One of the reasons that apartment & multifamily investing is available to a great many real estate investors is that cash flow is the primary consideration in loaning money on a purchase.

It isn’t about the credit score of the buyer, and it’s less about the standard residential concept of “loan-to-value.” Though appraised value is important, cash flow is critical. There are two ways in which lenders look at the cash flow.

These ratios indicate the ability of the property to generate enough cash to pay the monthly mortgage, as well as leave a profit for ownership.

Cash Flow Analysis, Stability and Future Risk

First, it’s very important to get the income and expense numbers “right.” Are all of the rents at market rates? If some tenants have been given special deals, or just generally the rents are all below market, then income could be better if rents are increased at expiration of leases.

Expenses should be appropriate, reflecting efficient management, reasonable repair costs, good turnover rehab practices, and no “sweetheart deals.”

Any expense categories that are out of line should be addressed, or a plan put in place to deal with them after purchase. When approaching a lender for an apartment or multifamily mortgage, documentation of the ability to raise rents and/or cut expenses quickly could result in a better mortgage deal, as cash flows can be expected to improve.

The next consideration is the expected stability of rents and cash flow into the future. Lenders hate risk, so a marketing plan, budgets, and projections of future vacancy and credit losses is critical. Once the current and projected cash flow is determined, two common ratios can be applied to see how lenders will look at the property for a mortgage.

DSCR – Debt Service Coverage Ratio

This ratio takes the net income from operations, or cash flow, and compares it to the expected mortgage payment. Most lenders want to see a ratio of at least 1.25-to-1 of cash flow over the mortgage payment. In other words, if the mortgage payment is to be $8000/month, then cash flow should be at least $10,000/month to yield this 1.25 DSCR.

Break-even Ratio

Here, the lender takes the annual operating expenses, adds the annual debt payments, and divides the total by the Gross Operating Income (GOI). What they’re going is seeing at what point the income overtakes the expenses, or the break-even. If the annual expenses are $35,000, and the debt payments total $72,000/year, a GOI, gross operating income of $150,000 would look like this:

($35,000 + $72,000) / $150,000 = 0.71, or 71%, the Break-even Ratio

Generally, lenders want a Break-even ratio lower than 80%.

I’ll share more with you soon…

Warm Regards,

Karen Hanover, CCIM Candidate
Apartment Education Institute, President