The Second Rule of Thumb and Financing

When a property sells, it shows a lender what someone is willing to pay for that type of property today! This resets the baseline on property values. When a bank looks at a property, they want to make sure that they are investing in something that is a good investment. As a result, there are several things that a bank looks at when they are determining if they want to lend on a property. It is very important to make sure that you don’t over offer on a property because you will find it very difficult to get financing.

The lender will look at how well the property can pay for itself. This is called the debt coverage ratio. If the property doesn’t have enough cash flow to cover the monthly payment and the estimated expenses, then the lender will not be inclined to lend on the property. If you can convince them to lend on the property, they are going to require a significant down payment. Most banks require a minimum of a 1.25 to 1.5 debt coverage ratio. This means that the property is going to have to produce enough income to cover the monthly payments plus an additional 25% or 50%. This additional income is usually a buffer for expenses and profit.

The lenders are also going to look at the purchase price. They are not going to lend you the money if you are paying more than appraised value. An appraiser is going to come in and look at the net operating income and apply the current CAP rate for the area. They will take condition and potential into consideration, but when it is all said and done, if the property doesn’t appraise for what you offered, you are not going to be able to get a bank or any investors on board at the price that you offered.

When you are evaluating a property, make sure that you really evaluate the numbers so that you can make an educated offer. You want to get the property at a price that allows you to make a profit. If you are going to do all the work to improve the property, you deserve to make the profit. As always, happy investing.