How to buy and finance apartment buildings

Apartment building loans are a lot like other residential real estate financing. It all starts with a property, borrower and lender, and it all ends, if all goes well, with a closed loan and newly purchased or refinanced property.

Here’s a guide to what borrowers need to know about how to buy and finance apartment buildings:

What constitutes an apartment building?

Detached homes, condominiums, duplexes, triplexes and fourplexes typically are classified as one-to-four-unit properties, or one-to-fours. Properties that have five or more dwellings are categorized as apartment buildings or multifamily housing.

A loan for a duplex, triplex or fourplex doesn’t differ much (if at all) from a loan for a detached house, but loans for larger properties involve “a little different underwriting, a little higher qualification,” says Dan Borland, office manager for commercial real estate at Wells Fargo in Orange County, California.

How to qualify

One difference is that before an apartment loan is approved the lender might consider more qualitative information to try to understand the borrower’s experience as a rental property owner or manager.

“We’ll look at the candidate and say, ‘What has that person owned and what has been their management experience collecting rent, managing properties and handling a project of that size?” Borland says.

The borrower’s credit score, income and personal and business tax returns will be considered along with two years’ operating statements and a current rent roll for the property.

The most important property metrics are:

  1. Net operating income: The annual income, minus expenses that a property generates from its operations

  2. Debt service coverage: Measure of cash flow relative to debt payment obligations

  3. Loan-to-value (LTV) ratio: A measure of the loan amount relative to the value of the property

“The property has to service its debt at a comfortable margin,” Borland says.

Borrowers who need more flexibility might want to turn to a small bank, says Blake Kreutz, commercial loan officer at County Commerce Bank in Ventura, California.

“We typically look for a 30 percent down payment and credit score is important, but it’s not a deal-breaker,” Kreutz says. “If someone is stronger in one area and weaker in another, we can work around that.”

Mixed-use and partially-occupied properties

Mixed-use properties might be classified as commercial or residential, depending in part on the proportions of each use. A typical configuration of many apartments over a few stores is treated as an apartment loan.

“If it’s 50-50 or there’s a lot more commercial, the underwriting changes and it becomes a little more conservative structure,” Borland says.

Apartment buildings that are vacant or only partially occupied can be financed; however, the loan might be short-term and have a variable rate with the expectation that it would be replaced with long-term financing once the property has been stabilized.

If the rents don’t support the debt, the borrower’s cash flow could help; however, “it would take a pretty strong borrower to support a whole building with a mortgage on it,” Kreutz says.

Conforming or portfolio?

Like one-to-four loans, apartment loans come in standardized types that lenders can sell to Fannie Mae or Freddie Mac and customized types, known as portfolio loans, that lenders keep on their own books.

Standardized or conforming loans typically have a slightly lower interest rate, but the guidelines are more rigid.