I've noticed a lot of confusion and forum posts seeking guidance on 'commercial' mortgage financing for apartment complexes of 5+ unit up to 20-100+ units. Having supported several investor acquisitions of small balance multi family recently and originating mortgages for the better part of two decades here are some quick pointers and considerations for investors:
- Residential loans are considered multi family properties of 1-4 units. Anything greater than 5+ units is considered commercial and usually underwritten based on the occupancy and rental income.
- For greater than 5+ multi family properties the 'best' initial source for financing could be a local credit union or bank. Borrowers will want to be members, local and generally have a very strong credit profile.
- Most 5+ unit lenders will want the borrower to provide documentable real estate related investment experience. Likely at least 1-3 properties owned and operated within the last 3 years. The greater the number of units (and operating responsibility) the stronger experience could be required (and preferred.)
- Many residential lenders now offer 'business loans' or DSCR (debt service coverage ratio loans) from 5-8-10 units. Standard is 30%+/- down (70% LTV) provided that the income to expense ratio (rental income vs. PITI and operating expenses) is at least 1 to 1. This means the rental income is sufficient to support all obligations. If the income is insufficient, the borrower could be required to put more down to make the ratios work. Beyond 10+ units borrowers will want to connect with a reputable broker/lender with specific lending programs for high density complexes.
- Appraisals for 5+ units take more time and are more expensive. An example is a six plex we helped sell on the Oregon Coast. The appraisal took 2-3 weeks to perform and the cost was just under $5k. Some lenders (depending on the number of units) will even require two appraisals..paid whether the loan closes or not.
- Reserves. The greater the number of units, typically the more reserves lenders will want to validate. For 15-29 units one lender requires a net worth of greater than 50% of the loan amount the investor is seeking to borrow. Most have at least a six month PITI reserve requirement for the subject property and sometimes for all property owned that reflects on credit. Usually if the owned properties are held in an LLC they do not need to be factored into the qualifying ratios or required reserves.
- The majority of commercial loans are closed in an LLC. Borrowers will need to provide Articles of Incorporation and breakdown of ownership.
- Closing duration of multi plex mortgage loans is typically 45-60 days and more complex transactions can take up to 90. Be sure to provide ample due diligence for delivery and review of seller records and extended periods for appraisal (and review), title and underwriting.
- As with any RE transaction, it's best to consider the other parties perspective when determining feasibility. If you were a bank/lender and an investor wanted to borrow funds on a property with several moving parts (actions towards repayment) what would you want to see from the applicant? Cash. Credit. Collateral and experience.
Cash - Available capital for down payment and reserves for repayment. Demonstrated ability to save.
Credit - A good indicator of if a borrower is going to meet their obligations is whether they have done so in the past. The lower the score, the more down is likely to be required.
Collateral - The quality of the asset the loan is being secured by. Borrowers usually only put down a fraction of the purchase price, the lender is stuck with the property if either of the above criteria fail. The lower the condition of the property, the less leverage or likely they'll be willing to collateralize.
Experience - Maybe a low risk 5-6 units a rookie could handle but anything above that requires considerable time. The forums are filled with fun land lord and operational testimonies. Lenders usually require documented experience because they know borrowers need it. There could be workarounds by adding or creating an LLC that includes experiences RE investors but my general investor guidance is to crawl before you walk.
Beyond a local CU or bank the next best way to find a suitable location is probably a referral from your RE broker or listing broker. If the listing broker has done their due diligence they should have a source for lending that is familiar with property and able to lend to a qualified buyer. Out of courtesy and necessity to our investor clients we keep a handy investor focused lender cheat sheet categorized by mortgage specialities. Our policy prior to showing or exploring 5+ unit investments is to have a dedicated or strategic lending partner fully qualify buyers with a clear and concise overview anticipated costs and timelines.
For many newer investors once they're familiar with commercial requirements for 5+ multi family unit mortgages tend to refocus on more conventional residential transactions (1-4 units) with much lower borrower barriers to entry. Keep an eye out for 'loop holes' or alternative perspectives..for example a client recently approached us for financing a 16 Plex. After sending us the property details it turns out that the property was comprised of two tax lots, eight units on each. We were probably the third or fourth lender the investor spoke with but the first to identify an alternative lending solution. The proportion or ratio of lenders that provide accessible financing for 8 units compared to 16 units is probably 100 to 1.
The point is there are a lot more questions to ask & answer when financing more complex properties, and that goes for both borrowers and lenders.
Any fantastic commercial loan success stories?
