Financing Multi-Family Buildings
Financing is vital in real estate transactions. Be it a 10-unit building or 1,000-unit portfolio, investors want positive financial leverage. In parallel to this, lenders (including CMHC) are eager to finance acquisitions, but only on their own terms. While the purchaser would like to put no money down, few lenders will accept this. Finding a middle ground between these two perspectives is what informs what percentage down payment the buyer will need.
Too often, investors make mistakes when estimating the down payment needed for an acquisition. This is because the needed down payment is a moving target for every lender involving many variables. These include the cost of funds for the lender, what the asset’s stabilized net operating income is, whether there are any capital expenditures needed, and are the rents in place real or do they need to be normalized.
There are many financial tools available to analyze a prospective loan, but using an example can help illustrate the analytical process. This example assumes that the borrower is borrowing from a CMHC insured loan.
- 30 Unit Building
- Purchase Price: $5,000,000
- Gross Income in place: $300,000
- Real Net Operating Income (meaning stabilized net operating income with soft costs that may not be in the broker’s pro-forma such as vacancy and bad debt, property management fee, repairs and maintenance, etc.): $200,000.
- There are no major capital expenditures needed in the short term, (the property is in good shape)
- Cost of Funds for the lender: 2.0%
- Amortization: 25 years
- Interest Rate: 3.15%
- Debt Coverage Ratio (NOI / Debt Service): 1.3 (Being a Crown Corporation, CMHC has conservative lending metrics)
With these variables, what is the loan amount likely to be for this asset?
In this example, the total allowed debt service (interest & principle payment) would be $153,846 per year (1.3 DCR) or $12,820 per month. Given the rate and amortization, this restricts the maximum loan amount to $2,665,416. This loan may end up being a little less, depending on the CMHC fees that are added to the loan which can be 2.5% of the loan amount or even higher.
Thus, in this example where the purchase price is $5,000,000, the needed down payment would be the difference between the loan amount of $2,665,416 and the purchase price: $2,334,584. This equates to a 47% down payment being required.
This is only an initial analysis with a given set of inputs, however. If the property and the borrower qualify, the amortization can be increased to 30 years or more, and with that the loan amount could be greater: $2,990,982. This is a significant increase to the loan amount (12% more borrowed) and decreases the needed down payment to 40%. However, not all assets will qualify for a 30-year amortization and it is best to have this cleared with the lender prior to the offering process, to make sure that there will not be any mistakes or additional delays after an accepted offer.
Clearly the financing of multi-family assets is important and directly impacts the achievable price of an asset at point of sale and is worth careful discussion with your Real Estate and Mortgage Broker.