Occupancy rates ? Borrowers want to know that a building will have the right balance of occupied and vacant units. If a building has no vacancies, it?s assumed the rents are too low. If there are some vacancies, it?s noted that you likely are charging the right amount. Beyond this, lenders will examine occupancy trends. If it?s an out of the ground construction, they will review occupancy rates for surrounding complexes. If, for example, there are 10 complexes in the area and all of them have a 30 percent vacancy rate, the lender will require the borrower to justify why another building is necessary when the existing properties seem to satisfy the existing need. If this justification can?t be made, the loan will not move forward. o Rent rates ? In a given area, rents must be comparable. If a borrower is planning a property that charges a $4,000/month rent rate when the surrounding complexes charge only $1,000/month a lender will challenge the borrower?s logic. The borrower will have to explain why someone would want to pay four times as much rent to live in that particular area. o Condo conversions ? Apartment complexes are converted to condominiums because the value of the collective of all units is greater than the value of them as a rental property. For a condo conversion loan to go through, the lender must be satisfied that there is a shortage of purchase options in the geographic area within this particular price range. If comparable housing pricing exists in the area, the likelihood of the condo conversion loan going through is low. Remember the Reassessment Period It?s important to understand that multi-family loans usually go through a reassessment process after a specific number of years. A lender will usually make the loan for five years at a given rate, but will amortize the payments on a 25 or 30 year payment schedule. By extending the payment schedule the lender helps guaranty that the borrower can make his or her payment, while the five year ?reassessment? period helps the lender protect itself and renew the loan at current loan rates. After the five year period, the borrower can either refinance the loan with the existing lender at the current market rate or can pay off the loan in full (a balloon payment) and look for another lending partner. Value to the Broker Multi-family loans are one of the three most popular commercial loans available, right along side loans for office buildings and shopping centers. Because they are familiar and lenders are generally comfortable with multi-family lending, every mortgage originator should be aware that these types of loans will generally be well received by his or her investing partners. By making a multi-family loan option part of a broker?s lending cache, opportunities abound. Before moving forward and presenting these types of loans, however, brokers should become familiar with the specific rules that dictate multi-family loans as well as the evaluation criteria lenders will examine. With this knowledge under their belts, brokers are well suited to continually unearth new opportunities. About Andrew Bogdanoff Andrew Bogdanoff has more than 35 years? commercial lending experience and founded Remington Financial Group in 1993. He has served as the company?s president since its inception, and, under his leadership, RFG has closed billions of dollars in transactions. Andy can be reached at For more information on Remington Financial Group, please visit


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