How to Finance (Almost) Any Multifamily Property

Disclaimer

• This is not a solicitation or offer

• Nothing in this presentation is meant to be legal, Tax or financial advice

• Consult you lawyer for legal advice

• Consult Tax Advisor for Tax advice

• Consult your Financial Advisor for Financial advice

Agenda

• Who Owns Multifamily Properties

• What Drives Interest Rates

• Who Loans Money

• Anatomy of A Loan

• Types of Financing• Conventional

• “Creative”

Ownership of Multifamily Property

All

Properties

2-4 Unit

Properties

5-49 Unit

Properties

 

50+ Unit

Properties

Individual Investor 71% 83% 49% 7%

Limited Liability Partnership/General Partnership 5% 3% 8% 30%

Limited Liability Company 10% 5% 20% 37%

Real Estate Investment Trust (REIT) 1% 1% 1% 3%

Real Estate Corporation 1% 0% 4% 1%

Other Corporations 1% 0% 2% 4%

Nonprofit Organization/Housing Cooperative 2% 1% 5% 12%

Other 8% 7% 11% 5%

Total 100% 100% 100% 100%Source: NMHC tabulations of 2012 Rental Housing Finance Survey microdata, US Census Bureau.Updated 5/2015.

What Determines Interest Rates

• Interest- The price you pay for money• I will sell you a dollar for a dollar and ten cent• Discounting Mechanism for Inflation

• Interest rate is the measure of risk• Risk of Borrower repaying loan• Risk of Economy improving• Risk of Inflation

• Government Policy• Economic stimulation or cooling off• Need for Government to borrow (deficit

financing)

Who Loans Money

Primary Sources of Funds

• Credit Unions

• Savings and Loans

• Banks

• Portfolio--loans are funded by a bank or other institutionalized lender which does not securitize or sell their loans into capital markets.

• Terms may be more flexible than a securitized loan and it is typically serviced by the lender.

• Securitized loans are pooled and sold on the secondary market.

Mortgage Broker

• An intermediary who brings mortgage borrowers and mortgage lenders together.

• A mortgage broker collects an origination fee and/or a yield spread premium from the lender as compensation for its services.

Borrower Mortgage Broker

Lender # 1

Lender # N

.

.

.

.

.Loan Application

Private Lenders

• Your Rich Uncle

• High Net Worth Individuals

• Someone’s IRA

• Sellers

Borrower’s Liability

• Recourse Loan-A type of loan that allows a lender to seek financial damages if the borrower fails to pay the liability, and if the value of the underlying asset is not enough to cover it. A recourse loan allows the lender to go after the debtor's assets that were not used as loan collateral in case of default.

• Non-Recourse Loan-A type of loan that is secured by collateral, which is usually property. If the borrower defaults, the issuer can seize the collateral, but cannot seek out the borrower for any further compensation, even if the collateral does not cover the full value of the defaulted amount unless there is fraud involved

Some Important Metrics

Metrics

• The most important property metrics (Lenders look at) are:• Net operating income: The annual income, minus expenses that a property

generates from its operations

• Debt service coverage: Measure of NOI relative to debt payment obligations

• Loan-to-value (LTV) ratio: A measure of the loan amount relative to the value of the property

• Acquisition Cost= Down payment +Escrow Fees+ Loan Cost + Other Fees (appraisals, inspections, etc.)

NOI and Cash Flow for Dummies

• Net operating income: The annual income, minus expenses that a property generates from its operations

NOI = Income - Expenses

• Cash Flow: The cash flow (before tax) is the net result of gross income minus expenses and debt service.

Cash Flow = NOI – Debt Service

Cash Flow

Debt Service

Higher Debt Service = Lower Cash Flow

Debt Service Coverage Ratio

• The DSCR or debt service coverage ratio is the relationship of a property's annual net operating income (NOI) to its annual mortgage debt service (principal and interest payments).

