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Cash Flow Ratios in Apartment & Multifamily Investment

Posted by: Karen Hanover

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

Categories : Apartment Investing Articles, Featured

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Lenders’ Ratios for Apartment & Multifamily Mortgages

Posted by: Karen Hanover

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