Navigating the Multifamily Purchase

So you have made a decision to purchase a Multifamily property. That's the easy part! Hopefully, you have read my previous Newsletter discussing the best circumstances in which to make your purchasing decision. Today, let's dive into qualifying for the loan and qualifying the property. Commercial Real Estate financing is based more on the performance of the property than on the borrower. That being said, lenders look for these key attributes in a borrower:

• Borrower experience - typically owing at least three CRE properties is optimal, however, concessions can be made with Mitigating Circumstances (see below for explanation)
• Credit Score - a decent FICO is 650, of course, the higher the better
• Credit Utilization - using no more than 30% of available credit is recommended
• Credit History - no recent lates (in the last 12 months) on mortgages, credit cards, autos, etc.
• Bankruptcy - must be three years since disharge
• Liquidity - plan on no less than 5% of the purchase price - this will cover the required reserves which is often 12 months of the monthly payment, although can be lower such as 3 to 6 months reserves
• Worth Mentioning - CRE Investors should own their primary residence. Lenders may not take you seriously unless you at least own your home

Mitigating Circumstances: This is a situation in which the borrower may not own other CRE properties, but has a high FICO - usually 720 or higher, liquidity of a million dollars or more, owns other real estate such as SFR rentals and/or is a CRE or Residential Realtor. Disclaimer: Every lender is different in what they consider Mitigating Circumstances.

Now that we've discussed qualifying the borrower, let's look at qualifying the property. The Debt Service Coverage Ratio (DSCR) is the most used benchmark for qualifying the Multifamily property. This analytical tool measures the debt of the property in relation to rents & expenses. Lenders consider the Net Operating Income (NOI) to determine the DSCR. Confused yet??!!?? Believe me, it's not as complicated as it sounds! Below are the formulas for the DSCR and NOI:

DSCR = NOI/debt service

NOI = Income - Expenses

Of course, to my point above, the actual analysis of the Multifamily is a bit more complicated. The reasons for this is due to consideration of other income and expenses associated with the MF. Other sources of income include parking fees, laundry facility income, storage units, bike storage, building WIFI, pet rent, late payment and NSF charges. Other expenses can include management fees. If the borrower is not experienced owing MF properties, the lender will require the borrower to hire a management company to manage the property. There will always be a vacancy factor calculated in as well: usually 5% that will come off the top of the property income. Other expenses to consider include insurance, property taxes, advertising, employee payroll, utilites and the like. The 50% rule should be applied when making your purchasing decision. This means that half of the gross income generated by the MF should be allocated toward the operating expenses when determining profitability. This will help you to not overestimate profit and underestimate expenses.

I highly recommend speaking with a Commercial Real Estate Realtor or CRE lender before making a buying decision. The DSCR of the MF is critical to obtaining financing.

In my next Newsletter I will be going over the different lending options for Multifamily properties. You don't want to miss this! Until next time: Happy CRE Investing!