Financing a Multi-Family

[Dj Samson]

Hello! This is a newbie question but couldn't find it asked anywhere else. I want to buy a multi-family building and plan on spending the next year saving up the down payment and learning more about analyzing investments. I want to live in one of the units and rent out the rest. But I'm just starting my first "grown up" job. I spent the last few months since graduating college working for myself and part-time for a hotel with low wages. How long will I need to work for this company to establish a solid track record of income before I can apply for a conventional loan?

[Shane Pearlman]

Hey DJ,

This is a great question! There are some key details lacking, but I'll make some assumptions, and you can fill in with more questions.

Small Multi-Family

Loans are very different on 2-4 unit buildings Vs 5+ unit buildings. 

Smaller Multi-Family loans, which includes duplexes, triplexes and fourplexes, fall under the residential umbrella and are often the same banks and similar process to your traditional single family loan. What you need:

* Downpayment. The amount will depend on a wide variety of factors. Perhaps you can finagle some crazy FHA 3% down, but more likely, you will have to pay a minimum of 20%, often 25 - 30% down depending on location, loan amount and history. The owner occupancy will affect this quite a bit.

* Income History. How much and how long. Fundamentally they want 2 years of tax returns (and average the amt). I've seen people get away with less, but typically with higher earnings and a good story. The amount you earn matters. There is a debt to income ratio they will allow, after which you get cut off. I think 43% is the highest ratio they will allow someone to have. Want to get bigger loans, earn more!

* Rental Income. Initially you will need to show that you can carry the entire loan with you own earnings. Once you can show 2 years of tax returns with a schedule e (rental income), then they cut you a break and allow 75% of the property income to be added to the bottom line of your earnings in the debt to income ratio calculation. 

* Reserves. You can't spend ever penny, they won't let you. For these size loans, they want to see 6 months of expenses. You can use retirement accounts if you have them, but they won't give you the money unless you can point to those reserves somewhere.

Commercial Multi-Family

When you hit 5+ units, it isn't just about you anymore, the property has to pass muster on its own. So what does that mean?

*  Debt Service Ratio. The bank is looking at your apartment and thinking, if you newbie investor screw up and I have to take ownership of this asset, do I want it? The way they do this is to conservatively fill out their own property analysis and determine a ratio. There was a straightforward blog post om BP last year explaining it: http://www.biggerpockets.com/renewsblog/2013/09/09... . Banks like to see a 1.2 ratio or higher. Now this is all about choosing the right deal.

* Experience. The bigger the deal, the more you have to show that you are likely to succeed at a deal. The bank actually had me create an investor resume when applying for a 9plex a few months back. They wanted to see successful experience with similar sized deals, or a progressions that showed you were ready for the next step and this was the right match.

Timing and a thought.

You my friend have a great adventure ahead.

* Be Patient and Strategic. You need a couple good tax returns. That just takes time. That said, there are things you can do to help you once the time is right. Be careful of lowering income. One year I had to carefully time deductions from my business to increase my net income in order to qualify for a bigger home loan. 

* Get Experience. Find an opportunity to get hands on property management. Be a caretaker in an apartment. Take a small part time job at a PM company.

* Romance a Bank. That said, not all banks are filled with faceless paper pushers. You can begin a relationship with a local portfolio lender who might be willing to take a risk with the right property on a young man who has shown accountability.

* Find a Partner. Right now, you have time and energy. There are other people with money. Some people are good for loans. My third rental property was bought mostly with someone else's cash. I had a great deal in hand, experience managing / running a remodel, a team on the ground with a good track record, and I was willing to absorb some risk if things didn't pan out. They had cash earning negligible returns, no time and saw an opportunity but needed a active person to do all the work. Often you simply need to find out what problem they need solved and find a way to be of service.

Good luck and vote it this comment up if this helps. Happy to reply to any followups. Probably an overkill when the answer you really wanted was "2 years" but there you have it. =)