Negative leverage is everywhere. Same $500K building, four ways to buy it

Negative leverage is everywhere. Same $500K building, four ways to buy it

Real Estate Agent · Louisville, KY · Member since 2017 · 1k+ posts · 1k+ votes

There's a 283-unit apartment complex on the water in Tiburon, California, across the bay from San Francisco. In 2020 the owners borrowed $210 million against it, interest-only, five years. Then rates went up, occupancy slid from about 92% to about 80%, and they signed new leases at lower rents to keep units full. The lender gave them an extension last November. Last month the loan went delinquent anyway, and now they're talking about extending it another six months.

Down in Los Angeles, a 64-story, 785-unit tower that opened in 2023 had its $360 million loan default, and the owner handed the lender the keys. Downtown LA added more than 10,000 apartments in five years.

Wall Street calls it extend and pretend. The lender doesn't want the loss, the owner doesn't want to give up the building, so everybody signs an extension and hopes rates come down.

The national picture in plain English

A lot of apartment loans get bundled and sold to bond investors as commercial mortgage-backed securities (CMBS). In October, 8.09% of the apartment loans in those bonds were at least 30 days late. In 2024 that number was under 2%. To be fair, after 2008 it got to about 17%, so we're at about half of that. And it's concentrated: agency-backed apartment loans were only about 0.80% late in August. This is mostly big buildings, heavy borrowing, short-term or floating-rate loans bought when money was cheap.

The problem: nearly $300 billion of apartment loans come due in 2026, at borrowing rates roughly double 2021.

Why the math broke

A cap rate (capitalization rate) is a building's yearly income after expenses divided by its price. A building that nets $50,000 a year and sells for $1 million is a 5% cap.

In early 2022, the average apartment building traded around a 4.6% cap and the 10-year Treasury was about 1.8%. Borrow cheap, buy, make money on the gap. This August, apartment cap rates were about 5.4% and the 10-year was about 4.7%. It's around 5% now. Agency apartment loans were running about 6.25% to 7.25% in October.

When your loan costs more than the building earns, every dollar you borrow makes your return worse, not better. That's negative leverage. Smaller buildings, 5 to 50 units, averaged about a 6% cap in the second quarter. Here in Louisville, that's most of what trades.

Same building, four ways

Say a building is listed at $500,000 and nets $30,000 a year after taxes, insurance, repairs and everything else, before the mortgage. That's net operating income (NOI), and it's a 6% cap. Put 15% down every time, payments on a 30-year schedule:

  • Full price, bank loan at 7.25%: you lose about $399 a month

  • Full price, seller carries the loan at 5.5%: you make about $87 a month

  • 90% of asking, bank loan at 7.25%: you lose about $109 a month

  • 90% of asking, seller carries at 5.5%: you make about $328 a month

Same building. A $727 a month swing, about $8,700 a year, just from asking for two things instead of one. That's negative leverage flipping to positive.

Why a seller might say yes

A lot of small building owners here have held 15, 20, 30 years and owe little or nothing. They don't need a lump of cash. They need the building sold, a steady check, and a smaller tax bill. With seller financing they collect interest, and getting paid over time can usually spread out their capital gains (an installment sale). Their CPA will know it. I'm a Realtor, not a CPA, so they should run it with theirs.

A seller-financed offer can even come in at a higher price than your cash offer. Price and terms are two different levers. When a bank loan doesn't pencil, terms are how the numbers work for both sides.

For anyone getting seller financing accepted on small multifamily right now: what rate and term are sellers actually agreeing to? And do you lead with terms in the first offer, or bring it up after they turn down your cash number?

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  • James JonesPro Member
    Investor · Collierville, TN 38017 · Member since 2017 · 1k+ posts · 713 votes
    2d

    Rob, this is the same math I run on every single-family deal in Memphis, just on a smaller scale. If the loan costs more than the property earns, the deal does not work, no matter how good the building looks.

    I buy under $100K, ARV $180K-$265K, and I need Section 8 rent of $1,395-$1,950 for a 3BR+. I use the 1% rule first, then DSCR at 70-80% LTV on about a 30-year amortization. The rent has to cover the payment, taxes, and insurance with room left over. If it does not, I walk, even if the price is fair.

    Your point about price and terms being two levers is right. I do not chase seller financing on my deals, but I do the same thing with price: I would rather pay less for a house that rents strong than pay full price for one that barely covers the loan. The monthly number is what decides it.

    • Real Estate Agent · Louisville, KY · Member since 2017 · 1k+ posts · 1k+ votes
      2d

      James, that's the right order of operations. Rent first, loan second, price last. If the monthly number doesn't work on day one, a fair price doesn't save it.

      Louisville is a little different from Memphis on the small multifamily side. A lot of our duplexes and fourplexes trade in older parts of town where taxes are reasonable but insurance and deferred maintenance can eat the margin fast. So I'd add one line to your check: get a real insurance quote and the age of the roof and HVAC before you trust the DSCR math.

      When a deal comes up short at 70-80% LTV, do you ever go back to the seller with a lower price tied to the rent, or is that usually a walk for you?

  • Mike GrudzienPro Member
    Lender · Eugene, OR · Member since 2019 · 2k+ posts · 1k+ votes
    2d

    Good advice.

  • Drew SygitBusiness Member
    Property Manager · Royal Oak, MI · Member since 2012 · 13k+ posts · 9k+ votes
    1d

    If interest rates keep rising, we'll see more SFR sellers being forced into seller-financing if they want to sell.

