48 units in decline: How much could the bank lend?

Question

Hi Everyone,

Long story short, I have a property that is on a downhill slump right now. Over the last 7 years the property owner has gone from have a property manager full-time, to part-time, to none at all. The owner's CPA convinced her to let him manage the property instead. You can see the rent has steadily decreased. This owner is checked out and the broker let us know the projected gross rents for this year will be $125k. Long story short, my partner and I believe there is huge potential in this property for an involved owner. Financials below.

Our question today is with 25%-30% down for the acquisition, how much do you all think a bank would loan for? I have a feeler out to a local bank but would love some outside opinions from the great people here as well!

Thanks for your help,

Ben

Don Konipol · Answer

@Ben Granja, the above advice that a bank will lend 80% of lower of appraised value or purchase price is incomplete.  That 80% figure is hard to obtain and usually reserved for borrower's with strong financial statements, experience in owning the type of property being purchased, and a solid A or B subject property.

A more realistic LTV would be 75% or lower, perhaps as low as 60%.  AND with an additional caveat: the PROVABLE cash flow from the property must service the debt with a cushion of at least 20 -25%, so a debt service coverage ratio of 1.2 - 1.25.

That being said, the 'gap' can, in some cases, be filled by seller carrying back a second lien.  So, if a lender is only willing to lend 60%, the bank may allow a seller second of 15%, reducing the buyers down payment to 25%.

Best to go into the deal with the expectation of putting up 25% down; 'Creative' financing is possible, especially on a turn around type acquisition, where the buyer may be adding value to the property through better management, renovation, tenant mix, etc.

One thing to watch out for is what I call 'the great lie' of apartment sales.  It goes like this, and is used in every distress sale "the rents are below market and can easily be raised".  In most cases the rents are NOT below market; they may be below market IF the property were in better condition, or run better.  But they are almost never below market for the present state of the property.  And, they can never EASILY be raised.  If they could EASILY be raised the current owner would have raised them.  Even in the case of true below market rents, the act of raising the rents will cause a loss of some tenants, which results in a loss of income and the expense of obtaining new tenants.  Some inexperienced property owners think that they won't lose tenants by raising rents if the current rate is below market because the tenants will discover that fact and decide to stay put.  In fact some will.  But others won't be able to afford the rent increase and will either have to find a cheaper and lower quality place, or stay and fall behind and have to be evicted; others will,leave because they are angered.  In any case, it may be profitable to raise the rents, but it's NEVER easy.

Michael Seeker · Answer

@Ben Granja - Depending on the bank, they'll most likely give you up to 80% of the lesser of the value of the property and the purchase price.  So it depends on what the property is worth and what the contracted sales price is.

If you've got a $1M property that you're buying for $500K, the bank will most likely only give you about $400K.  If you've got a $500K property that you're buying for $1M, again the bank will most likely only give you about $400K.  It all depends on the appraisal.