Cleo Mcdougald Jan 05, 2022

Multifamily loans are available for either the refinance or purchase of a multi-unit housing property; they commonly pertain to apartment buildings but can also support the purchase of mobile home parks, specialized housing needs, mixed-use, and smaller structures like duplexes. Due to the higher sums of money associated with such assets, the terms and requirements for multifamily loans differ from single-unit mortgages.

In the following guide, Bank of Hope details multifamily loan qualifiers, what to expect from the application process, and answers to common questions.

 

Table of Contents

  1. Multifamily Loans: Differences Between Commercial and Residential Multifamily Mortgages
  2. What You Need to Qualify for a Multifamily Mortgage Loan
  3. Equations Commercial Lenders Calculate (and You Should Too)
  4. Advice for First-Time Multifamily Property Investors
  5. Other Frequently Asked Questions About Multifamily Mortgages

 

Click here for information on multifamily loans offered at Bank of Hope. 

 

1. Multifamily Loans: Differences Between Commercial and Residential Multifamily Mortgages

When discussing multifamily loans, a crucial point to clarify is what qualifies as commercial versus single family mortgage; the former refers to properties with five or more units while the latter applies to buildings with two to four housing units.

The process of applying for the two types of multifamily mortgages differs based on borrower and property requirements. Differences include:

 

Home Mortgage (Non-Commercial) Loans (2-4 units) Commercial Multifamily Loans (5+ units)
Borrowers are typically individuals or may include trusts Borrowers may be individuals, trusts, partnerships, corporations or limited liability companies
Loans are recourse Loans may be recourse or non-recourse (limited liability)
Borrower Debt to Income Ratio Requirements Property Debt Service Coverage Ratio
Less stringent credit score requirements Requires a higher credit score (usually above 680) to qualify
Lenders place less emphasis on past experience with financing Lenders place significant emphasis on past experience
No Environmental Report Environmental Report
The maximum depends upon the number of units, capping at $1,054,500 Minimum tends to start at $500,000 with no maximum

 

Due to the disparity in real estate and applicant requirements, some financial institutions (such as Bank of Hope) have teams dedicated to commercial loans. In turn, the Mortgage department handles financing for 2-4 units.

 

2. What You Need to Qualify for a Commercial Multifamily Loan

There are no universally agreed-upon rules about who can qualify for multifamily mortgages. Most banks want at least 25% equity position, but they also consider other factors when assessing the level of risk each property and applicant presents.

Building Considerations

  • The age and condition of the building(s)
  • The current occupancy rate and estimated monthly income (including actual collections)
  • The number of units and unit sizes
  • Current and historical income and expenses
  • Debt Service Coverage Ratio - the ratio of income to debt payments
  • Loan to value ratio - the ratio of the loan to the value of the property
  • Market performance 

Borrower Considerations 

  • Credit scores and professional histories for key owners
  • Personal Financial Statements and Schedule of Real Estate to determine net worth, balance sheet leverage and cash flow
  • Liquidity requirements to support the subject and the sponsors portfolio
  • Past successes with multifamily properties and within the market

Remember, the designated professionals evaluating your multifamily loan application bring a wealth of experience assessing risks. If multiple financial institutions decline your request, it may be a sign to re-evaluate risks factors and consider a different structure.

Accompanying Paperwork

Both the applicant and the bank greatly benefit from documentation proving the financial viability of the commercial multifamily property. The following is typically requested:

  • Current Detailed Rent Roll
  • Profit and loss (P&L) / Operating statements
  • Purchase Agreements (if applicable)

What’s more, be ready to share the following:

  • Personal Financial Statement and Schedule of Real Estate Owned
  • Resume
  • History of recent capital improvements
 

3. Equations Commercial Lenders Calculate (and You Should Too)

Commercial lenders don’t only weigh the financial track record of the borrower but also the potential profitability of the multifamily property. Calculations they rely upon include:

Net Operating Income (NOI)

Net Operating Income is a measurement to determine the profitability of a commercial real estate asset. The equation is calculated by determining the annual revenue and subtracting the annual recurring property expenses such as property taxes, insurance, utilities, repairs and maintenance, management expenses and replacement reserves. Mortgage payments and non-recurring expenses are typically excluded. The net operating income will help determine the cash flow for the property. For example, say you want to purchase a property that generates $6,000 in monthly income and $2,000 in monthly expenses. You would take $6,000 minus $2,000 = $4,000 monthly income. NOI is commonly expressed over a 12 month period, therefore multiply by 12 to determine NOI = $48,000 in NOI.

Capitalization Rate (Cap Rate)

This metric is used to forecast the rate of return from asset based on the current or potential net operating income. The cap rate is calculated by dividing the property’s net operating income by the current market value. Taking the above example, let’s say you are purchasing that same asset for $1,100,000 and the annual NOI is $48,000. The cap rate would 4.36%. Alternatively, an estimate of market value can be determined by taking the net operating income divided by the estimated market cap rate.

When comparing similar properties, the property with a higher cap rate can mean a better investment holding all things equal. Properties with higher cap rates than market cap rates could potentially be a red flag.

Gross Rent Multiplier (GRM)

This metric represents the purchase price divided by the annual rental income. For instance, let’s say you purchase a seven-unit apartment building for $1,100,000, and the combined annual rental income generates $100,800. You would then calculate $1,100,000 divided by $100,800 to equal 10.91. The GRM score provides easy grounds for comparing various investment opportunities, as a lower score signifies a more profitable property.

Loan to Value Ratio (LTV)

This metric accounts for the difference between the loan amount and the apartment property’s appraisal. Simply calculate this by dividing the total debt by the property value. The higher the ratio, the higher the perceived risk of the investment. Lenders often have a maximum they’re willing to accept; for example, Bank of Hope will accommodate multifamily mortgages with LTV up to 75%.