    • Real Estate Agent · Louisville, KY · Member since 2017 · 1k+ posts · 1k+ votes
      1d

      Drew, agreed, and I'd add that it doesn't even take higher rates. It just takes rates staying where they are long enough for sellers to stop waiting. A lot of owners who bought or refinanced cheap have been sitting tight hoping for a better market, and the ones who actually need to sell are figuring out that carrying the note is sometimes the only way to get their price.

      Here in Kentucky the cleanest version I see is a free-and-clear owner who'd rather take monthly income than a lump sum. If there's an existing loan, the due-on-sale clause and getting the paperwork right matter a lot more, so I'd want a real estate attorney looking at it before anyone signs.

      Are you seeing it mostly from free-and-clear owners in your market, or are people starting to try wraps on top of existing loans?

  • Chris ColtonPro Member
    Investor · San Antonio, TX · Member since 2026 · 124 posts · 50 votes
    1d

    Thank you Rob. This helped me see price and terms as two separate levers. I am still learning on small deals in San Antonio, and I now check rent first and work back from the monthly numbers before I talk with a seller. I appreciate you laying it out so plainly.

    • Real Estate Agent · Louisville, KY · Member since 2017 · 1k+ posts · 1k+ votes
      1d

      Chris, glad it helped. Checking rent first before you ever talk to a seller is the habit that saves people the most money, especially on small deals where one bad assumption eats the whole cash flow.

      One thing I'd add as you keep learning: once you know the monthly number the deal has to hit, you can go into the seller conversation with two different offers that both work for you. One is a lower price with a normal loan, the other is closer to their price with better terms. Sellers often care more about one than the other, and you won't know which until you ask.

      When you run the rent first, where are you getting your rent numbers in San Antonio, actual leases or listing sites?

  • James JonesPro Member
    Investor · Collierville, TN 38017 · Member since 2017 · 1k+ posts · 713 votes
    1d

    Rob, it's usually a walk — but I'll make one lower offer first, with the math attached. The rent sets the price, not the other way around. If a house needs $950 a month to clear the 1% rule on a $95,000 all-in and it's only renting at $800, I'll show the seller exactly that and offer what the numbers support. Most of the time they say no, and I move on — deal flow is the bottleneck, not any single house. I never put earnest money down, so walking costs me nothing but the time I spent running the numbers. Chasing a deal past what the rent supports is how you end up holding a property that doesn't cash flow.

    • Real Estate Agent · Louisville, KY · Member since 2017 · 1k+ posts · 1k+ votes
      1d

      James, the lower offer with the math attached is the part most people skip. A seller can argue with your opinion of the house, but it's harder to argue with the rent sheet. Even when they say no, a few of them call back after another month on the market, and now they already know how you got to your number.

      Treating deal flow as the bottleneck is the right mindset too. If you're attached to one house, you'll find a reason to stretch. If you've got ten more to look at, walking is easy.

      Out of the sellers who turn down that first lower offer, how often do any of them come back to you later?

  • Eugenia ChetverechenkoBusiness Member
    Accountant · Chicago, IL · Member since 2026 · 6 posts · 1 vote
    17h

    Rob, one more consideration from the seller's tax perspective: seller financing can spread out the gain, but not necessarily all of it. Any ordinary depreciation recapture is generally taxable in the year of sale, even if the seller receives almost no cash upfront. Definitely worth running the tax numbers before agreeing to terms, so the seller doesn't end up with an unexpected tax bill.

    • Real Estate Agent · Louisville, KY · Member since 2017 · 1k+ posts · 1k+ votes
      19m

      Good point, Eugenia, and one I should have put in the original post. Recapture is the piece that catches sellers off guard. Someone who has owned and depreciated a small multifamily for years can owe tax on that recapture in the year of sale, even if the note only hands them a small down payment.

      In practice that pushes the down payment up. If the seller needs enough cash at closing to cover that bill, the low-money-down version of seller financing doesn't work for them, and the buyer should plan on a bigger check than they hoped.

      That's why I ask sellers here in Louisville to get their CPA's numbers before we talk terms, not after. Do you usually see sellers set the down payment to at least cover the recapture, or handle it some other way?

  • Real Estate Agent · Chicago, IL · Member since 2017 · 2k+ posts · 2k+ votes
    8h

    Chicago that same building bought in 2020 now has rents 30 to 40% higher, so we really did not see this issue unless you way overleveraged betting on unrealistic ARV at refi. It seems very market specific. Agree though some buildings are hard to finance now but you just need to do updates to boost the rents, it's rare I see any of my type of clients at least wanting turnkey without raising rents to market to boost cashflow, etc.

    • Real Estate Agent · Louisville, KY · Member since 2017 · 1k+ posts · 1k+ votes
      14m

      Fair point, Henry, and it is market specific. Louisville rents went up over that stretch too, but insurance and property taxes went up with them, so a good chunk of the extra rent got eaten before it ever reached cash flow. That's where the squeeze shows up here.

      Agree on the value-add side. The small multifamily deals that pencil best in Louisville right now are the ones with rents clearly under market and some deferred updates, where the buyer can push income instead of waiting on rates. Turnkey at full market rent is the one that's hard to make work with today's financing.

      When your clients bring rents up to market after updates, are they doing it at renewal with the current tenants, or mostly as units turn over?

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