Commercial Financing...

125 Replies

Hello Everyone! I am just getting into contract in the next few days with a 47 unit multi-family property. The numbers are great, the occupancy is high and the property is well maintained! My questions is this....

I am going for a meeting next week with my first lender who is/has done deals within the last year with financing multi-family properties. He has already reviewed the numbers on the property and says it looks very solid...

Here's the tricky part... I am a younger investor. The lender said, first he needs to have 20% cash down payment.. Good part is, I have the cash in my savings account! Next, my credit is great....800+....

Now for the bad news...I only show very little income, maybe $40,000 a year (self-employed)...

The debt service coverage ratio is "1.64"...fairly strong..Property historical tax returns speak for themselves.. Problem is, I don't.

I have the cash down payment required by the lender, I have the credit score needed but I don't have a large enough income on paper coming in...

Here's another curveball... I have a father who is well-qualified for the loan. This being my deal he wants me to do this solo...He has mentioned he is willingly to co-sign because he has cash reserve accounts which would justify the "recourse" aspect to the lender however he doesn't want his "debt to income" ratio to get skewed because he wouldn't being earning any "profits" from this deal...

So firstly, is there any hope for me qualifying?

Secondly, is there a way for my father to be on the loan without it affecting his "debt to income ratio"? In case he wants a loan in the next few years, I don't want him to be affected by being on the loan..Is there a different way to structure the loan buy just utilizing his cash reserve accounts?

Please advice everyone, looking for all suggestions...

Thanks!

Keep in mind the complex will be in contract just above $1.3m...so my DP is 20% of the purchase price....

@Nik S.

The commercial loan world doesn't really allow "co-signer's" for commercial loans. The "co-signer" would need to have an equity stake in the property. So your dad would need to be part owner in the property...probably at least 20% based on what the bank will allow. The bank will also look at your experience...if you don't have any experience and low income that will definitely be a negative to underwriting. What about reserves? How about net worth? They will look at both of these factors when underwriting the loan. Does your father have experience in real estate? Local banks can get over the experience portion for stabilized multi-families if the borrowers have strong financials (both income and capital).

Congrats on being a young investor and tackling a good sized deal. Just be careful of the pitfalls. It looks like you are buying just shy of 28k/door. Can you tell us anything about the deal? Rents? Who pays utilities? expenses etc etc?

If your dad Is co-signing on a personal guarantee or recourse loan it will be counted against him.

If you default they will look to him to make it right. That debt he is obligated for so of course they will count it as debt.

At 1.3 mill you are looking at a local to regional bank.

Non recourse you have to get into 3 to 4 million or higher. Be careful not to do a 5 year loan because of a refi bomb eating up any of your gains.

Banks look at net worth and liquidity.

You might want to bring in another partner and only put half of your money down and save the rest for reserves.

How much cash do you have additional over the 20% down payment?? Generally they like to see 10% liquid of the loan amount for reserves after down payment. Sometimes you will get lucky and they will go lower at 300 to 400 a door. It depends on the lender and loan terms.

Another option is to find a fully owner financed deal with some down. They will be more flexible with reserves and they will understand you own a business and write down a bunch of income to pay little taxes.

Thanks for the response Chris...My father owns multiple single family homes as well as motel(s).. experience is there..I have grown up in the business!

Father has the net worth as well as reserves. I simply have the down payment.

Utilities are paid by the tenant....Rents are $490-515...Property is over 93% occupied and has been for the last 2-3 years...very stable. My expenses run about exactly 50% of gross rents...So if we "split" down payment.. can that be considered his equity?

Also, my question is would my dad then have an outstanding loan on his credit? or would we be essentially splitting the amount being financed?

My only concern was if I attach him to the loan with "cash equity", will his credit reflect an outstanding loan (the 80% being financed)?

Thanks Chris...looking forward to your response!

I have set aside $10-15k for reserves....so downpayment + $15k for reserves in my account...

My net worth is slim to nothing other than the cash I have....I have been working for my fathers "empire" for the last 4 years....

