If you want to get the right financing, your move from single-family to invest in Multi-unit residential building will need a lot of planning and due diligence.
Property investors looking to expand their horizons and move to the next investment level often find that things have changed along the way. Case in point: financing and the differences existing between single-family or condo financing, as well as the amount of work and due diligence needed to obtain financing for Multi-unit residential building properties.
Banks and other lenders impose stricter conditions when it comes to Multi-unit residential building financing, as the focus moves from individual assets and relationships to a bigger commercial venture where revenue and income are the most important. With the greater due diligence expected by the lender comes added expense, more time devoted to the venture, and potential problems along the way.
So what can an investor do? Since financing requirements are stricter and more exacting in the Multi-unit residential building market, what are the best courses of action for those wanting to progress from single-family to Multi-unit residential building strategies?
“You’re dealing with bigger numbers and something that is considered a business,” because investors don’t have to live in any of the units they want to purchase, banks regard the investment differently.
Anything higher than a five-plex will be considered commercial.
While a single-family dwelling typically requires the customary 5% down payment and is approved by the Canada Mortgage and Housing Corporation (CMHC), a 15% down payment is required for commercial properties. And even with a bigger down payment, more hurdles await.
The first issue is determining and analyzing the “rent roll”. Then the status, maintenance, and repairs of the property have to be addressed. This is of key importance to lenders because they are concerned about the profitability and longevity of the building: they don’t want broken pipes or mold to compromise either.
In some cases, investors don’t even know what they are getting themselves into. They enter the arena of Multi-unit residential building investing with the same rules they abided by previously, only to discover that it is a different animal completely. The rules in the Multi-unit residential building market are applied more consistently and much more scalable.
Another financing pitfall for investors is that long-term costs are considerably higher (although amortization periods may also be spread out over an extended length of time).
Investors get caught up in the costs of long-term financing, they tend to do things conventionally (i.e. big down payment) when it is more cost-effective for them to use high-ratio mortgage insurance.
High-ratio mortgage insurance is typically purchased by the lender through the CMHC, Genworth, or Canada Guarantee, Canada’s three default insurers. The price of the premium is passed on to the buyer as a closing cost or financed through the mortgage.
The reason high-ratio insurance can be a preferable option, is that the insurance guidelines make it possible to do high-ratio mortgages at a lower cost. So while there may need to be a per-door application fee or insurance on the loan, providing that the investor has the ability to amortize, the effect of the cost of borrowing can be a lot lower.
If the buildings don’t meet the standards of conventional lenders, private lenders may help complete the transaction. Interest rates may be higher, but they can still be decent, and the property can still exhibit cash flow at the end of the transaction.
Certain factors will usually figure in all lenders’ security assurance. A full inspection report will often be required to get them to look at the property and consider the application. Most lenders will also want to see appraisals and environmental reports.
Even within these conditions, investors have to recognize the nuances and understand how they are different from residential property purchases. For example, the appraisal process for Multi-unit residential building involves comparing the property in question to others. Investors get frustrated because commercial property is typically evaluated based on income.
Investors interested in commercial property need to realize that lenders aren’t interested in theoretical cash flow: they are focused on current and historical cash flow.
So even before they reach the lending and finance stage, investors need to make sure that the property is “bankable”. To do this, they can review the details with a mortgage professional or expert who can provide them with a letter of intent or similar evidence of initial discovery.
Once again, the difference lies in the fact that the pre-approval on a commercial building is based on the property itself, while residential pre-approval is subject to the buyer.
Providing any (or all) of these documents in advance can help speed up the application process and put lenders at ease regarding the security of their investment.
Some lenders are wary of particular areas and will insist on documentation, especially the costly environmental reports.
Where should you go?
Ross says that there is not really one place to go for Multi-unit residential building financing. He advises the investor to go to the place that suits the property.
For example, if a buyer wants to invest in a property in a small town with limited economic growth and little industry, a specialized type of lender will be necessary. But if they are looking at a Triple-A commercial building in a large city, they could go anywhere for financing.
It is very important of putting together all financial statements and “resumes of properties” in advance. The lender treats it as a business and in the commercial world a buyer needs to have statements and personal worth statements.
If not, investors will find that lenders will pass in favor of a deal that comes with a more complete financial information package.
This statement and adds that the inclination for commercial lending is waning. Proper disclosure and presenting the deal in a way that appeals to the lender is therefore paramount.
The bottom line
Stock investors who sink $1 million of their own money into a company likely know a lot about that company beforehand. Anyone planning on buying a $1 million asset in the real estate field should join organizations (like Rockstar) that can help people facilitate such a venture or invest in their knowledge accumulation so that they are prepared.
He adds that it’s not just the financing. Investors need to address the considerations of the property for their personal situation as opposed to the property itself.
According Calum Ross (mortgage broker) states that in Multi-unit residential building investments the ‘Four C’s’ of credit apply, no matter what condition the property is in and/or how things turn out.
Character refers to the borrower’s financial history. It is normally determined by looking at the credit history, particularly the credit score (FICO score).
Capacity refers to a business’s ability to generate revenue in order to repay a loan. Since a new business (in this instance a real estate investor) has no track record showing profit, banks consider it risky.
Capital refers to the business’s capital assets, which might include machinery and equipment for a manufacturer, product inventory, or establishment fixtures. Banks consider capital but still hesitate because if your business goes under, they are left with depreciated assets that they need to sell at liquidation value. To a bank, cash is the best asset.
Collateral is the assets and cash an investor offers to obtain a loan. In addition to good credit, an established ability to make money, and business assets, banks often ask an owner to pledge personal assets as security.