The Multi-Family Mortgage Underwriting Guidelines and Process

Today, obtaining financing for multi-family dwellings can be a challenging endeavor. It is not unheard of for a seller or principal to inflate the value of their property by understating expenses and vacancy rates or inflating rental income. In addition, property inspections can uncover a seemingly endless list of necessary or potential costly repairs. Even without any unscrupulous actions, lenders will work to turn over every stone and minimize their risk.

Leases can be determined inadequate, tenants undesirable, the property condition or location unacceptable, the borrower’s credit too weak, or the property NOI not verifiable. As you might suspect, there are a host of other reasons that can make loan terms undesirable or get an application denied.

That’s the bad news. The good news is that a well managed, under-leveraged apartment loan is a fairly straightforward transaction with plenty of interested bidders. Providing that the property’s income and expense ratio makes sense, the units are in at least average shape, and the borrower financially appears that they can handle a few bumps in the road; lenders are very receptive to multi-family. Also, HUD and Fannie/Freddie have some very aggressive loan products that should be considered.

Financial Analysis and Lending Ratios (for recourse loans)

Three ratios are used by most lenders:

• Debt Service Coverage Ratio (DSCR)
• Personal Debt Coverage Ratio (PDCR)
• Loan-To-Value Ratio (LTV)

Lenders spend most of their time processing loans by verification of the numbers (numerators and denominators) of these ratios. If the numbers are not verifiable or do not “add up” the loan application may hang in limbo or be rejected.

Debt Service Coverage Ratio

Debt Service Coverage Ratio=Net Operating Income/Debt Service

The Net Operating Income is determined by taking the total amount of the income from the property and deducting all operating expenses. These expenses include real estate taxes, insurance costs, maintenance, repairs and all other operating expenses. A mortgage payment is not included as an expense.

Debt Service is the monthly mortgage payment on the property. Most lenders require this to exceed 1:2. A Debt Service Coverage Ratio any less than 1.0 states that the net income from the property is not enough for the borrower to make the mortgage payments without taking money from any personal income or assets. This ratio weighs heavily in an underwriters decision making.

The Personal Debt Coverage Ratio

The second ratio for loan underwriting is the Personal Debt Coverage Ratio (PDCR). This ratio is a comparison of the borrower’s total monthly debt versus the borrower’s monthly income.

PDCR=Monthly Personal Debt/Monthly Personal Income

A lower number is desirable for a Personal Debt Coverage Ratio. For example, a personal debt ratio of 100% or more would usually mean the borrower is close to insolvency. In other words a Personal Debt Coverage Ratio of 100% or more would mean the borrower’s monthly obligations are equal to or greater than the borrower’s monthly income.

Personal debt coverage ratio is a consideration for loan underwriters. The PDCR is the borrower’s total monthly debt in contrast to their adjusted gross monthly income.

Lenders swing toward smaller PDCR’s when evaluating a loan request. A Centurion Bancorp loan officer will help you with the policies of the major multi-family lenders.

The Loan-To-Value Ratio

Multi-family investment property loan applications are more thoroughly scrutinized than residential loan requests. Lenders often will offer to loan only 60% to 75% of the value of a multi-family property. Loan to value is the percentage of the loan amount divided by the purchase price or value. The LTV guidelines vary based on the credit worthiness of the borrower, the property, tenant evaluation and income analysis.

Loan-To-Value= Total loan balances (1st + 2nd mortgages)/Fair Market Value (per appraisal or sales price, whichever is less)

In the event the appraisal valuation is lower than the purchase price, the lender will use the appraisal instead of the purchase price to determine the LTV.

Creditworthiness

Credit of the borrower will be evaluated. If a Corporation, LLC, or trust is making the purchase, the principals’ personal credit will be evaluated. Most lenders require a high credit score and a reasonable credit history for commercial or investment loans.

You will want to make sure your credit report is free of blemishes and erroneous information. Obtain a copy of your credit report and review this with your loan officer. If there are several principals involved, each one’s personal credit will be evaluated.

Property Analysis

Lenders will review and analyze Fair Market Value and Fair Market Rent. Any special use property, such as a mixed use project that incorporates retail tenants, will require additional underwriting.

The property age, structure, condition, parking, units per building, unit bedroom/bath count, location, and the common area grounds will all be considered and compared with similar properties to decide the risk, evaluate the value, and determine the LTV.

Amenities available on the property and conveniences located close to the property are reviewed. On site laundry facilities, swimming pools, and club houses can attract more tenants but can also increase liability risk to the owner. Insurance costs for the property owner are also a factor.

Rental income will be compared to other rental property and the market, including the residential housing market. When single family home values in the area are low and loans fairly easy to obtain the rental pool for desirable renters shrinks. When renters can buy a home for close to the same or less than rent, available quality tenants can be tougher to obtain.

Tenant Analysis

Lenders conduct a complete analysis of current tenants and leases. Long standing tenants with good payment track records will carry more favorable weight than newer tenants. So will tenants with longer lease agreements.

Leases will often be reviewed by the lender’s legal counsel for complete and legal terms and conditions. Leases with inadequate terms and conditions can create more risk for the borrower and subsequently the lender. Sometimes a lease won’t be considered in the rental analysis and therefore affects the property’s valuation.

Many underwriters conduct local public records searches for tenant litigation and property complaints. A property with more tenant litigation occurrences can fall into a higher risk category causing the lender to request a lower LTV, increased interest rate, or deny the loan.

The pool of renters available in the area will also be considered. Low income housing areas often bring higher risk tenants than more desirable locations.

Initiating Your Multi-Family Loan Process

At a minimum, you’ll need to present the following information in your commercial lending application.

Your Centurion Bancorp loan officer can assist you:

• Marketing package
• Copy of purchase/sale agreement
• YTD + two most recent year-end financial statements for property
• Background summary on tenants including rent roll and unit mix
• Borrower’s background summary or resume
• Last two years personal federal tax returns from the principal borrower(s)-including all schedules
• Current personal financial statement of principal borrower(s) including all real estate schedules (dated and signed with original signature)

Lending Institution Fees

Lenders have different fee schedules for multi-family loan applications and loan processing. These fees vary between lenders. Your loan officer can get you information on the schedule of fees for each institution. Also, there are additional closing costs for escrow, title, environmental, and so forth we can assist in calculating. Fees vary, however, leading institutions range as follows:

Loan Origination 0-2 points.

Attorney   $0-$5,000

Appraisal  $1,500-$3,000

*note: some lenders may charge higher fees

*** Disclaimer***  While we do our best to be accurate, we recommend that any information provided here is reviewed by an attorney or tax consultant.   Fees are generic and simply an estimate of transaction costs.