Crunching Numbers: Various Financing Options & Debt Service

[Rick L.]

I'm transitioning from perusing small residential multifamily properties (2-4 units) and SFH's to larger 10+ unit properties. It's been easy to compare deals since the financing has been strictly conventional fixed rate mortgages. However, how do I compare a large multifamily deal, where financing is being offers as ARM or Balloons VS. the conventional fixed rate mortgage deals I have in the past???

How do I make sure I'm achieving similar investment returns with such different financing options? ARM/Balloon vs Fixed Rate Mortgages???

[Account Closed]

Originally posted by @Rick L.:

@Account Closed

Regardless of whether you use an ARM or balloon (extremely risky) to finance the investment, if the investment horizon is similar -- 20 years for instance as you mentioned, then you would (or can) estimate what you feel the average mortgage rate is going to be on the multifamily investment during that horizon. It isn't too different from you assuming or estimating what the rental income will be for multiple years.

With the ARM, after the initial rate adjust, you don't know if the new rate (if you choose not to refinance) is going to be more or less; or if the new rate will force you to either refinance or sell the investment (which may not be at too good a price).

You have a similar issue with the balloon payment mortgage too. You are also unaware what the new rate will be when/if you refinance (assuming there aren't any cashflow issues and that you can indeed refinance). You may also have to sell the investment before the 20 year horizon.

How valid your assumptions are would be very critical in determining the accuracy of the evaluation. The capital structure is still just debt financing but each financing (ARM or balloon) can drastically influence some very critical issues. The IRR is also a tool that could be useful in this regard.