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   ARTICLE   |   From Scotsman Guide Residential Edition   |   August 2014

Checking Out the Commercial Side

Expand your origination opportunities with multifamily loans

Solid rent growth and tight vacancies in many major rental markets mean that multifamily investments continue to be attractive to investors. For mortgage professionals who work primarily on the residential side of the market, multifamily lending can make a lucrative and interesting addition to their origination portfolios.

Interested mortgage professionals should consider sources for multifamily- lending opportunities from within their own networks and get started by learning how to analyze these types of deals. Consider the following as a guide on getting started in the multifamily- lending arena.

Generating leads

Start by contacting your existing referral sources, including your previous loan clients, and let them know that you can help them with multifamily transactions. Your current real estate agent, tax adviser and real estate attorney contacts may not know that you now can help their clients with these types of transactions. Ask if they work with clients who are interested in purchasing or currently hold multifamily-property investments.

Other excellent referral sources may include anyone in your network who works directly with multifamily investors. Property managers who work with numerous apartment-building owners can be a good source, as well. Likewise, consider reaching out to building contractors who help apartment owners maintain or rehabilitate income-producing properties.

Terms and calculations

Regardless of your approach to generating leads, it’s critical for you to establish your expertise and credibility to be successful in multifamily lending. To do this, you must understand the rationale for determining property value and supportable loan amounts. It’s also important to understand key terms, calculations and other factors that are used in analyzing multifamily-lending opportunities.

Start by looking at the property’s income to analyze a multifamily-property loan. A property’s net operating income (NOI) is the amount of income minus vacancy costs and annual expenses, before debt-service payments. In other words, follow this formula:

Rental income
(aka gross scheduled income)
— vacancy
— annual expenses
= net operating income

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As noted in the previous calculation, the property NOI is the key to unlocking most of the information relevant to originating a multifamily loan. A solid understanding of property expenses results in a more accurate determination of the NOI. Multifamily expenses, as estimated by appraisers, can range anywhere from 20 percent to 45 percent of the property income, depending on a large variety of factors, including the property’s age and quality, tax rates, and improvements.

Although expenses can vary, the safe bet for an initial assessment is to estimate that expenses will be 30 percent to 35 percent of the total property rental income. Note that appraisal- estimated expenses can be quite  different from the actual expenses that are incurred by the property owner. Consider some important variables that affect expenses.

  • Older properties generally have higher expenses because of potential deferred maintenance.
  • Actual expenses are generally higher than appraisals if the property has undergone capital improvements.
  • Certain expenses, including management expenses and reserves, are not paid by all property owners. Appraisals, however, must always account for these potential expenses.
  • Property tax is generally the largest expense item, but the actual tax expenses may be different from the appraisal estimates. For example, a property that was purchased 20 years ago may incur a much lower actual tax expense than today’s standards depending on the state and municipality where the property is located.

Debt-service-coverage ratio

After establishing the amount that the owner is netting from the property, you should decide the loan amount that the property can support. Keep in mind, however, that the lender does not want the property owner to use all of the net proceeds of the property income for payments on the loan. There has to be a cushion between the NOI and the debt payment. This cushion is commonly referred to as the debt-service-coverage ratio (DSCR).

In the multifamily-lending industry, the DSCR is also referred to as debt-service coverage (DSC) or debt-coverage ratio (DCR) — all of which are interchangeable terms with the same meaning. This ratio is used to reduce the NOI by a predetermined amount in order to calculate the debt that can be supported by the income from the property.

In general, the cushion that lenders require is somewhere between 15 percent and 25 percent of the net income generated from the property. Therefore, the DSCRs for multifamily properties can range anywhere from 1.15 to 1.25, with a typical DSCR of 1.2. Variations in DSCRs are generally based on specific lenders’ underwriting guidelines related to property condition, market conditions (e.g., excess inventory or high vacancy rates) or the financial strength of the borrower. In any case, a property’s NOI divided by its DSCR equals the available amount for loan payments.

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Cap rate

Valuation of multifamily properties is another fundamental necessity in determining a property’s financing opportunity. The primary method used by appraisers in arriving at multifamily-property values is the income approach. In this approach, the appraiser estimates a value by dividing the NOI by the capitalization rate (cap rate).

The cap rate is a measure of risk that shows the expected rate of return for an investment asset. Cap rates are estimated based on a number of variables such as property quality and location. They also are heavily influenced by general interest rates.

Higher cap rates result in lower property values and vice versa. Originators should know that the market is currently experiencing a low cap rate environment for multifamily assets in most parts of the United States. This is because of the historically low interest rate environment along with healthy occupancy levels for this particular asset class. The result of this low cap rate environment is high valuations for multifamily properties and significant lending opportunities for loan originators.

You can calculate a property’s value by dividing its NOI by the current cap rate. Multifamily lenders use the estimated property value as another tool to calculate loan amount. Typically, lenders will use a maximum of 75 percent loan-to-value (LTV) ratio and adjust downward based on a variety of underwriting considerations. For income-property analysis, the DSCR method is the primary method used to determine loan amount and the LTV method is a secondary check to ensure compliance with underwriting guidelines.


Becoming familiar with the aforementioned terms and calculations can go a long way in familiarizing residential mortgage professionals with the commercial side of the origination market. Beyond this, keep in mind the following steps that are generally required when working with a lender to obtain a multifamily loan:

  1. Send your preliminary package to the lender, including rent roll, operating history, tax returns, and the borrower’s loan application or financial statement.
  2. The lender issues a letter of interest (LOI) that includes the broker fee.
  3. The broker sends the following to the lender: borrower-signed LOI and the deposit check, completed lender forms, and supporting documentation.
  4. The lender orders a credit report.
  5. Escrow is opened, and the title report is ordered.
  6. The lender orders an appraisal.
  7. Additional reports are collected that may be required by the lender, including inspection report, seismic-evaluation report and environmental report.
  8. The file is submitted for final loan approval after all third-party reports are received.

After the loan is approved, the loan documents are sent to escrow. The loan documents are then executed by the borrower and sent back to the lender that wires the loan funds directly to escrow. Escrow distributes the proceeds accordingly, including the broker origination fee.

At this point, the multifamily-loan transaction will be complete — and you will have booked a new deal and expanded your service capabilities.  


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