The Potential In Commercial Multi-family Loans
For residential mortgage professionals, steady rent growth and demand for vacancies in major rental markets, are making multifamily investments attractive to potential investors. The benefits of Multi-family lending can be lucrative and an interesting addition to mortgage professionals’ origination portfolios. Here are guidelines for your interest in investing.
Always utilize network contacts starting with existing referral sources from previous loan clients, such as real estate agents, tax advisers and real estate attorney contacts, by communicating and publicizing to help them and their clients with multifamily transactions. Follow up by asking if they work with clients interested in purchasing or currently hold multifamily- property investments.
Other excellent referral sources include property managers who work with numerous apartment-building owners and building contractors who help apartment owners maintain or rehabilitate income-producing properties.
Terms and Calculations
To establish your expertise and credibility for multi-family lending it is crucial to learn and understand the rationale for determining property value, supportable loan amounts, key terms, calculations and other factors used in analyzing multifamily- lending opportunities.
Start by looking at the property’s income to analyze a multifamily-property loan. A property’s net operating income (NOI) is the amount of rental income minus vacancy costs and annual expenses, before debt-service payments. A property NOI is the key to finding all information relevant to originating a multi-family loan.
An understanding of property expenses results in a more accurate determination of the NOI.
Estimated by appraisers, multifamily expenses can range anywhere from 20% – 45% of the property income, including factors such as property’s age, quality, tax rates, and improvements.
An initial assessment is best to estimate expenses at 30- 35% of the total property rental income. Appraisal estimated expenses could differ from actual expenses incurred by the property.
Debt Service Coverage Ratio (DSVR)
After establishing the amount that the owner is netting from the property, decide the loan amount in which the property can support. It is imperative to not use all of the net proceeds of the property income for payments on the loan. In general, lenders leave a cushion, which is the amount between the NOI and the debt payment, commonly referred in multi-family lending industry, debt service coverage (DSC) or debt-coverage ratio (DCR).
This ratio is used to reduce the NOI by a predetermined amount in order to calculate the debt supported by the income property. DSCRs for multi-family properties can range anywhere from 1.15 – 1.25, with a typical DSCR of 1.2. A property’s NOI divided by its DSCR equals the available amount for loan payments.
The primary method used by appraisers to determine multifamily property values is the income approach where the appraiser divides the NOI by the capitalization rate (cap rate). The cap rate is a measure of risk that shows the expected rate of ROI asset. Cap rates are estimated based on a number of variables such as property quality and location, and are heavily influenced by general interest rates.
Higher cap rates result in lower property values and vice versa. The result of this low cap rate environment is high valuations for multi-family properties and significant lending opportunities for loan originators. To calculate a property’s value by dividing its NOI by the current cap rate, multifamily lenders use the estimated property value as another tool to calculate loan amount.
Lenders will typically use a maximum of 75% loan-to-value (LTV) ratio. Lenders then adjust downward based on a variety of underwriting considerations. For income- property analysis, the DSCR method is the primary method used to determine loan amount and the LTV method is a secondary check to ensure compliance with underwriting guidelines.