Moving From Residential Rentals to Commercial Multifamily
Five units changes everything about how a property is financed. Here is what is different and how to prepare for it.
The jump from a fourplex to a twelve-unit building is the largest single step in a real estate investor's career, and most of the difficulty is in the financing rather than the operations.
Five units is the line
One to four units is residential lending: appraisal by comparable sales, 30-year fixed terms, and a personal guaranty. Five or more units is commercial: valuation by net operating income and capitalization rate, shorter terms with balloons, and often an entity borrower.
How value is determined
Net operating income divided by the market cap rate. This is the most important concept in commercial real estate, because it means you can create value directly by raising rents or cutting expenses rather than waiting for the market. At a 6% cap rate, an extra $1,000 a month of NOI adds $200,000 of value.
Terms to expect
Debt service coverage requirements of 1.20 to 1.30, loan-to-value around 65% to 75%, five to ten year terms with 25 or 30 year amortization, and a balloon at maturity. Non-recourse is available on stronger assets and larger loans; smaller deals usually carry a guaranty.
Preparing your package
A current rent roll, trailing twelve months of income and expenses, your personal financial statement and schedule of real estate owned, and a one-page summary of the business plan. Arrive with those and you will be taken seriously, and we can put the deal in front of several lenders the same week.
Does this apply to your situation?
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