One of the most common questions I get is, “How Do I Get A Multifamily Loan?” The simple answer, “Be Prepared!”
One of the most common misconceptions in multifamily investing is a bank will lend you money strictly on the properties performance and NOT look to the buyer for any guarantees. This is known as a non-recourse loan and it does exist, for properties of institutional quality, typically well over 100 units. For smaller properties and newer investors, forget this loan product exists, for now.
We’re going to focus on how to get a recourse conventional loan product from a local community bank. Most community banks will hold their loan products in house and not sell them to the secondary mortgage market so this gives them the flexibility to make in house decisions.
The lender will want to see the last 3 years of property performance in the form of profit and loss statements or Schedule C tax returns if the sellers are an entity or Schedule E if they’re an individual. They will ask for a current rent roll, want to see all the leases and ask for proof of security deposits.
Typically you will need to get a new alta survey, lenders title insurance, termite and pest inspection, appraisal which will be ordered by the lender, and if the property is older than 1978 you will need a lead based paint disclosure. If the property is in a coastal county or in tornado alley, you may be required to get a wind binder in your insurance policy and an earthquake binder if the property is in a seismic zone.
If you really want to make a statement then you should put together kick butt executive summary. This should include the acquisition strategy including any repairs and upgrades you’re planning, a budget for the first of operations, a cash flow analysis for the holding period and any interior and exterior images of the property. If this is a re-position then before and after shots of previous projects and property performance will go along way.
You may be required to provide a balance sheet, 3 years of tax returns and a credit score. If you have partners then the bank may require the same from them. If you have passive investors from a small equity group then they may even require a guarantee from them as well. I have seen this more and more lately.
You may want to go ahead and start the process for setting some kind of entity, such as an LLC. This will help protect you and your partners personal assets. This doesn’t have to be done prior to getting the loan process started but you will want to have it completed prior to closing so you can assign the contract to the new entity. Consult an attorney on how to setup an entity for investment properties.
If everything is in place and looks good and you make it through the initial underwriting, the lender you first meet with before he sends it to the board, then the board should present a term sheet with their offer of financing. This is typical for larger loans, but don’t be surprised if you see it on all commercial transactions.
A typical loan product for smaller multifamily properties will have an interest rate about 50 to 75 basis points above what you would expect a home owner could get. This means if you have good credit and can get a house at 3.8% then expect a commercial loan product to come in around 4.5%. Depending on the age of the property you will probably see a 20-25 year amortization. If your property is more than 30 years old then expect 20 years and in some cases if deferred maintenance is high they may only go 15 years.
The loan amount will be based on the lower of of two things, debt service coverage ratio (DSCR) and loan to value ratio (LTV). A typical DSCR is 1.2 to 1.3. This means that the net operating income (NOI) should be 20 to 30% higher than the annual debt service. The LTV will typically be 75% but can be adjusted up or down based on the strength and experience of the borrower and the properties past performance.
Most lenders will ask for a loan term shorter than the amortization period. This is known as a balloon payment or loan maturity. The most common time frames are 5, 7, and 10 years. When this period expires the remaining loan balance must be paid in full or renegotiated for a longer term. You will want to negotiate this depending on your investment strategy and holding period.
Being prepared and knowing what to expect will help you get your multifamily loan approved. As you gain experience and invest in more multifamily properties this will become second nature and the relationship you build with your lender will go a long way in your success.