I have property overseas that's very valuable (in my name) however it's in another country so I don't believe lenders will even consider that....

So I am stuck & have to utilize my father...Defauliting isn't the question here, its how to structure the loan in a way not to stretch my fathers debt-to-income ratio...

@Nik S.

Let me clarify about the equity stake....he just needs to be an owner in the property (probably 20% or more). He doesn't necessarily need to bring capital to closing however will need to sign a personal guarantee. I think you could structure a solid deal with your father. Let's say you offer him 25% ownership, 25% of cash flow, and 25% of the upside of the deal for signing on the loan. That could be a win win for everyone involved.

In regards to the DTI issue...why is your father worried about this? Commercial loans don't show up on your personal credit report like conventional residential mortgages do. If he is worried about getting additional commercial mortgages it won't be an issue as long as the property cash flows. His global cash flow picture will be important to commercial lenders.

@Joel Owens 5 year fixed loans are pretty much the only loans you can get with local/regional lenders right now for smaller commercial loans. They are just as scared as we are in regards to interest rate risk. There are small balance CMBS loans out there sub 2 MM with non-recourse however the fees are so high it almost doesn't make sense. Some life insurance companies are doing small balance recourse loans sub 2MM with longer fixed terms however the fees are also extremely high.

Chris... I like where your going.... When you say he needs to sign a personal guarantee... Will the outstanding loan ($1,084,000) show on his credit report as outstanding Bc he gave a personal guarantee?

In additional Chris, I have set aside the closing costs as well..,. See I only need him for the banks reassurance... I'll be honest, I am trying to settle a way for me to reap most if not all profits because ultimately it is all my efforts and hard work going towards the property...

I am getting tentatively :

20 years amortization

4.5 - 4.75% rate

20% down

5 year fixed with balloon or refinance..

My exit strategy is based on a 4 yr hold plan..

I'm 26 years old trying to leverage myself into the real estate game... Doing everything and anything to start my own setup...

Chris. He mentioned to me that if he "co-signs" he wouldn't be able to get a car loan Bc his report would show an additional $6000 a month liability with no income to offset (coming from the 47 unit complex)...

He currently has no commercial mortgages loans on him....

Okay Chris... Due to your extremely valuable information... I think I know what needs to happen....

My father will have no stake or ownership....just be a "personal guarantor" on the loan...which to my knowledge means it won't affect his DTI ratio nor show up anywhere on his credit... Basically, if by chance the loan defaults he will be fully responsible....this way he's not on the title.. And assuming he can do his life / business like he never had any involvement with my deal...

I'm hoping they will look at me lightly & heavily scrutinize my fathers assets/liabilities = net worth.... Even tho my income is less, they have assurance if they need to for recourse of the loan..

I'm hoping the lender can see our scheme and have faith!

"20 years amortization

4.5 - 4.75% rate

20% down

5 year fixed with balloon or refinance.."

These are exactly the crap loans that all the small banks are pushing. If you accept these loans you better have strong multiple exits in place.

I have seen local banks to regionals in some cases go 7 to 10 years out for existing clients that hold high deposits at the bank giving the loan. They will bend over backwards and in some cases loan outside of normal parameters to keep the business such as move to 25 year amort. and 7 to 10 year fixed.

The longer the term fixed in years the fixed interest rate starts rising. Go ahead and plan out your exit with a very high refi interest rate or selling and see if the property with very modest annual rent increases still makes sense.

The debt you can obtain on a property is the number one problem to solve in many cases. If you can't land reasonable debt then the deal becomes a dud.

Originally posted by @Nik S. :
Chris. He mentioned to me that if he "co-signs" he wouldn't be able to get a car loan Bc his report would show an additional $6000 a month liability with no income to offset (coming from the 47 unit complex)...
He currently has no commercial mortgages loans on him....

Your reference to DTI refers to residential mortgage so your father fears his DTI will be affected if the payment from the apartment building shows up on his credit report right?

