Strategic Decisions When Purchasing Multi Family Properties
The Purchase Decision: When considering the purchase of an apartment complex (or any income generating rental property), there are several critical features to consider.
1. “Attractive”:
a. general “curb appeal” (important to tenants and buyers)
b. overall security for tenants
c. income generating capacity that would support the asking price Why: Nelsonian Theory has it that “Before you buy, figure out how to get out of the property later”
Ask yourself this question: “If I were offering this property for sale today, will I get interested qualified buyers at this price?
2. “Strong pride of ownership”
a. Can it be made to reflect a “price of ownership” consistent with the level of rents that I target? Again: Think resale.
b. Long term tenants appreciate pride of occupancy, and will pay decent rent for a safe and clean place to call home.
3. “Well maintained property”
a. Did the prior owner do a good job in maintaining it?
b. If not, there will be a price penalty.
The Financing Decision: The lender will require certain information with the application. The most important information is the operating history of the property.
1. “Schedule E’s / Form 8824’s” and “Year-End Reports”:
a. The lender will require the last three years of the owner’s operating performance from filed tax returns, and manager’s Year-End Reports.
b. The lender and the lender’s appraiser will use this information to establish a baseline of rents and expenses.
c. The Target: a normalized Net Operating Income (“NOI”) which is the annual cash flow if owned free and clear of debt and before personal income tax considerations)
d. The lender’s allowed Debt Coverage Ratio (“DCR”) when divided into the normalized Net Operating Income (“NOI”) will define the lender’s opinion of the maximum annual principal and interest payment that the property can safely support.
i. Today’s DCR for apartment complexes: 1.25 to 1.30
ii. FYI: That has increased from 1.15 two years ago
e. The amount of annualized debt service (P&I) when divided by 12 will define the maximum allowed monthly debt service (P&I only) that the lender would permit for the property.
f. When the monthly maximum debt service is applied to the lender’s interest rate (6% to 7% today) and maximum allowed loan term (25 to 30 years today), this will define the maximum amount of loan that the lender will permit for the property.
g. There is no mystery involved. If you can define the normalized NOI and can obtain the Debt Coverage Ratio (DCR) that the lender will use, then you can determinate in advance the maximum available financing for the property. A good commercial – investment broker will do this prior to bringing a property onto the market.
SIDE-BAR COMMENTS AND STRATEGIC OPINIONS FROM “THE GURU”….
1. DCR-based Calculations can be misleading.
a. Recently I made such a calculation for a 72 unit apartment complex that I was marketing. Using current lender standards (1.30 DCR, 6% interest rate, and a 30 year term), the calculation inferred that the lender should be willing to make an 84% Loan to Value Ratio (“LVR” or “LTV”) loan. My observation: Fat Chance!!
b. Lenders still feel edgy about going past a 75% LVR, even when the “financial moon and stars” are in perfect alignment. However, do not abandon the information presented above.
2. Interest Rates change quickly. Never trust old information
a. There are several really good and dependable lenders that I look to for current and accurate information. I may be able to help.
b. There is nothing that will ruin your day more than tying up a really good property, then finding out that something has changed, and you have to sheepishly step politely out of the “Winner’s Circle”. Again, maybe I can help IF I AM BROUGHT INTO THE GAME EARLY ENOUGH TO BE ABLE TO MAKE A SUBSTANTIAL IMPACT.
3. Use FIXED RATE LONG TERM Financing.
a. I will try to remain “Politically Neutral” here (I am a registered “Independent” and have been since 1964), but in my opinion what the current administration is doing will lead to super inflation in the fairly near future.
i. Super inflation leads to super interest rates.
ii. You can’t just leave the printing press on at the Treasury without having someone notice…Gee, maybe there is a downside to “too much money”.
b. Absolutely avoid a variable rate loan.
i. You will become the custodian of the apartment complex for the lender as the variable rate loan indices start to climb.
ii. With a variable rate loan, the lender would have passed the inflation risk through to you.
3. Use the LONGEST AMORTIZATION TERM AVAILABLE.
a. This would require the lowest monthly PI payment.
i. You can always add more to the payment if cash flow is available
ii. But you can back off to the lowest required payment if cash flow turns negative for a period.
4. These are times that build wealth and character!
a. Be cautious, but keep moving forward!
i. Interest rate are MEGA-CHEAP
1. The last “Great Recession” (1980-86) first mortgage price was 21.5%!!
2. Today’s “Mother of Recessions” has first mortgage prime at around 6%.
3. We have never seen a recession where prices are “right” and money rates at “right” too.
a. But borrow with an interest rate that can not be adjusted for at least 5 years and preferrabley10 years. You can thank me later.
ii. Prices and investment yields are getting “more right” every day.
1. If you can borrow at 6% and invest at 8%, you are making money on money you don’t even have. WHAT A COUNTRY WE LIVE IN!!!
Contact me if you:
1. have questions about this information; or,
2. are looking to purchase or sell an apartment complex.
I know my “stuff” and can buffer you from certain dangers.
Bob Nelson, CCIM
The 1031 Guru
41 years of commercial – investment brokerage expertise
(541) 485-8100
bob@1031guru.com
www.1031guru.com
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