Debt Service Coverage Ratio (DSCR)

This metric embodies the generated rental income (minus operational costs) in relation to the mortgage payments. The goal is to determine if you can be profitable, even in the face of unforeseen expenses. The greater the estimated cash flow, the less perceived risk for the lender.

This equation is slightly more involved than the previous. First, you must calculate the net operating income using a formula similar to:

Annual revenue - property taxes - property management expenses - insurance - estimated maintenance and repairs - utilities – estimated replacement reserves= net operating income

For example, let’s say you operate a multi-unit property that generates $1,000,000 in annual revenue, but you are responsible for $100,000 in expenses (taxes, management costs, repairs, etc.). This would make your net operating income $900,000.

To figure out the DSCR of the multifamily loan, you would divide the estimated net operating income by the annual loan payments. So, let’s say that the building in the above scenario was financed using a loan that requires $800,000 paid annually. To calculate the DSCR, you would divide the net operating income of $900,000 by the annual debt of $800,000 to receive a score of 1.125.

While a score of 1.125 is greater than the “break-even” score of 1.00, most commercial lenders may view this DSCR score as representing too high a risk (1.15 is a commonly cited threshold). After all, there are always unexpected factors that can influence annual income or estimated expenses, such as costly repairs, unit vacancies, etc.

When assessing what DSCR scores are acceptable, lenders may also factor in your past successes with multifamily properties, as well as the local property and market projections.

Commercial multifamily lenders consider such equations when assessing the overall financial soundness of the investment property. If they find that the opportunity presents too high a level of risk, a lower loan amount may be considered.

 

4. Advice for First-Time Multifamily Property Investors

No amount of online research can fully prepare you for the realities of being a landlord. There will always be curveballs, whether they are global pandemics, unpredictable tenants, or unforeseen vacancies. To help minimize your financial risk as a first-time investor, consider the following:

  • Start with a residential property with four or fewer units rather than a commercial multifamily building. In fact, many lenders won’t even consider inexperienced investors for the latter. With fewer units comes fewer chances of “bad luck” or becoming overwhelmed. Plus, the reduced upkeep costs and loan amount make the debt more manageable.
  • Consider hiring a Property Management Company. Property management companies can assist with tenant screening, leasing, collection of rents, eviction process, maintenance, paying expenses and understanding of laws.  They are also experienced with managing and may have local expertise in the neighborhood.
  • Listen to the Experts. There are a variety of publications and online sources to help. Consider signing up for a podcast series on apartment or real estate investing, blogs or networking groups. 
  • Aim to have a Debt Service Coverage Ratio (DSCR) closer to 1.5 than 1.2 for your first property. As alluded to above, part of being a landlord is expecting the unexpected. Therefore, err on the side of caution as a first-time investor by having a generous repository of funds to cover surprise operational costs. Such instances include everything from increasing taxes to costly tree care services to a leaking water heater. As you accumulate experience, you strengthen your ability to budget appropriately.
  • Avoid “fixer-uppers” unless you have relevant know-how. There is quite an allure to buying an outrageously cheap property “as is” intending to “fix it up.” However, if you’re unfamiliar with the process, it’s easy to underestimate related costs and the construction timeline. You risk finding yourself spending far more than you anticipated while paying the mortgage on a property that remains uninhabitable for longer than you anticipated.
  • Avoid buying in an “up-and-coming” neighborhood without evidence. The dream of every multifamily investor is to buy an affordable property on a “bad” block, only to have that neighborhood soon improve (sending the rent rates skyrocketing). If this is your strategy, look for the telltale signs that an area is on the rise: reduced crime rates; businesses opening; properties being sold with increasing speed and for higher prices; and proximity to other thriving neighborhoods. What you should not do is gamble on hype alone. Far too often, realtors’ promises of soon-to-be-up-and-coming never transpire or take much longer than you foresee.
 

5. Other Frequently Asked Questions About Commercial Multifamily Mortgages

Are multifamily loans appropriate to put towards construction projects?

For many financial institutions—including Bank of Hope—commercial construction loans would be the more appropriate route.

What are the minimums and maximums for commercial multifamily loans?

For commercial multifamily loans, the minimum tends to start at $500,000 with no set maximum. Bank of Hope often grants mortgages of at least $25 million or more on a case by case basis.

I plan on doing aesthetic renovations and asking for higher rent. How can I reflect this when estimating rental income?

Owners should review a variety of sources to determine the appropriate rent amount to charge. Market surveys can be conducted by surveying other properties or through online sources (Zillow, Apartments.com).  If an appraisal is ordered, an appraiser will generally determine the appropriate market rent for each unit type in the market.

Can multifamily mortgages apply to mixed-use buildings?

Yes, though at least 50% of the generated revenue must come from residential use.

Return on Investment – A multifamily real estate investor generally profits through value and/or rent appreciation. Upon appreciation of the asset, they may elect to sell the property or refinance.  Sales proceeds may be used to purchase other assets. Refinancing allows the investor to lower their interest rate and/or mortgage payment. Another way refinancing may help an investor is by generating cash out proceeds for capital improvements which may in turn increase equity and/or cash flow through rent appreciation, enhance liquidity or for investment in other assets.

Why Choose Bank of Hope For Your Commercial Multifamily Mortgages

Bank of Hope works diligently to make the application process as smooth as possible while simultaneously helping to maximize the ROI of your investment. A dedicated team specialized in commercial multifamily loans will be with you every step of the journey to provide advice and expedite turnaround times. 

Visit our multifamily loan service page or message us to talk with an expert.

Cleo Mcdougald is a multifamily loans professional.   

The views and opinions expressed in this article do not necessarily represent the views and opinions of Bank of Hope.

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