If yes, and he is using residential conventional financing or even portfolio financing (in most cases) a lender will not count this mortgage against him as long as you can prove that the other co-obligator (you) has paid the mortgage for 12+ months. This proof is documented by 12 months cancelled checks showing you paid the mortgage or by 12 months bank statements so make sure to keep good records and a separate business checking for the apartment building in the event this is needed from your father in the future.

This means that during the 12 months of payments after the apartment loan was acquired the mortgage (if it shows up on the personal credit report, not all commercial loans report to exp/trans/equ) they will factor this $6580 dollars into his DTI.

One exception is if he is also an owner on title and goes on the loan (most commercial banks will require this) as well then he can utilize the income from the property to offset the expenses.

Seeing as how its has 1.6% debt coverage ratio, this property would show us as a cash flowing asset to the bank on the commercial side and would be a positive for your father and on the residential side as well. I've checked with Fannie Mae and Freddie Mac, we'd use 75% of projected monthly gross rents - PITIA (prinipal/interest/tax/insurance/assessments).

How conventional residential lending considers rents is much different than commercial the residential lender in most cases just factors in 25% discount to your gross revenue then takes that remaining 75% of gross to apply against the PITIA. If the resulting number is positive its added to qualifying income and if its negative its added to monthly obligation that needs to be qualified for.

Hope that sheds some light on the residential vs commercial income implications of the multifamily purchase.

Albert please clarify "pitia" formula..

I take my gross rents & subtract 25%.... from the 75% of gross rents then I subtract my tentative mortgage payment, real estate taxes & insurance?

If the number is positive, then that can be added to qualifying income and or if the number is negative than that is the amount to be obliged to as a monthly liability?

Please explain how to properly do this equation...

ie:...gross rents $265k (x) .75= $198,500

(-)82k mort, 40k R.tax, 5k ins.

$198,500 - $127,000 = $71,500 (+) quailifying income? so no liability?

Someone please clarify...

Originally posted by @Nik S. :
Albert please clarify "pitia" formula..

I take my gross rents & subtract 25%.... from the 75% of gross rents then I subtract my tentative mortgage payment, real estate taxes & insurance?

If the number is positive, then that can be added to qualifying income and or if the number is negative than that is the amount to be obliged to as a monthly liability?

Please explain how to properly do this equation...

ie:...gross rents $265k (x) .75= $198,500

(-)82k mort, 40k R.tax, 5k ins.

$198,500 - $127,000 = $71,500 (+) quailifying income? so no liability?

Someone please clarify...

Its 75% of monthly gross income - PITIA which is monthly mtg, tax, insurance, assessments your using the annual figures instead of monthly.

Slight alignment needed. If you have a 25% equity and income, that is what you'd be credited with, you'd get tagged for the full debt amount within 12 months, after 12 that Fannie Mae compensating factor may kick in, a lender is not required to look at it that way as they may look at the obligation and off set it with the income, they could only consider 25% of the income, all the income as agreed, this will depend on what lender is originating.

Residential lenders may be more restrictive, usually not, but they don't have to take compensating factors into consideration. It's best to address your dad's loan situation with his lender before you structure you deal. Tax returns will determine income after a couple years. :)

@Nik S.

As Bill mentioned you need to speak with a banker first in regards to how it will directly affect his future ability to borrow. More than likely if the property performs and he wants to continue seeking commercial loans he shouldn't have a problem. Car loans are extremely easy to get...however he should talk to the local bank that is going to finance the multi-family and any other banks that he currently has a relationship with. If he holds large deposits with any specific local bank or credit union more than likely they will not have an issue extending him a car loan. They might tick his rate up a 100 basis points however that really isn't a big issue.

If you are reasonably confident that you and your father have the ability to obtain financing then your number one priority is to go through proper due diligence. Be very careful when underwriting the deal. Utilize your fathers expertise however also lean on the help of competent professionals. As this is your first deal you are probably looking at this property with rose colored glasses. Remove those glasses, stomp on them, and replace them with a pair of cautiously optimistic ones. Good luck!

