Welcome to the fourth article of 1 Vision Capital’s guide to buying an apartment building: Obtaining Financing! By this point, you’ve decided that this is the right investment move for you, have budgeted appropriately, and have done your due diligence. Now it’s time to work out the final loan.
We touched lightly on managing personal finances in step two, and this step will focus on securing enough capital to buy the building of your dreams.
Before we dig into the big three options for commercial financing, there are a few significant areas to consider before moving forward with your loan of choice:
- Lender-required reserves: Lenders will generally require you to maintain one or two common types of reserves to approve financing: interest reserves and cash reserves. These ensure that you meet operating expenses, insurance, taxes, and repairs. Required reserves may total as much as six months of payments, depending on the lender.
- Recourse vs. non-recourse loans: A recourse loan means that if you eventually default on payments, the lender can pursue other avenues beyond foreclosure. However, with a non-recourse loan, the lender can only go after the property. Non-recourse loans are preferable, but they’re difficult to obtain. They typically require steeper down payments and carry higher interest rates.
- Due diligence: Lenders look favorably at properties with good market potential, high occupancy rates, and long-term tenants. You’ve given yourself an advantage if you’ve done your due diligence upfront by evaluating income, expenses, vacancy rates, and the property’s condition.
- Don’t use your name: Your accountant and attorney will advise you whether a limited liability company (LLC) or corporation is a better choice. It’s best not to buy an apartment building in your name because of the complexities and risks inherent in apartment ownership.
Due to the size and price point of the purchased building, you’ll likely use commercial lending instead of residential lending. The three best commercial loan options for the 2023 market are government-backed apartment loans, portfolio loans, and short-term apartment loans. Each type depends on how well-qualified the buyer is in addition to the length of ownership.
Let’s look at each of the loans in more detail.
Government-Backed Apartment Loans
Government-backed apartment loans are best for prime borrowers who want a loan with a down payment and an affordable interest rate. They follow guidelines from one of three entities: the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Company (Freddie Mac), or the Federal Housing Administration (FHA). Their stricter regulations are the tradeoff for lower interest rates and easier down payment requirements—for instance, limits on the number of units that can be financed and income requirements for borrowers.
These multi-family real estate loans are mortgages guaranteed by a governmental agency, such as the Department of Housing and Urban Development (HUD) or the Federal Housing Administration (FHA). Government-backed loans are an essential financing tool for many apartment investors, but they may not be the best option for everyone. This leads us to our next choice.
Also known as bank balance sheet apartment loans, portfolio loans are held by the bank, fund, or financing company that issues the initial loan. They aren’t sold and scrutinized on the secondary market, which means they don’t have to adhere to the requirements of government-backed loans. While this sounds like an immediate boon, the government does not support portfolio loans, so this financing option runs the risk of higher interest rates and fees.
The good news is that portfolio loans can often be larger and have more flexible terms and qualification requirements than conventional loans. They’re generally easier to qualify for and are funded more quickly than government-backed loans. Lenders can opt to allow higher debt-to-income, loan-to-value, and loan size maximums. These loans are a good choice for owners who don’t live in the same community as the apartment building.
Short-Term Apartment Loans
Also known as multi-family bridge loans, short-term loans typically have terms of one to five years and can be obtained from private lenders. These loans are popular for apartment building owners looking to renovate, rehabilitate, or expand an existing apartment complex. One of its greatest advantages is the funding speed—loans are typically funded within ten days, allowing you to compete with all-cash offers on properties.
There are two types of short-term loans that are most commonly used:
- Hard Money Loans: Typically utilized by borrowers who can’t obtain permanent financing due to properties in disrepair or credit issues. Hard money loans are considered last-resort financing. While the minimum credit score is as low as 550, interest rates and fees are generally much higher.
- Commercial Bridge Loans: Bridge loans are provided to purchase a property with additional funds to help renovate apartment buildings. While they’re harder to qualify for, bridge loans generally have lower interest rates than hard money loans.
Due to the short terms of bridge loans, this financing option sees the most use in fix-and-flip investments. Investors must ensure their ability to repay the loan in full before the end of the term, as defaulting on payments could result in losing the property to foreclosure.
Another Step Toward Financial Freedom
Congratulations! You’ve taken another giant step in achieving financial freedom! Moving away from single-family rentals and partnering with a real estate syndication like 1 Vision Capital ensures that you’re working with experts in the field whom you can trust to make your money work for you. Visit our website for more information, or give us a call at (830) 326-9181.