DSCR= NOI/Annual Debt Service

NOI = $225,000ADS = $115,000

DSCR = $225,000/$115,000 = 1.9

Loan to Value (LTV)

• Loan-to-value (LTV) ratio: A measure of the loan amount relative to the value of the property

LTV=(Amount of Loan)/(Value of Property)

Property value = $735,000Amount of Loan = $588,000

LTV=$588,000/$735,000=80%

The Anatomy of a Conventional Loan

• Treatment of Income (Rental vs. earned)

• Entry Cost/Issues• Terms

• APR

• Interest Rate (Fixed vs. Adjustable)

• Fees

• Points

• Exit Cost/Issues• Balloon Payment

• Prepayment Penalties

• Underwriting

How do Lenders Reduce Their Risk

• FHA and other Government Guarantors

• Securitizing

• Higher Down Payments

• Shorter Payback periods

• Higher Debt Service Coverage Ratios

• Seasoned Income

• Longer Investment Experience

• Recourse Loans

Types of Financing

Example Property

• 8 Unit Building

• Asking Price -- $800,000

• Purchase Price -- $775,000

• NOI = $49,676

• Loan Fee = 2%

• Property is Repositioned at Year 2

All Cash: NOI = Cash Flow

• Cash Flow = NOI-Debt Service= $49,676-0= $49,676

Down Payment from Savings

• Obtain Commercial Loan with 35% Down (65% LTV)• 30 Year

• 5% Interest

• NOI = $49,676

• Debt Service = $32,471

• Cash Flow = $17,225

Cash Out Refinancing/(Home) Equity Line of Credit

• Borrow Money Against Existing Property for Down Payment

• Down Payment/Loan = $271,250

• 1st Loan Payment = $32,471

• 2nd Loan Payment = $17,474

• Cash Flow = NOI – Loans

• Cash Flow = $49,676- $32,471- $17,474 = -$249

Purchase Owner Occupied Multifamily Property

• My Current Rent $1500/Mo ($18,000/Yr)

• Goal: Purchase 3 Units, Live in 1 Rent out 2

• Purchase Price: $625,000

• 10% Down, FHA Loan

• Current NOI = $22,903

• Debt Service = $36,235

• Cash Flow = -$13,333

• Owner Unit = $10,800

• Effective Cash Flow = - $24,133

• Add in Prior Rent = $18,000

• Total Out of Pocket = $6,133

• Most Out of Pocket will be Recaptured through Tax Benefits

Year 1 Year 2 Year 3 Year 4 Year 5

Cash Flow ($24,133) ($15,913) ($14,980) ($14,018) ($13,028)

Add In Prior Rent $18,000 $18,000 $18,000 $18,000 $18,000

Total Out of Pocket ($6,133) $2,087 $3,020 $3,982 $4,972

Five Year Cash Flow Projection

1031 Exchange

• Allows gains from transfer of property to be tax deferred

• Must exchange a property for one of equal or greater value

• Property must be “like-kind”

Self-directed IRAs/401K

• IRA Owners can Set up a Self Directed IRA with a Custodian

• IRA Owner Directs Custodian how to invest contributions

• Other (IRA) Investors can invest in a given investment

• IRA Owner must follow strict rules

IRA Owner

Transfer IRA

Self Directed Custodian

Other (IRA) Owner

Stocks/Bonds Gold/Commodities Real Estate

Partners– My Brains, Your Money

• Each Partner brings Money, Expertise, or Time

• Debt vs. Equity Split

• Make sure agreements are documented

• Example A

• All Partners put up same amount of money and split proceeds equally

• Each partner provides a different amount of money and split proceeds proportionally

• Example B

• Some partners bring money others bring expertise (Property Management, Property Location/Analysis, etc.). Proceeds split proportionally

• One partner loans all money others bring expertise. Money lender takes lion’s share of proceeds

A general partner has responsibility for the actions of the business, can legally bind the business and is personally liable for all the business's debts and obligations.

