All key players from the borrower, the mortgage broker, the borrower’s attorney, the title company, to the bankers, the bank’s attorneys, the appraiser, engineer and environmental consultant need to be kept in forward motion because if any player drops the ball, the whole schedule can and will go awry. The most typical time frame to close a commercial mortgage is somewhere between 90 and 120 days.

Occasionally, an investment opportunity may present itself to an investor that must be acted upon very quickly. Our affiliated company, W Financial. is a direct private lender capable of closing on a transaction in as little as one week. Learn more about W Financial by visiting: W Financial

Many buyers assume that they can obtain financing for around 75% of the purchase price. The fact is that they can usually borrow about 75% of the property’s appraised value. Depending on a variety of factors, ranging from long-deferred maintenance to low rents being paid by rent-regulated tenants, there may be quite a disparity between the property’s purchase price and its appraised value. This can result in quite a surprise for a buyer who may need to provide considerably more equity than was initially expected. Today’s low interest rates are certainly helpful, but they will not necessarily result in higher loan amounts due to such valuation constraints.

It is common for a “gap” to exist between the premium price that a Manhattan brownstone or townhouse commands in the marketplace and its appraised value as seen “through a lender’s eyes”. Part of the explanation for the “gap” pertains to elements of ownership that will benefit an owner/occupant, but would be meaningless to an investor. While the lender will size up a property much like a serious real estate investor, concentrating on the property’s cash flow, an owner-occupant enjoys benefits such as living in the property as well as tax benefits which may justify paying a premium price.

A typical recent example involves an eight-unit, Upper West Side townhouse in contract for $4,450,000. 75% of the purchase price would be $3,337,500. However based on the actual income and expenses of the building a lender would barely be able to justify a $3,769,494 value (see chart on page 2). Even if the lender is willing to consider a blend of the sales price of the property and it’s value to an investor, the appraised value may still not exceed $4,059,747. 75% of $4,059,747 is only $3,044,810, which is $292,690 less than the mortgage amount the buyer was hoping for. Yet based on the above income and expense assumptions, ~$3,250,000 is a loan amount that would likely be comfortable for a number of lenders.

Vacancies in a prospective property present less of a problem as lenders are usually willing to attribute “market rents” to those units. Lenders generally assume that the building’s new owner will be able to fill the vacant units within a reasonable amount of time. Of course, the lender will also check public records (DHCR filings, etc.) to ensure that any vacant units are free of rent restrictions. The buyer cannot automatically presume that a vacant unit can be rented at “market value.” Over time, rents may be increased via vacancy and renovations above $2,000 and therefore become deregulated. If a unit that will be owner-occupied could be rented for, say $10,000 per month, lenders will typically include such market rents in their income calculations.

“Projected” rent rolls often make sweeping assumptions about what might happen in the future if all goes perfectly according to plan. A buyer may see huge upside potential in a given property, assuming that deals can eventually be struck with low rent-paying tenants, but a lender will be acutely aware of the risk that any rent-regulated tenant(s) may not leave.

Let’s take a very basic look at how a lender typically analyzes the cash flows in a multifamily rental property. For the sake of simplicity, let’s assume for this example that there are no stores or other commercial spaces:
Purchase Price: $4,450,000 | Proposed mortgage amount: $3,200,000 (73% of purchase price, 75% of value)

Start with the gross annual income: [$470,088]

1. Now subtract a 5% vacancy allowance from that number: [-$23,504 = $446,584]
2. Now take that result and subtract a 5% management allowance: [-$22,329 = $424,255]
3. Next subtract the actual current expenses (We’ll assume $85,000 for this example). Remember to include all other typical categories such as: RE taxes, water and sewer taxes, fuel, utilities, payroll, repairs and maintenance, legal & accounting, replacement reserves, and miscellaneous (each lender will have their own way of estimating these expenses based on their past experiences). For small buildings with 10 or fewer units, some lenders will plug in $300 or $400 per unit for management expenses rather than 5% of the income).
4. The resulting number is your net operating income (NOI). [$339,254]
5. Now plug in the annual interest and principal payments for your proposed mortgage amount with a realistic “ballpark” estimate for the interest rate and amortization schedule. As of 6/18/03, let’s assume a 4.75% rate amortizing on a 25-year schedule: [$226,478]
6. You should now be able to multiply your annual debt service by 1.25 and get a number equal to, or less than, the net income [$339,254]. If the property you are seeking to buy passes this test, then there are probably a number of lenders who will be interested in financing it for you. If your prospective purchase does not pass the test, reduce the loan amount until it does. This will give you a very realistic way to “screen” properties to see what you can comfortably afford to buy.
7. This example yields a debt service coverage ratio (DSCR) of 1.53, which is comfortably better than the minimum 1.25 coverage that most lenders would seek (Net Operating Income [NOI] = $339,254, divided by (annual debt service $222,346) = 1.53. Although the required DSCR varies according to property type and from lender to lender, it is a simple enough concept. It is essentially a “cushion” that assures the lender that even if some income is lost during the course of the loan term for some reason, the borrower will still have sufficient income to service the mortgage on the property.

