How to Finance (Almost) Any Multifamily Property
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1 How to Finance (Almost) Any Multifamily Property
2 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
3 Agenda Who Owns Multifamily Properties What Drives Interest Rates Who Loans Money Anatomy of A Loan Types of Financing Conventional Creative
4 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.
5 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)
6 Who Loans Money
7 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.
8 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 Loan Application Mortgage Broker Lender # Lender # N
9 Private Lenders Your Rich Uncle High Net Worth Individuals Someone s IRA Sellers
10 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
11 Some Important Metrics
12 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.)
13 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 Higher Debt Service = Lower Cash Flow Debt Service
14 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 = $225,000 ADS = $115,000 DSCR = $225,000/$115,000 = 1.9
15 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 = $735,000 Amount of Loan = $588,000 LTV=$588,000/$735,000=80%
16 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
17 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
18 Types of Financing
19 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
20 All Cash: NOI = Cash Flow Cash Flow = NOI-Debt Service = $49,676-0= $49,676
21 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
22 Cash Out Refinancing/(Home) Equity Line of Credit Borrow Money Against Existing Property for Down Payment Down Payment/Loan = $271,250 1 st Loan Payment = $32,471 2 nd Loan Payment = $17,474 Cash Flow = NOI Loans Cash Flow = $49,676- $32,471- $17,474 = -$249
23 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 Five Year Cash Flow Projection 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
24 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
25 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
26 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 partners generally do not have any kind of management responsibility and are not responsible for its debt obligations.
27 Seller Financing
28 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
29 Master Lease/Lease Option/Sandwich Lease Example 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
30 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
31 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.
32 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% 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 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
33 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. Funds are solicited from public Investors must be accredited investor 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.
34 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-
35 Five Year Performance Based on Financing Method You Can Pay Me Now or You Can Pay Me Later
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