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Residential Income Property and Mortgage

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Residential Income Property and Mortgage


mortgagephotoA mortgage is the pledging of a property to a lender as a security for a mortgage loan. While the mortgage in itself is not a debt, it is the lender’s security for a debt. In other words, the mortgage is a security instrument for the loan that the lender makes to the borrower. This security instrument is given to the lender for the repayment of the loan. Should the borrower fail to repay the loan, the lender has the right to take the property.

Getting a mortgage for a residential income property/apartment building is not like getting financing for a SFR (single family residence). Residential income properties (apartment buildings also known as multi-family properties), are properties occupied by tenants from all social groups who pay rent and in the process generate an income for their owners. These properties are categorized according to the number of units they have.

Buildings with up to four units can be purchased with conventional residential loans, and thus are not considered as being commercial properties. Buildings with five or more units, on the other hand, are considered commercial properties, thus requiring a commercial loan. As such, the loan on commercial properties (5 units or more) is based on the cash flow of the property and not on the investor’s personal credit score, as would be the case with a conventional loan. The banks will treat these properties as businesses and will analyze and evaluate them from their P&L (Profit/Loss) perspective when deciding what amount to lend, or whether to lend at all.

Each commercial financing is underwritten on a case-by-case basis and not all banks do commercial financing. In fact, there are lenders and mortgage brokers that specialize only in financing various asset class of commercial real estate, such as apartment buildings, office buildings, retail projects and industrial properties.

When an investor applies for mortgage financing, the application will be evaluated by the financial institution on its own merits. Regardless of the apartment building’s number of units, its rents, age, appearance, location, accessibility and value in relationship to the local market will be analyzed. In addition, apartments with special-use privileges or limitations will have their own considerations.

There are a few common criteria that every lender uses to determine whether to grant the loan. The most fundamental of these is the loan-to-value (LTV) ratio. The LTV is determined by dividing the loan amount by the purchase price. Each specific lender has their own requirements, which basically describes how much of a down payment the purchase will require. It can be helpful to find out the lender’s LTV requirements and use that to determine the loan amount one can expect on a property.
 
Commercial investment properties are viewed somewhat more conservatively than residential properties. They will require a larger down payment, 20% to 25% being the bare minimum. However, each commercial mortgage lender has their own lending guidelines, and some may require more than 25%, depending on the quality of both the buyer and the property. It also depends, to a degree, on their appetite for new loan origination at any particular time, and their assessment of the existing real estate market conditions.

All lenders will insist on a professional appraisal of any property, and some may demand the right to use their own appraisers (and charge the buyer for that). The lender won’t loan the buyer/investor more money than they think the property is worth. The lender will use the appraisal value to determine how much of a loan they will make. The buyer/investor must show the lender a sufficient cash flow indicating that the buyer/investor has the ability to service the debt to pay down the loan.
 
If the loan application is from a business less than three years old, the personal credit of the principals will be evaluated as well as that of the business itself. For tightly held companies there may be a longer period. For established corporations with a proven track record, their business performance and credit ratings will be evaluated.
 
The lender will want specific information about the property, and the buyer/investor should acquire as much information as possible to determine if it is a good investment. The acquirers of the property should begin by getting at least two years accounting statements of operating expenses, and the rent rolls, as well as statements indicating rental deposits held, active leases and other pertinent information. This information should be readily available prior to making loan application.
 
One important issue to remember in acquiring residential income properties  (apartment buildings) is for the accounting of tenant agreements and deposits. The seller should be asked to provide building’s estoppel certificates. These are tenant statements specifying the rent they pay and the amount of deposit and/or last months’ rent they paid when they moved in. Tenant deposits are normally transferred to the new owner, and there is usually a place on the sales contract for a rental property to specify these. The buyer/investor must also look at the vacancy rate, net operating income (NOI), and perform a property analysis before submitting the purchase offer.

Residential income properties are considered to be one of the least risky types of commercial investment. Therefore many lenders are inclined to accept DCR ratios lower than they would for other forms of commercial financing. Be sure to determine the lender’s DCR policy for your type of building before you spend the money on an application or appraiser. Ask them if they can give you a preliminary review of the property you are thinking to purchase.
 
One source of hard money for down payments and operating costs is home equity. If you have enough equity in your home, you might be able to tap into this equity. Speak to a mortgage professional about home equity or refinancing loans to help get you started. Commercial lenders will sometimes allow a greater than 80% Loan-to-Value (LTV) ratio for a property. One of the methods they use to do this is called cross collateralization, basically using the equity in other properties to help finance the purchase of commercial property.

For more information call Sami at 310.432.6513

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