From the desk:Medium Multifamily (5-20 Units)

Why does the loan on a 7-unit look nothing like a house loan?

Turns and light rehab are what my small crew does, mostly for other people's rentals, and one of the brokers I work for sent me a 7-unit as a pocket listing before it goes up. 7 units, three 2BRs and four 1BRs, asking 610k, current rents total 5,900 a month.

I've owned my own house and that's it. I called the bank I use for the business and the guy said something like "five units and up is commercial, so we're underwriting the building." Then he said 25 year amortization on a 5 year term and I said I thought loans were 30 years and he said not these.

So what I don't get:

If they're underwriting the building, does my personal income matter at all? I have decent business income but it's lumpy.
What is a 5 year term with 25 year amortization actually asking me to do in year 5?
The broker keeps saying the value is "the NOI over the cap rate." I can do that arithmetic. What I can't do is tell whether his NOI is real.

I can fix anything in that building myself at cost, which is why I'm even looking. What I can't do is tell whether 610k is a number or a hope. Deadline is soft, he wants an answer in about two weeks before it lists.

Answer

3ehernandez74PO2BPRO5

Taking your three in order.

Your personal income still matters, it just isn't the main test. The lender's first question is whether the building's net operating income covers the debt payment with a cushion, usually expressed as debt service coverage. NOI is gross rent, minus a vacancy allowance, minus operating expenses. Taxes, insurance, utilities the owner pays, management, repairs, turnover. Debt payment is not an operating expense, it sits below NOI. Most commercial lenders also want personal guarantees and will look at your liquidity and net worth, so lumpy business income does come up. Get the actual coverage ratio and the guarantee requirement from your lender in writing before you spend a weekend on this.

The 5 year term with 25 year amortization means your payment is calculated as if you had 25 years to pay it off, but the loan comes due in 5. In year 5 you refinance, sell, or pay the remaining balance. That leftover balance is the balloon. The risk you're taking on is that in year 5 rates and lender appetite are whatever they are, and the building has to support a new loan on that day's terms.

On the NOI being real: don't accept a summary. Ask for two years of tax returns or a Schedule E for the property, 12 months of bank statements showing deposits, the current rent roll with lease start and end dates, and the tax and insurance bills. Then rebuild the NOI yourself. If the broker's expense number is under about 35 percent of gross on a small older building, either the seller is deferring something or he's left management and reserves out entirely.

5,900 a month is 70.8k gross. Whether 610k is defensible depends entirely on what's left after expenses, and right now nobody in this thread knows that number, including the broker.

8 replies

1priya_n21PO1C

Cobalt, the part I'd want answered first is who manages it. I've been chasing income without a second job for two years and every time I get to five-plus units somebody tells me management is no longer optional. If you're already swinging a hammer for other people all week, when exactly are you showing units?

2brandonlee36Passive

Anchor covered the loan. I'll add the one that got me: at seven units you own the systems, not just the units. One boiler, one roof, one water service. My eight-unit ate 14k in a single February when the boiler cracked, and no tenant cared that my "reserve" was theoretical.

Also, since you do turns for a living, be honest about your labor rate. You'll be tempted to underwrite repairs at your cost. Your lender won't, your appraiser won't, and the next buyer won't. Model it at market cost and treat your own labor as extra margin you might capture, so the deal doesn't depend on you personally being available in year three.

1luis_carrera Get yours

610k on 70.8k gross is 8.6x gross rent, which tells you nothing until the expenses land. Run it three ways: 35, 45 and 52 percent expense ratios. At 45 percent your NOI is about 39k, so a 6.4 cap at asking, and that's before you've argued about whether the rents are at market. Three columns takes ten minutes and it usually ends the conversation.

-1Rena Expert

The mechanism behind your banker's answer is that at five units the property is generally financed as commercial real estate, underwritten on the asset's cash flow, and valued by capitalizing income rather than by comparable sales. Both of those change how you work.

On valuation: value equals NOI divided by cap rate. That equation is why this tier has a value-add lever. If you raise NOI by 5,000 a year and the market prices similar buildings at a 7 cap, you've added roughly 71,000 of value, and you can do that with rent increases or with expense reductions. A single family rental valued off comparable sales gives you no such lever. That is the central appeal of the tier and also its main risk, since the same arithmetic works in reverse when NOI falls or cap rates move out.

On financing: the shorter term with longer amortization is standard in commercial lending, and it puts refinance timing risk on you. The size of that risk depends on one assumption, which is where NOI sits when the balloon comes due. If you underwrite flat rents and the loan comes due in a soft year, you may face a paydown to requalify.

Specific rates, coverage minimums, amortization schedules, guarantee terms and prepayment structures vary by lender and change over time. Get your quote in writing and read the prepayment and recourse language rather than relying on a phone summary.

The broader multifamily market absorbed a very large wave of new supply and national vacancy has been elevated near 8.5 percent, with forecasters expecting absorption to overtake deliveries and vacancy to compress into 2027. That backdrop matters for your rent growth assumption. It doesn't change the fact that your entry price has to work on today's in-place income.

1paulgrant17PassivePRO5

On the rent roll, ask for copies of the actual leases rather than the summary. My landlord friend found two month-to-months and a tenant whose "rent" included mowing. That stuff never shows up on the one-page rent roll and it's yours the day you close.

1kevin_lombardPG1BPRO5

Slightly basic question from someone reading over your shoulder: if the building is valued on income, and the seller has kept rents 200 under market for ten years, isn't the seller the one who lost the money? Or does the buyer end up paying for the upside anyway because brokers price it on what it could be?

0renee_dubois Get yours

Juniper, both happen. The seller loses the value while he holds it, and then the broker tries to sell you the fix. What I do is offer on in-place income and put the pro forma in the letter as the reason I'm interested, never as the basis for price.

Cobalt, one more from running six units: your insurance quote on a 7-unit commercial policy will not resemble your homeowners policy, and I've seen it come back 60 percent over what a seller was paying because his coverage was stale. Get a real quote from your own agent before you're under contract, not after. It hit my first deal by about 3,400 a year and that was 48k of value at the cap rate I bought at.