Good Morning everyone! I've taken all of your advice and it's helps tremendously!

@Chris . My father & I agreed to have both of our names on the title / loan.. His ownership is 25%....!

@Joel Owens - I did ask my 1st lender for a 7yr fixed as opposed to 5yr!

@Albert Bui - I walked into my first meeting with confidence as I was able to clear my doubts with my father...

Can't thank you all enough for giving me a great start to my first attempt in financing!

I am in contract so I'm excited to get this deal closed!

I requested a 75 day close for ample time to due due diligence as will as secure the appropriate financing!

I will keep you all posted!

Thanks again!

@Bill Gulley - my father has no current loans on his head so I was able to help him understand that structuring the deal in the right way would be the key to my success! key . By reassuring that after 12 months, lenders may not consider it... He was okay with it! His doubts are now cleared as he has a stake in the LLC.! Thanks!

Originally posted by @Nik S. :
@Bill Gulley - my father has no current loans on his head so I was able to help him understand that structuring the deal in the right way would be the key to my success! key . By reassuring that after 12 months, lenders may not consider it... He was okay with it! His doubts are now cleared as he has a stake in the LLC.! Thanks!

You might read what I said carefully, it was written carefully, I said "may" I didn't say a lender "will" not count the loan after 12 months.

If your father got into a commercial loan a lender may well, most likely, consider your loan arrangement.

No loan is ignored by anyone! It is a contingent liability.

I really wouldn't be telling your father what will be done especially from internet forums, get to his lender and have them explain what they will be doing. I understand you may sense a risk here that could backfire on you, I'd not look at it like that as that lender will have some leeway and what ever their internal policy might be there is most likely a way they can make things work. I have a feeling that in the realm of what you are doing, all will be fine but get it from the horse's mouth. Don't just tell him the issue goes away in 12 months. :)

REST ASSURE.... I'm no dummy hah!

All my questions were backed by the lender. I used his knowledge and his understandings to answer my queries...

He said "may" as well.. It's not my fathers main concern. Basically laying out all potential liabilities when taking ownership... I've asked the lender detailed questions to clear up any misunderstandings.

Basically I was just giving my gratitude for the added efforts amongst the replies! Ultimately the lender and the underwriting will be the sole understanding / structure of my deal as each lender handles things that ceter to their demands / needs!

Nik, it will depend on what type of credit your father is looking for. When the contingent liability was mentioned that it may not count towards his qualifying below, the assumption was that:

- it was a liability, but its only a liability if the expenses exceed the income, hence negative cash flow using the formula 75% of gross - PITIA. If the property was recently purchased and there have been no tax returns filed on the property yet and your father went to go get a conventional residential mortgage this is how the income would be considered

- we were looking at how his qualification may be considered when looking at "residential financing," 1-4 units. A Commercial lender or a local bank may not see it the same way but it can be nearly assured that a lender who sells a loan to Fannie Mae, Freddie Mac, or Ginnae Mae will be using the below to determine contingent liabilities: (copy & paste FNMA guide)

Co-Signed Loans
When a borrower co-signs for a loan to enable another party (the primary obligor) to obtain
credit—but is not the party who is actually repaying the debt—the borrower has a contingent
liability.
The liability does not need to be considered as part of the borrower’s recurring monthly debt
obligations if the lender can verify a history of documented payments on the co-signed debt by
the primary obligor and ascertain that there is not a history of delinquent payments for that debt
(since this could be an indication that the co-signer might have to assume the obligation at some
point in the future).
Generally, the primary obligor should have been making payments on the debt for at least 12
months (although shorter payment histories may be considered on a case-by-case basis).
The liability does need to be considered as part of the borrower’s recurring monthly debt
obligations if:
• payment by the primary obligor cannot be sufficiently documented,
• a sufficient payment history has not been established for the debt, or
• the primary obligor has a history of being delinquent in making payments on the debt.

