Rental Property Investor · Cincinnati, OH · Member since 2015 · 128 posts · 59 votes
Hello BP Community! I am considering multifamily properties from 3-10 units. I know anything from 2-4 units will require a residential loan and anything more than that will require commercial financing. Curious to hear opinions on:
1) Res vs Comm Loans and any caveats / gotchas I should consider?
2) Whether or not I should even be considering a Commercial MF for my 1st investment?
3) Whether I would qualify for a commercial loan considering my experience level?
4) Any other recommendations / advice.
For background -- I am looking to purchase a property between $150k-$350k and have enough for the 25%-30% down if it is required, although that would tie up a significant amount of my capital. Look forward to everyone's feedback!
Commercial loans are much easier to secure then residential. They don’t care if grandma gave you $25 for Christmas and you deposited in your bank account. They only care for the most if the property cash flows.
I agree with @John Warren once you get the first one under your belt you are good to go. Local small banks are the way to go. Much easier to work with. They will ask for LLC Articles, Operating Agreement, EIN number, 2-3 years of tax returns and make sure your debt service coverage ratio (DSCR) is at least 1.25. If your DSCR is 1.7 or better you may be able to get 80% LTV instead of 75%. You will still need an appraisal. Make sure your numbers included the correct ARV. I have completed numerous commercial loans. The extra cost is worth it.
@Kyle Neff I don't think you should ever be afraid of commercial loans. They are a pinch more expensive as far as closing costs, interest rate, etc, and they also have shorter terms in most cases (5 years is kind of standard). With that being said, when the deal works it works. Getting approved for a commercial loan starting out would be more challenging, but if you go to local banks you will have success.
If you are worried about tying up capital with the down payment, that would lead me to believe it may not be time to jump into larger deals. I have been scaling up for the past few years, and each deal becomes more rewarding.... but also more capital intensive. You need funds well beyond just the down payment. You will need operating capital, funds for doing immediate improvements, reserves, etc.
Just going to throw out there that you can get a commercial loan for a 2-4 unit. I've done this multiple times. The reason being my LLC owns the properties, so it cannot be a personal loan.
Whether you are going small or big, you can still qualify for a commercial loan. However, the bank will likely require personal tax returns and a personal financial statement, since you will be acting as the guarantor of the loan. As @John Warren said, they are more challenging for starting out, but certainly not impossible. If you've got a good deal you'll be good to go.
Thanks John! I appreciate the insight - I tend to be a little overzealous when it comes to things I am very interested in - like REI. But it wouldn't hurt me to dip my toe in at first and start with a few smaller properties before diving in.
Did you start in singles, multis, a mix? I am always interested to hear how someone got started, and how their journey has evolved. Do you mainly focus in IL or do you go outside as well?
Thanks Jack! Did you purchase your properties under your LLC from the beginning, or did you ever purchase traditional and then move under the LLC later? Getting the LLC formed is on the top of my list.
I’d consider the long game. Getting into a commercial loan and building up business credit can open the doors to larger lines of business credit down the road.
As mentioned previously, this comes at a slightly higher cost with shorter repayment terms. But maybe the short losses outgrow the long term gains.
I’d run the numbers on your personal financial situation/plan.
Awesome insight, Jairo. I am always trying to keep the long game in mind. That being said, I will probably start out with some smaller multis (residential) to get some experience and build up to the bigger opportunities. Would be curious to hear how you started and how/if your path has evolved over time.
@Kyle Neff I started with a four unit in a quiet working class suburb called Lyons that was right next to my house at the time. The deal went so well that I went all in, and since then I have purchased an additional 48 units of apartments. It is funny, but my first deal is still probably my best and easiest deal to date. The deals since have all been profitable, but have been much heavier lifts to get off the ground.
I purchased two properties without an LLC. One was within a partnership and the other was on my own. Both were paid for in cash. I then sold the second one to the LLC I formed with a new partner, and have since acquired two more.