A limited partner is a partner whose liability is limited to the extent of the partner's share of ownership. Limited partnersgenerally do not have any kind of management responsibility and are not responsible for its debt obligations.

Seller Financing

Master Lease/Lease Option/Sandwich Lease

• Lessee is Future Buyer

• Seller Leases Proper to Future Buyer

• Lessee agrees to purchase property at some future Data

Master Lease/Lease Option/Sandwich LeaseExample

• Comparable property worth $775,000

• This Property is mismanaged• Vacancy Rate Is 15%• Expenses are 45%• Gross Scheduled Income = $74,700• NOI is $34,922• Debt Service is $32,451

• Offer• Lease for NOI of $40,000• Option for $5,000• Purchase Price $700,000

• Allocate $50,00 for Repositioning• Make Repairs and Upgrades• Get Vacancy Rate to 5%• Get Expenses to 35%

• After repositioned value $1,084,960• NOI of $54,248• Cap Rate of 5%

• Property now Properly Managed• Vacancy Rate Is 5%• Expenses are 35%• Gross Scheduled Income =

$81,576

• Action• Exercise option for $700,000• Obtain Loan for $705,000• Cash Flow of $21,000

All Inclusive Trust Deed, Wrap around mortgage and Subject to

• Beware of Due on Sale Clause

• Beware of Seller Paying Mortgage

• How it Works• Seller remains on the Mortgage

• Creates a deed to show that buyer has equity ownership of property

• Buyer pays seller agreed upon monthly payments

• Seller pays mortgage from proceeds

Buyer Seller Lender

Hard Money Lender

• A hard-money lender provides short-term loans.

• Investors use hard-money lenders to acquire investment properties relatively quickly.

• Hard-money lenders do not use conventional standards to extend credit to borrowers.

• A borrower uses a hard-money loan as a temporary, short-term loan solution until he can acquire more conventional financing for the property.

Hard Money Similar to Master Lease

• Comparable property worth $775,000

• This Property is mismanaged• Vacancy Rate Is 15%• Expenses are 45%• Gross Scheduled Income = $74,700• NOI is $34,922• Debt Service is $32,451

• Offer• Purchase Property for $700,000• After Repair Value $1,084,960• Borrow 70% of ARV ($759,472) at 12%• Debt Service is $93,744

• Allocate $50,00 for Repositioning• Make Repairs and Upgrades• Get Vacancy Rate to 5%• Get Expenses to 35%

• After repair value $1,084,960• NOI of $54,248

• Cap Rate of 5%

• Action• Obtain Loan for $705,000

• Pay off Hard money Lenders

• Need to account for negative Cash Flow of $99,089

Year 1 Year 2 Year 3

NOI $34,922 $52,668 $54,248

Debt Service $93,744 $93,744 $45,420

Cash Flow -$58,822 -$41,076 $8,828

Crowdfunding and Syndication

In order for an individual to qualify as an accredited investor, he or she must accomplish at least one of the following:

1) earn an individual income of more than $200,000 per year, or a joint income of $300,000, in each of the last two years and expect to reasonably maintain the same level of income.

2) have a net worth exceeding $1 million, either individually or jointly with his or her spouse.

3) be a general partner, executive officer, director or a related combination thereof for the issuer of a security being offered.

• Funds are solicited from public• Investors must be accredited

investor

Crowdfunding Vs. Syndication

Crowdfunding

• Typically Short term financing

• Recourse Loans

• Borrower• Find Investment• Apply to Crowd for Financing

• Crowdfunding Group• Find Accredited Investor• Underwrite Loan• Lend Money

Syndication

• Can be Debt or Equity Financing

• Sponsor finds Accredited Investor and Arranges Financing

• Sponsor finds Investment

• Sponsor Manages the investment and distributes proceeds based on agreement with investors

• Top 10 Real Estate Crowdfunding Websites- http://www.crowdcrux.com/top-real-estate-crowdfunding-websites/

Five Year Performance Based on Financing Method

You Can Pay Me Now or You Can Pay Me Later