Nik, LOL, didn't mean to imply you were a dummy, just a thought about getting into the moment. I think you've covered it well then and you're on top of it. Good luck. :)

Albert, my comments were to slightly making a correction, I did not say you were wrong, but more about being incomplete.

The guideline you posted says "may" it does not say "shall" it says "may not", it doesn't say "will not" or "can not".

There is no guideline in secondary market financing that can not be made more stringent by the lender or a mortgage banker. That was the issue, telling people a lender will or will not might be saved for matters where a violation of law is involved instead of an underwriting matter. I'm sure you're a good originator, the underwriting side in compensating factors, is another matter as there is no rule that keeps a lender from adopting a more prudent position. It could mean that a more stringent lender will miss making some loans, it may also mean they have a lower default rate, higher quality of business and fewer denials if the need underwriting approval as most originators do. :)

A commercial guarantee is typically an unlimited guarantee. It is also a contingent liability as others have mentioned before me. With a cosignor, like on consumer type deals, party a and b are both liable for monthly payments and will both get collection calls, letters etc, in addition to the debt showing up on their personal credit report. For a commercial guarantee it is different. Party A is the one that deals with the bank, signs most paperwork including your own personal guarantee....party b, and c, d, e, however many there are, obviously signs his own. With this commercial debt, it is not on his personal credit report, but he will be required to disclose this on his financials and future loan applications. Because this is a contingent liability, party b, your dad, wont have a clue there is an issue until your loan has or is about to be transferred to the special assets department of your bank for loan work out....ie, they want their money back and you need to refi elsewhere or face foreclosure or some other forbearance type remedy. That is what i do. So, if you miss a payment, need to turn in financials, your dad will have no idea. When we call the note, that's when your dad gets involved. Most commercial guarantees are unlimited although there can be limits on them...say $250,000 per party. Either way, we go after the easiest, quickest source of repayment first. We don't care who really owes what or what personal arrangements you have or anything else. All that matters is there is some number of parties that signed a personal guarantee and the bank has recourse against all of them. Now, my advice to anyone and everyone is pretty much common sense. This is a business deal, not a personal favor. If you are not going to potentially earn something from this deal, DO NOT sign a personal guarantee. Smart banks will not even accept one because they can and have been thrown out. Why??? Consideration. What consideration does party b get for signing the personal guarantee and taking the risk of having to bail out party A if he was not ever going to gain anything from it. A commercial guarantee is a contract. In order to be legally binding, what is one of the required ingredients in a contract? Consideration. No consideration, no enforceable contract. Now...not saying a bank will force that issue....just the smart ones with decent counsel advising them. At the end of the day, it will be the defendants attorney pushing the issue, not the bank. When it comes to commercial deals, cash is king. If you pull out too much capital, then you will run into issues. It does not matter if that is to pay yourself a reasonable salary of $30,000 to manage the business. No matter how good your other numbers look, low cash reserves is a huge red flag for banks. Come review time, ratios a little low, delinquency up, appraisal a little low but tons of cash on hand, no or minimal worries. You need plenty of reserves and to keep them available for the bank to see on your BUSINESS balance sheet. The bank might even require you keep them on deposit with them. I don't have time to go into it, but there is something in the loan and guarantee agreement called the Right to Offset. Google it. Finally....there is cross collateralization. That means if you go to your dad's bank, or have multiple deals with your bank, all collateral for all the loans will serve as collateral for all of your loans. I know that may not make sense or sound too logical so here is an example. You and however many guarantors are tied to your loans have 3 separate deals at this bank. Lets say you pay off the loans for deals 1 and 2 but loan 3 is in trouble....maybe current but just hit with low appraisal, or there are other covenant busts. Guess what....they won't release your collateral from deal 1 and 2 until deal 3 gets fixed to their satisfaction. Anyway, i have rambled on long enough. I am a commercial banker that does loan work out. That is why i am very careful when it comes to commercial loans. The last thing i ever want is to have some version of me call me up and introduce themself as my new banker because my loan was downgraded and i have been deemed an exit credit.