Getting started in multifamily requires cash and some math homework
Getting started in the multifamily-property market
- Lenders will want to see tenant-rolls and operating income on the rental property.
- Experience in multifamily management is a big plus in obtaining financing.
- Traditional banks generally offer the best loan terms.
- There are nonbank financing sources, but they're usually more expensive.
The U.S. multifamily-property market is big. It also is a market that attracts a lot of relatively small investors taking their first crack at commercial real estate.
The smallest multifamily loans, for two- to four-unit residences, can be financed with residential mortgages. The interest rate is higher if the owner doesn't live in one of the units, and the borrower's income and credit scores play a central role in lenders' funding decisions.
When you move up to five units or more — condominium communities, townhouse developments and apartment buildings large and small — the financing is through commercial mortgages. Credit scores play some role in funding decisions, but lenders will also look very closely at the property itself, especially its income potential.
There’s some homework required, if you have your eye on a multifamily property and need a loan to fund the deal. Here's some information to gather (mostly from the seller) before you meet with a potential lender:
- Three years of profit and loss statements on the property;
- An outline of the current rent structure for the property and a report of month-by-month rental income over the previous 12 months;
- A year-to-date operating-income statement;
- The current tenant roll;
- Current photos of the property;
- A copy of the purchase agreement.
That's for starters, to give lenders (and you) an idea of what the property is worth, based on the return on investment the property is likely to generate. You also will need to get a list of sales prices of similar properties in the area to complete the picture. If lenders are interested, you might later be asked to provide copies of leases, floor plans, maintenance records and any necessary environmental reports.
Although commercial loan decisions are based more on income potential than personal credit, you'll have to provide some level of personal financial statements and tax records, especially if you haven't done business with the lender before. Banks will give more weight to the personal financial information than will nonbank lenders.
You'll also need to document some ability to manage multifamily property. If you don't have direct experience, you might be able to convince the lender that you have transferable skills in bookkeeping, collections or business ownership, or pledge to hire professional management. Having direct experience yourself, however, is a major plus.
Lenders get some help in financing multifamily deals through loan- programs offered by Fannie Mae and Freddie Mac, the two government-sponsored enterprises (GSEs) that are well-known for their influence in the residential market. Fannie Mae will acquire and securitize multifamily loans with terms of five to 30 years and a maximum loan-to-value ratio of 80 percent.
With bank financing, you can get economical loans at interest rates similar to residential loans. Elsewhere, there are dozens of nonbank lenders who make multifamily one of their specialties, but you'll need to make a more substantial downpayment — typically 25 percent or more of the purchase price — pay higher fees and normally have to deal with a balloon payment that will force you to refinance in a few years.
In addition to the downpayment, a lender might also require you to have additional cash on hand — such as enough to cover six months of principal, interest, taxes and insurance payments on the property being acquired.