All three of these properties in the LLC have commercial debt in place.
@John Warren that's an awesome story, and gives me a lot of motivation to tackle my next project. Thanks for sharing, and kudos to you on all your success!
@Kyle Neff for sure. I think anyone can do it with a lot of hustle, hard work, saving and smart leveraging of properties. The thing I love about the rental game is that this has all been done before!
Commercial loans are much easier to secure then residential. They don’t care if grandma gave you $25 for Christmas and you deposited in your bank account. They only care for the most if the property cash flows.
I agree with @John Warren once you get the first one under your belt you are good to go. Local small banks are the way to go. Much easier to work with. They will ask for LLC Articles, Operating Agreement, EIN number, 2-3 years of tax returns and make sure your debt service coverage ratio (DSCR) is at least 1.25. If your DSCR is 1.7 or better you may be able to get 80% LTV instead of 75%. You will still need an appraisal. Make sure your numbers included the correct ARV. I have completed numerous commercial loans. The extra cost is worth it.
You can form an LLC in most states on line. I can get mine by tomorrow by expediting the process ($100). You will want to make sure your LLC is done correctly, but if time is short go online and then you can correct it later to make sure you met your asset protection (purpose of an LLC). You can have an attorney draw up an operating agreement and check the LLC. I take care of the EIN number with the IRS (IRS.gov) myself. You will need your Articles from your LLC first.
@Kyle Neff you don't need to form an LLC before putting a property under contract. The local bank I use to finance my apartment deals in the Chicago suburbs has no issue with me assigning the contact to the LLC once we put it together. I have never created an LLC before putting a property under contract. Make sure you know how long this will take though, as it can take longer in some states than others (Illinois... I am looking at you)
@Joseph Phillips the five year term is when you have to refinance the loan with the bank. This is the banks way of protecting itself if interest rates go up. These banks are holding the notes on their books and they don't sell them like most residential mortgages get sold.
I get 20 year Commercial loans for my rentals because they allow me to acquire financing on cheaper properties. Also the process is much quicker for me and the loans go against my company instead of my credit. A traditional mortgage below 52,000 is really hard to get if not impossible because of regulations.
It depends on what you’re looking to do really. I will definitely be using both Commercial and Traditional loans!
Thx John and Kyle. What refinancing options are normally available after initial five years? Can one negotiate lower rate etc. ? What would be the normal loan conditions for a LOC and pluses and minuses of going that route? Thx
In my experience, too many new investors focus on the wrong things when starting out. Things like a LLC, business cards, website, etc. Go find a screaming deal first and then worry about a commercial loan versus a residential loan.
You can always place the property in a LLC later.
As others have mentioned, small banks are better than big national banks when it comes to commercial financing. While the terms are not as good as residential loans, they are way easier to obtain. Loan approval is fast and if you build a good relationship with the commercial banker, you can use creative financing on future deals.
Your challenge will be no experience. This is where the residential loan comes to the rescue. I’d narrow your search to a 4 unit with 30-year traditional financing.
Just make sure you buy for cash flow in a decent area that will attract the ideal residents.
Commercial and residential loans function in different ways for different purposes
Residential loans are used to purchase residential property (as you probably surmised). Residential properties are typically between 1 - 4 units.
The interest rate is fixed and the loan is amortized over longer periods of time. The most common being a 30 year amortization period.
Commercial loans, as you probably guessed again, are used to purchase commercial property. Generally speaking, you will need a commercial loan to purchase properties 5 units and up.
The interest rate on commercial mortgages will usually be higher than residential loans. Another key difference is the amortization schedule is usually shorter. Most of the time it is between 5 - 10 years and sometimes 20 years.
However, the payment schedule or amortization period can be spread out to a longer period of time. For example, the loan can be for 10 years but the amortization period can be set for 30 years.
Good luck and feel free to PM if you have any questions