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 · 740 votes
    5d

    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
      5d

      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
    5d

    Good advice.

  • Drew SygitBusiness Member
    Property Manager · Royal Oak, MI · Member since 2012 · 13k+ posts · 9k+ votes
    4d

    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
      4d

      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 · 146 posts · 63 votes
    4d

    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
      3d

      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?

    • Chris ColtonPro Member
      Investor · San Antonio, TX · Member since 2026 · 146 posts · 63 votes
      1d

      Rob, I start with the listing sites to see what places like it are asking nearby. Then I try to check that against what landlords and managers in the area are actually getting. A listing tells me the ask. An actual lease tells me the real number, so I treat the listing as a starting point until something real backs it up. That rent first habit is the one thing that keeps me from talking myself into a deal.

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

      Chris, that's how I do it too. The asking rent is a ceiling, not a number to underwrite.

      Here in Louisville the gap shows up most on older duplexes and small multifamily, where a lot of units are still leased under market because the owner never pushed renewals. So I want the current leases and the rent roll first, then I compare that to what similar units actually leased for, not what's sitting on the sites. How long a rental listing has been sitting tells you a lot too. If it's been up for weeks, that ask isn't the market.

      The other check I like is talking with a couple of local property managers. They know what's signing this month and will tell you when a number is a stretch.

      When in-place rents come in well under what you think the market will bear, how much of that upside do you let yourself pay for in the price?

    • Chris ColtonPro Member
      Investor · San Antonio, TX · Member since 2026 · 146 posts · 63 votes
      14h

      Rob, I try not to pay for it at all until I can see it. I underwrite on the rent that is actually in place, and I treat any upside as something I have to earn after I own it, not something I pay the seller for now. If the rent takes longer to get there, the deal still has to work on the rent I have today. That is how I keep from paying for a future I do not control yet.

    • Real Estate Agent · Louisville, KY · Member since 2017 · 1k+ posts · 1k+ votes
      7m

      That's the right order. Pay for what's there now, and earn whatever isn't.

      Where I see buyers here in Louisville get hurt is when the seller's pro forma rent becomes the asking price. A duplex with one unit well under market gets priced as if both units are already turned. Then the buyer is paying the seller for work the buyer still has to do, and carrying negative leverage the whole time they're doing it.

      The one place I'll bend a little is a unit that's under market because of a long-term tenant, not because of condition. That gap is usually easier to close than one that needs a rehab first. Even then, I want the deal to at least break even on today's rent at today's rate.

      When you underwrite in-place rent, do you take current rents as they are, or haircut them for tenants who look unlikely to renew?

  • James JonesPro Member
    Investor · Collierville, TN 38017 · Member since 2017 · 1k+ posts · 740 votes
    4d

    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
      3d

      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 · 19 posts · 3 votes
    3d

    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
      2d

      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?

    • Eugenia ChetverechenkoBusiness Member
      Accountant · Chicago, IL · Member since 2026 · 19 posts · 3 votes
      1d

      I think it really depends on the seller's situation. Not all depreciation is treated the same way for installment sale purposes, so the tax bill upfront might actually be smaller than they expect.

      I would typically look at the projected tax liability, how much cash the seller needs at closing and then work backward to structure the down payment.

      And you are absolutely right about getting the CPA involved before negotiating terms. It is much easier to structure the deal properly upfront than try to fix the tax consequences afterward.

    • Real Estate Agent · Louisville, KY · Member since 2017 · 1k+ posts · 1k+ votes
      23h

      That's a helpful distinction, Eugenia. The part that tends to hit right away is depreciation on the shorter-life pieces, like after a cost segregation study, while the straight-line part on the building itself can usually be spread over the note payments. So two sellers with the same building and the same price can face very different tax bills at closing.

      Working backward from the tax liability and the seller's cash needs is a cleaner way to set the down payment than picking a percentage first. Here in Kentucky I'd put state tax into that same math so nobody is surprised in April.

      From your side, how often do you see sellers who did a cost seg years ago and don't realize it changes the math on an installment sale?

    • Eugenia ChetverechenkoBusiness Member
      Accountant · Chicago, IL · Member since 2026 · 19 posts · 3 votes
      16h

      Rob, it's definitely something that can get overlooked, especially when the cost seg was done years ago or by a different preparer. Sellers often remember the upfront tax savings but don't necessarily think about what happens when they eventually sell.

      That's why I always want to see the full depreciation schedules before running the tax projections or discussing seller-financing terms. Otherwise, what looks like a great deal can come with a pretty unpleasant tax surprise.

  • Real Estate Agent · Chicago, IL · Member since 2017 · 2k+ posts · 2k+ votes
    3d

    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
      2d

      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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