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

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

Assuming the mere fact that it’s a foreclosure makes it a poor investment candidate is far from accurate.  Apartment & multifamily projects go into foreclosure all of the time, and reasons and motivations of the concerned parties can create all sorts of situations and opportunities.  In examining the situations and motivations of those involved in an apartment or multifamily foreclosure, the smart investor can ferret out profitable properties.

The Mortgaged Owner Losing the Property

Though it can be the case, the assumption that the owner losing the property is in this situation due to poor cash flow or problems not economically correctable is not accurate in many cases.  Sometimes the owner has gotten into a situation with other less profitable or negative cash flow investments, and can no longer continue without bankruptcy.  The foreclosed property in this case may be cash flow positive, and a factor in their ability to hold out until the current crisis.

It could be that there has been an increase in vacancies due to property condition and poor management.  But, if the condition items or management issues can be corrected at reasonable cost, negotiations with the foreclosure lender can gain concessions that make this a profitable apartment or multifamily investment.

The Lender

Motivation here is obvious.  Lenders make money loaning money, not managing apartment & multifamily projects.  The lender wants this property off the books as quickly as possible.  Unlike a single family home that can just be boarded up and ignored, there could still be tenants and some cash flow, so management headaches are present as well.

The Foreclosure Investment Buyer

Again, no mysteries here.  The apartment & multifamily foreclosure property buyer is looking for a bargain purchase with excellent future cash flow.  The ability to accurately identify costs and mortgage requirements to reach that positive cash flow point is crucial.  But, outlining the issues and costs during the negotiations can result in price or financing concessions from the lender that will make the deal happen.

Apartment & multifamily foreclosure purchase opportunities are out there.  Don’t let misconceptions deter researching them.

Karen Hanover, CCIM Candidate
Apartment Education Institute, President