Newbie looking at a small apartment complex and the financing

[Drew Lied]

Hey everyone,

I'm evaluating a small apartment complex, over 4 units, less than 12 and was wondering about financing.

Is this going to be difficult for me to get without any other deals done?

What's the minimum down payment I would need to put down?

What interest rate should we reasonably account for?

Anything else we should be aware of?

Thanks everyone!

[Jan Kerr]

@Drew Lied Hi Drew,

Everyone here has given you excellent advice. I will add a few more things. Anything 1-4 units is considered residential as far as loans go. Anything 5 units and up is considered commercial, so as they said, you will need a commercial loan. 

Get as much informaiton as you can from the seller as part of your due diligence period. Not just the rent rolls, but copies of the tenant's leases and/or rental agreements. A big one, which is not always as easy to get, is the current owner's Sechedule "E" (Profit and Loss Statements from the owner's tax returns). I'd ask for all of them for as long as they've owned it or the past 5 years if they've had it a long time. They hate to give this up to you, but with an accepted contract, you are entitled to see all of their financial records for the proeprty. If it is not too late, put that stipulation into the contract. When they object that too much personal informaiton is in their tax returns, just say that you only need the document relating to this property and they can black out any personal information like a SS#, etc. They can give you a Proforma, but the Tax Returns are a more realisitc picture of the finances of the property. They will only be claiming actual rents and income to lower their taxes and they will be maximizing their deductions in order to reduce their taxes. Proformas often paint you a pretty picture of future imcome potential and minimize expenses of owning it.  

You want to look at all possible expenses; Vacancy rates of the property vs normal vacancy rates of the area by zip code (see www.bestplaces.net to gather that info). Other expenses to calculate in are Property Management, Property Taxes, Insurance, Owner paid utilities for commona areas and during vacancies, Repairs, Maintenance (different than repairs), and make sure to include some Cash Flow for yourself. Even if it is just $50 per unit. Factor it in. Using current income for the property, deducting all these expenses will tell you what your NOI (Net Operating Income), will be with just the current income generated by the property. That NOI must be enough to cover all debt service. That is your mortgage payment Principal & Interest. When your potential lenders see all of this informaiton along with your pictures of the proeprty and bids and estimate for any repairs or upgrades, they will be confident in your ability to manage it becasue you have presented them with such a thorough evaluation and breakdown of all costs and expenses including cash flow. If you plan to manage the property yourself, still include the cost of property management. This will show the lender that you are practical and are getting professional help to compensate for your personal lack of experience.

You could take it even further and get informaiotn about the age of all appliances and give a calculation of the reserves you will need to replace them when their normal life span has come to an end. Stoves, regrigerators, dishwashers, range hoods, HVAC Units, disposals, water heaters, etc. as well as the age and type of the roof and how many years are left on it. Then give the bank your plan for turning the property around if it needs it to fill any vacancies and make any upgrades. Work on the vacant units first to bring them up to your desired standards for maximum rent potential. 

You must honor all leases and rental agreements until they expire. Give the tenants 30 days notice of rental increases before the leases expire, and make necessary upgrades to show them the value added to justify the increases. As tenants move out, renovate each vacant unit up to your new standards and raise those rents up to current market rates if they are currently below that. Make sure to address the exterior of the property too in your upgrades. People will pay more rent to live in a place they are proud of. Curb appeal counts! 

Finally, make sure you are given credit at closing for any of the tenant's security deposits currently being held by the owner. That money belongs to the tenants, not to the owner. By law it must be refunded to the tenant within 30 days of them vacating the property minus any itemized deductions you take for exessive wear and tear or damage. Nail holes and such things are not considered damage, that is normal wear and tear. If the deposits are simply deducted from your final balance owed at closing, you will have to replace it with actual cash held in a separate account from your property expense account. That is the law. 

Sorry the post was so long, but I wanted you to know all of this. Good luck!