Even when a building passes the DSCR test comfortably (as in this example), there are other parameters that lenders and appraisers use that may limit the loan amount, such as what capitalization rate is deemed appropriate, and whether the lender gives more weight to the income approach or to the sales approach.

There are plenty of variations on the theme of how different lenders evaluate, define valuations and establish loan amounts based on many details that are not readily apparent to the borrower. However, a conceptual understanding of how lenders approach underwriting a multifamily loan will be helpful if and when you or your client are exploring this market.

Currently, many borrowers are faced with a dilemma: Should they refinance now and pay a significant penalty, or should they wait until the penalty disappears, hope that rates are still attractive and refinance at that point in time? There is a very interesting solution to solve this dilemma. I am pleased to report that we are handling several transactions where we are locking in an interest rate now for a borrower where the closing will not occur until much later. In some cases, the closing can occur 10, 11 or even 12 months from the day that we initiate the process. This can allow a borrower to achieve the best of both worlds:

1. to lock in lowest possible interest rate now, and
2. to minimize the prepayment penalty on their current loan.

Any borrower with either a fixed or a yield maintenance prepayment penalty with 12 to 24 months remaining until maturity can benefit from this forward commitment and early rate lock program. Please give us a call if you would like to discuss in greater detail whether this program would be beneficial to you or your client.

For example, let’s assume a 15-year interest-only $1,000,000 mortgage at 7%. After the 5th year the borrower decides to refinance. The yield maintenance prepayment penalty would equal the difference between the current 7% rate and the yield that the bank would receive reinvesting the loan proceeds in a 10 year Treasury Note. (10 years being the remaining term of the loan).

To keep this example simple, let’s say that at the time of prepayment, the 10 year Treasury note is 5%. The borrower would be required to pay the lender the present value of the 2% difference for each year over the loan’s ten remaining years, or $200,000. This penalty will make the lender “whole” and insure that the lender will not experience an economic loss as a result of being paid prior to the loan’s maturity. This same formula applies to amortizing loans, however it is much easier to illustrate with an interest-only loan.

Each lender will have a slight variation to this formula, however the above example conveys the spirit of the yield maintenance penalty.

Anticipate the Obvious:

While no one can ever anticipate every possible contingency or problem that might arise during the financing process, it’s fairly simple to anticipate a number of routine occurrences and requirements, and to sweep as many of them out the way as early in the process as possible. Clearly, once you have accepted an offer from a lender and you’re waiting for the commitment to be issued, it’s usually a good idea to pull the trigger and order the title searches. Most real estate attorneys can order the title work from a company that they regularly use which is willing to assume the risk that if the deal does not close, there will be no fees for the searches.

Since title work is still one of the more primitive and time-consuming parts of the process, the earlier you start, the better. That way there will be plenty of time to deal with delays and to resolve pesky violations or other issues that may arise before the stress-laden pre-closing days arrive.

With regard to the survey, at the very least, make sure you’re aware of the new lender’s requirements. For example, if your new lender will require an ALTA survey, and the old survey was not prepared to those specifications, order it once you’ve accepted an offer rather than waiting for the commitment as the survey could easily take 4 – 6 weeks. Many surveyors are currently quite busy and not famous for quick turnaround, so by all means don’t leave this until the end.

Assignment of old mortgage – 1) God-given right, or 2) professional courtesy typically extended?:

” What do you mean, I’ll have to pay $154,000 in mortgage tax?!!!!”

No one wants to pay any more mortgage recording tax than absolutely necessary. Remember that if the property is in New York City, the borrower will have to pay mortgage recording tax for loans above $500,000 of $27,500 per million. Clearly you will want to minimize this tax by having your new lender take an assignment of the old mortgage. Let your new lender’s attorneys review, comment upon and approve the old mortgage and note early, rather than late, in the process. This is one more simple step that you and your attorney can take to minimize stress in the days leading up to your closing.

Don’t paint yourself into a corner:

With regard to the structure of the loan, at the outset, consider all the different ways your project may play out and plan appropriately. For example, if there is a chance that you will convert your newly acquired multifamily or mixed-use property to condominiums sometime down the road, you will want to be 100% sure that your lender will agree to having their loan repaid as units are sold (and as their collateral is whittled away). A long-term fixed rate might be a terrific play given today’s interest rates, but not if you might convert your new project to condominiums and may therefore need to prepay your mortgage incrementally.

Similarly, if there’s a good chance that you might sell the property within a few years of your closing, plan carefully about your prepayment penalty and/or your new lender’s willingness to permit a buyer to assume the mortgage.

To sum up: There are enough things that can go wrong and/or cause delays. In order to achieve a smooth closing, use any slack time to move as many of the obvious tasks from the “to do” column to the “completed” column sooner, rather than later. When crunch time comes just before the closing, you’ll want to be concentrating on any important loose ends in the mortgage documents, rather than being distracted by the trivia and “white noise” of routine tasks that should have been completed weeks earlier.