Jumping into commercial multifamily?

[Steven W.]

I am considering shifting my investment plans over to buy-and-hold commercial multifamily. I have some things that I'd like clarity on. I appreciate anyone who takes the time to read this (and especially respond). I've tried to be direct with my questions/assumptions and moved the fluff to the end.

Are these generally accurate statements?

When going for commercial loans I can expect to pay a point or more over a typical loan, and may need to have 30% down to get financing. It will also be unlikely to get a 30yr loan and instead I can expect a 15 or 20yr loan. The property details are more important than my details, so my credit score, income, and other assets are unlikely to impact loan terms for the better.

A commercial loan under or near 1M is considered a small commercial loan, and I may struggle to find a loan provider.

I've been reading that commercial multifamily between 5 to 10 units adds a lot of headache without really leveraging any economies of scale. Larger than that is when you really start seeing benefits with efficiencies.

The 1-2%/50% "rules" are still applicable to multifamily properties for quickly judging expenses before digging more. I should have the benefit of getting accurate expense and income data for any real property to validate cap rate and other information.

Property management costs are similar to what they are for a SFH (10%/mo + placement fee) until you get to a certain number of units where it then makes sense to hire an employee.

Insurance costs will be proportionally more than a SFH/4plex in the area would. e.g. If insurance was 5% for a SFH, it may be 15% for a commercial multifamily.

Some specific questions I have:

Will most lenders be hesitant/refuse to loan to me as a sole investor with no commercial history despite any starting capital I may have?

If 1M is too small to get a loan/favorable rates, what is typically the starting point for better rates?

Am I overlooking any major differences between SFH and commercial multifamily other than "everything costs more"?

Backstory:

Until recently, my research and action has been entirely in the residential space. I have SFH rentals that are working out well with a long term goal of 100 doors. My original plan to do that was by investing in 3 and 4-plex units while leveraging FHA loans. A new unit each year, until the rates were impacted to the point that other loan options were equivalent or I had enough cash flow snowballing to fund additional properties without a bank loan. I have enough income that saving the downpayments to do this annually would not be a problem, but...

I have since moved to Portland, and it is very difficult to find a cash flowing 3-4 plex. They are rare on the market, and their market price is pretty high when you can find them. This has caused me to look outside of the local area for residential multifamily properties. It then occurred to me that since I would not be getting a FHA loan, and I would need to deal with a remote purchase/management regardless of if it was a SFH, 4-plex, or 50 unit building that there is no reason to stick with my original framework.

It's looking more and more like commercial is the better path to my long term real estate goals. These forums have been invaluable as a tool, and I appreciate everyone's time.

Thanks!

[Benjamin Ficker]

Are these generally accurate statements?

When going for commercial loans I can expect to pay a point or more over a typical loan, and may need to have 30% down to get financing. It will also be unlikely to get a 30yr loan and instead I can expect a 15 or 20yr loan.

We run our pro-formas at 5.5% and a 25 year am. Most lenders we talk to want at least 30% down. The key is the Debt Coverage Ratio. Should be at least 1.2, we shoot for 1.25 on our numbers. With that said, we just had a client refinance a 5-unit instead of sell because he was able to get a 4.6% rate. 

The property details are more important than my details, so my credit score, income, and other assets are unlikely to impact loan terms for the better.

Yes, more important but your details are still vital to getting approved. Experience matters. 

A commercial loan under or near 1M is considered a small commercial loan, and I may struggle to find a loan provider.

Yes, but there are lenders out there. Maybe not a lot of decent commercial properties out there at that price, but they are out there. 

I've been reading that commercial multifamily between 5 to 10 units adds a lot of headache without really leveraging any economies of scale. Larger than that is when you really start seeing benefits with efficiencies.

I would say that about 5-7 unit properties. 8-10 definitely work better, but just not as good as a 20 unit.

The 1-2%/50% "rules" are still applicable to multifamily properties for quickly judging expenses before digging more. I should have the benefit of getting accurate expense and income data for any real property to validate cap rate and other information.

We don’t see many on market deals that hit the 1-2% rule. We run expenses at 35-45% of market rents for our pro-formas. I’ve sold deals where expenses were 70% of actual numbers. Raise your rents people. Has to go cash or private at that point. Value drops for sure. 

Property management costs are similar to what they are for a SFH (10%/mo + placement fee) until you get to a certain number of units where it then makes sense to hire an employee.

Yes.

Insurance costs will be proportionally more than a SFH/4plex in the area would. e.g. If insurance was 5% for a SFH, it may be 15% for a commercial multifamily.

That feels very high to me, though i don't have a recent deal in front of me at the moment. I'd focus on the overall expense ratio and DCR.

Some specific questions I have:

Will most lenders be hesitant/refuse to loan to me as a sole investor with no commercial history despite any starting capital I may have?

If you have rental experience, you’ll find a lender. 

If 1M is too small to get a loan/favorable rates, what is typically the starting point for better rates?

Your rate won’t significantly drop at higher price points. The deal I mentioned above was a 5 unit valued at $950k, refinanced at a 4.6% rate.

Am I overlooking any major differences between SFH and commercial multifamily other than "everything costs more"?

Haven’t heard you mention it, but keep in mind the major benefit of commercial multi-family is your ability to reposition. Much easier to do than with single family. A little rent increase and a little expense efficiency goes a long way towards overall value.

Also keep in mind SB 608 and how it will change financing coming up. Under market rents will severely limit your potential immediate upside.

Backstory:

...My original plan to do that was by investing in 3 and 4-plex units while leveraging FHA loans but...

Great plan.

...it is very difficult to find a cash flowing 3-4 plex...

Very difficult to find with actual numbers. Almost everyone who makes money in this market recognizes that it is a 2 step process to acquire and then raise rents to hit a return/cash flow. We shoot for a 5% cash on cash return on pro-forma number when we bring something to market. We end up with a quick sale and often multiple offers in this scenario.

This has caused me to look outside of the local area for residential multifamily properties. 

Even just the suburbs of Portland will get you drastically better cash on cash returns, though appreciation still makes the core desirable for some. 

It then occurred to me that since I would not be getting a FHA loan, and I would need to deal with a remote purchase/management regardless of if it was a SFH, 4-plex, or 50 unit building that there is no reason to stick with my original framework.

It's looking more and more like commercial is the better path to my long term real estate goals. 

1-4 Units for building equity, exchange in to 10+ units for cash flow. Of course there are equity place in larger properties, but this is a good general strategy.