Archive for debt service coverage ratio
Why look at apartment & multifamily investment? The real estate investor buying multiple residential single family rental homes has a major goal of getting the best cash flow.
Appreciation and other financial benefits of ownership are desired as well, but cash flow is king. And, investors successfully operating a number of residential home rentals are generally enjoying great cash flow. What they should consider is raising their expectations and the return on their investments from apartment & multifamily properties.
Economy of scale – It’s easy to dismiss apartment & multifamily properties as being just another rental unit with the same income that a home would get for the same square footage. But, even if their rents are exactly the same, the apartment & multifamily properties owner will realize much better cash flow due to economy of scale in operations.
With a large number of units concentrated at one location, often under one roof, costs per unit drop dramatically. Maintenance, repairs, management, marketing and other expense items all will take less of the revenue per unit in an apartment & multifamily investment.
Mortgages are Not Difficult – Another incorrect assumption that keeps some investors away from apartment & multifamily investment is the large amount to purchase, and the large mortgage. They are accustomed to the residential mortgage process, verifying income, credit history and getting an individual loan for each property.
Even if the lender takes the cash flow into account, it’s a loan on one property, so any vacancy or credit loss will impact performance greatly. The economy of scale of apartment & multifamily investment jumps in here as well. A couple of vacancies or non-paying renters in a 100 unit complex aren’t nearly as damaging to cash flow.
For these reasons, lenders originate mortgages based mostly on cash flow, not the credit score or other income of the buyer. In determining whether they’ll make a loan and for how much, two ratios are used frequently.
DSCR – Debt Service Coverage Ratio: to arrive at this number, the expected mortgage payment is divided into the cash flow, using monthly numbers is best. So, if the mortgage payment is estimated to be $8,000/month, and income is $10,000/month, the DSCR would be 1.25, generally considered to be the bottom line for lenders.
Break-even: to get this number, the operating expenses are added to the mortgage payments or debt service for the year, and divided by the income for the year. So, $275,000 in expenses & debt service, and $350,000 in income would result in a break-even of about 79%.
Knowing how lenders look at apartment & multifamily investments and cash flow will help you to identify amazing potential in the market.
I’ll share more with you soon…
Fondly,
Karen Hanover, CCIM Candidate
Apartment Education Institute, President
Tagged with: apartment & multifamily , break-even , cash flow , debt service coverage ratio , dscr , investments , Karen Hanover , properties , ratios
Funding Apartment & Multifamily Investments
Posted by:It’s a shock to many new apartment & multifamily investors when they find out that it can be easier to get a large loan for the purchase of apartment & multifamily project than to get a jumbo home loan. There are sound financial reasons for this, with lenders searching for mortgage income streams that provide security from cash flow backed by property value. The components of funding decisions for apartment & multifamily investments include:
Property Value – As with a residential home loan, there is careful consideration of the condition and value of the property’s facilities and land occupied. This isn’t the major criteria in granting a mortgage, or in deciding how much to loan, but it is one of the factors.
Cash Flow & Cap Rate in Mortgage Decision – Apartment & multifamily mortgages are decided primarily on the cash flow, which is used to calculate a capitalization or cap rate, and this cap rate is compared to other properties for sale and recently sold in the area. If recent apartment sales have closed at an average cap rate of 9%, and the subject property is at 11%, the lender will be more likely to originate a mortgage on the property.
The cash flow, or net operating income component, is a major focus of the lender. Careful scrutiny of financial data will be done to verify rental income is accurate. Just as carefully analyzed will be operating expenses. Are they normal, better or worse than the typical apartment or multifamily project? Are they likely to change for better or worse under new ownership? Are local business and economy healthy, with any improvement or problems foreseen? Any softening of rental demand could cause a drop in average rents, cutting cash flow, and placing the mortgage into default. Higher vacancy rates due to a major employer leaving the area could do the same.
DSCR, Debt Service Recovery Ratio – This ratio is used by the lender to determine how much to loan. Many use 1.25 or thereabout for this number, and it indicates a multiplier of cash flow over the mortgage payment. $10,000 in monthly cash flow, with a monthly mortgage payment of $8000 would yield this 1.25 DSCR. Higher is better, lower might kill a deal.
But, the good news is that a profitable property, with a DSCR higher than 1.25, a strong and secure cash flow, and a cap rate higher than other comparable properties is a strong candidate for a great mortgage deal. It’s not credit score or job income, but property financial performance that seals the deal.
I’ll share more with you soon…
Warm Regards,
Karen Hanover, CCIM Candidate
Apartment Education Institute, President
Tagged with: apartment & multifamily , cap rates , capitalization rate(s) , cash flow , debt service coverage ratio , dscr , Funding , Karen Hanover , mortgage
