Lender's DSCR test is sizing my 14-unit loan below what I need

Question

Working a 14-unit at 1.62M asking. My underwriting lands NOI at about 96k after a 5 percent management fee and 300 per unit per year in reserves, so roughly a 5.9 going-in cap. Bank quoted 6.75 percent, 25-year amortization, 5-year fixed, 1.25x DSCR, 70 percent max LTV.

The LTV isn't the binding number. At 1.25x, the most they'll let me pay in debt service is 96,000/1.25 = 76,800 a year. Against a constant somewhere around 8.3 percent that's a loan of about 925k, which is 57 percent of price. So I'm being asked to put 700k into a deal where year one cash flow after debt is 19k, call it 2.7 percent on equity, while the unlevered yield is 5.9. Borrowing money makes my return worse.

I understand the theory that the supply wave is thinning and rents firm up, and that I can push NOI. But I'd be paying full price today for a return that only shows up if the thesis lands. How do people actually handle the equity gap here, and does anyone accept going-in negative leverage on purpose?

Rena Expert · Accepted Answer

Your constant is right, 6.75 on a 25-year schedule runs about 8.28 percent of the loan per year, so DSCR caps you near 925k and the 70 percent LTV never comes into play. That's normal right now. In most quotes the coverage test or the debt yield test binds first, and at 925k your debt yield is 10.4 percent, which is comfortable enough that the constraint really is coverage.

Going-in negative leverage is a bet on two numbers, and only one of them is under your control. You control NOI. If you can move 96k to 118k over three years, the loan sizes differently at refi and the equity looks reasonable. You don't control the exit cap. At 5.9 going in with a 5-year balloon, a 75 basis point cap widening at exit eats the entire NOI gain. Run the deal at a 6.75 exit and see whether you'd still sign.

On the gap itself, the usual routes are more equity, a seller second where the bank permits subordinate debt in writing (many won't), or an interest-only period that relaxes the constant for a couple of years. Interest-only at 6.75 gives you a constant of 6.75 instead of 8.28, which sizes closer to 1.14M at the same coverage. Lenders price that.

One thing to price before you commit the 700k: your quoted proceeds are gross. Tax and insurance escrows, an upfront replacement reserve deposit, and an appraisal that comes in under contract all reduce what actually funds. On a 14-unit that can be another 40k of cash at closing you haven't modeled. Get the escrow schedule and the reserve requirement in writing from the lender before you set your equity number.

ehernandez74 · Answer

The subordinate debt question is the one I'd chase first. Every bank I've talked to about the 5 to 20 band either flatly prohibits a second lien or allows it only if the seller note is fully subordinate, payable from cash flow after their debt service, and disclosed at application. Two of them said no on the phone and then said maybe once the loan committee saw a 10 percent debt yield. Worth asking your banker whether a seller carry at, say, 200k for five years at 6 percent interest-only would even be considered, because if it is, your 700k becomes 500k and the whole math changes shape.

karen_whitfield · Answer

Negative leverage is survivable if you don't need the money for a while. My concern with 2.7 percent cash on cash is that one insurance renewal moves it. Mine went up more than rents did.

Lender's DSCR test is sizing my 14-unit loan below what I need

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