Most people don’t think twice about visiting the local or national bank for a loan when buying residential real estate. But larger investment properties such as apartment buildings fall into a different financing category.
Interest rates vary and approval criteria can be based on your credit score, experience level and the property itself.
1. Financing Options
As with any other type of commercial real estate, it’s important to consider the financing options available before investing in an apartment building. This step might seem obvious, but if you don’t fully understand the options and how they differ from residential mortgages, you can miss out on some of the benefits of owning multifamily property.
Most buyers of apartment buildings use a special form of commercial financing, known as a multifamily loan or apartment construction loan. These loans are specifically designed for income-producing properties and are subject to more rigorous underwriting requirements than traditional residential mortgages. Typically, borrowers need good credit (660+) and a large down payment to qualify for these loans.
These loan programs also tend to require a greater percentage of equity at closing, so you’ll need to have a significant amount of money saved or lined up before starting the search for your next apartment project. However, these are often some of the best apartment building loans around, providing you with a competitive interest rate and high leverage.
Another option is a CMBS loan, which provides non-recourse financing for multifamily property investors. These are backed by the assets of the lender, not the borrower, and typically offer better loan terms than traditional commercial financing. You can obtain these loans from many traditional banks, online lenders, and even life insurance companies.
2. Appraisal
When a borrower wants to purchase or refinance an apartment building, the lender will need to have the property appraised. This ensures that the loan amount is not more than the value of the apartment. The lender also uses the appraisal to protect itself in case the borrower fails to pay the mortgage and the lender has to foreclose on the property. The process is much like the residential financing of single family homes.
When appraising an apartment building, the appraiser looks at similar apartment buildings in the area to determine its value. This is known as the “value comparison” approach. However, this method can be difficult when evaluating new construction. New construction can have unique features that make it difficult to find comparable properties. In addition, the apartment building could be in a new location that isn’t yet developed and thus doesn’t have established values.
In this instance, the appraiser will need to look at the builder’s plans and budget to determine a projected value for the apartment. This is the best way to establish a market value. However, if a potential buyer is able to provide additional information or items that were not considered by the original appraiser that might affect the overall value of the apartment, then it may be possible to request a reconsideration of the appraisal.
3. Down Payment
There are many different types of apartment building loans available, including government-backed options and bank balance sheet loan programs. Lenders will consider a number of factors, including your credit score and financial history, your debt-to-income ratio, property cash flow, and your experience investing in and managing investment properties. Lenders will also look at the proposed purchase price of the property and its appraised value, as well as the minimum required down payment. Typical down payments range from 20% to 35% of the total purchase price or appraised value.
While government-backed apartment loans are highly regulated and can take the longest to fund, they tend to offer the lowest interest rates and fees. However, they require a high credit score and income to qualify for the maximum loan amount. Bank balance sheet apartment loans, on the other hand, don’t conform to government guidelines and may allow higher loan to value and debt to income maximums than government-backed loan programs.
Short-term apartment financing options like bridge loans and hard money loans are typically used for renovations, and they can be approved and funded in as little as 10 days. These are ideal for fix-and-flip investors who want to quickly compete with all-cash offers on investment properties. While they come with high interest rates and fees, these loan programs are often the quickest way to obtain an apartment building loan.
4. Closing Costs
Closing costs, or closing expenses, are a complicated amalgam of various fees and taxes that can be incurred at the closing table. They can vary by state and county, as well as be related to the lender and type of mortgage being negotiated. In addition, they can be influenced by the real estate professionals involved in the deal.
Homeowners Insurance: Lenders as well as condo and co-op boards require that you carry homeowner’s insurance. Depending on the size of the building and location, it can cost between $350 per year for a small one-bedroom property to up to $2,500 per year for a larger luxury two-bedroom apartment.
Flood Insurance: Also required for many properties, and based on the building’s location, can be quite expensive. Typically, the cost is not included in your mortgage.
Building Fees: Most condo and co-op buildings require a move-in fee, a transfer tax, a managing agent and co-op attorney fee and board application fees. All of these will add up.
Commercial financing is a different animal than residential 1-4 unit property financing. Lenders focus most on the experience of the borrower in multifamily property and the financials of the property. They may also look at the borrower’s metrics and credit history. There are many commercial mortgage loan options available for experienced investors. They include banks, agencies, HUD, CMBS and conduit lenders. A mezzanine loan can be layered over top of these to provide additional leverage for larger deals.