Apartment & Multifamily Lender Valuation Ratios http://www.karenhanover.com Real estate investors looking to maximize return on investment are usually leveraged to some degree. They're not paying cash for properties, using mortgages to leverage their returns for the cash available. What many do not realize is that it can be easier to finance 20 units costing $2 million than to purchase a half dozen homes for the same cost overall. It's because lenders look less at credit scores and income from other sources, and much more at the income or cash flow generated by the property itself. They do this using a couple of ratios. Break-even Ratio At the point the property generates enough income to surpass expenses, it is said to “break even.” Obviously, the sooner this happens, the better. And, this is a function of the rental income minus expenses. Good marketing, tenant-pleasing amenities and friendly management can increase rents. But, there is a lot to do on the expense side as well. Efficient management and cost control contributes to the cash flow, and this increases value and the amount a lender will mortgage on the property. So, what does this calculation, or ratio, look like? The annual operating expenses are added to the mortgage payments, yielding the cash going out. This is divided by the Gross Operating Income, or GOI. A property with $40,000 in operating expenses, and the same in mortgage payments, would have cash going out in the amount of $80,000/year. If this same property has $100,000 in gross rental income: $40,000 + $40,000 = $80,000 $80,000 / $100,000 = 0.80, or an 80% Break-even Ratio In fact, many consider this 80% Break-even ratio as a benchmark to shoot for. Many lenders will want to see this or a lower ratio before they'll provide a mortgage. DSCR or Debt Service Coverage Ratio A lender wants an apartment or multifamily project to operate with a positive cash flow that's high enough to make the mortgage payments, while enough is left over for profit and unforeseen problems or market fluctuations. The DSCR looks at this ability by comparing the cash flow to the mortgage payment. Of course, it's cash flow above operating expenses, so an example might be a property that will have a mortgage payment of $8000/month if the lender makes the loan. Since most lenders want to see a DSCR of at least 1.25, the property would need a cash flow of at least $10,000/month after expenses of operation. $10,000 / $8000 = 1.25 As both of these ratios compare roughly the same numbers, it's just a different way of looking at the situation. However, the excellent cash flows that can be achieved with apartment & multifamily investment can create situations very enticing to lenders. Apartment & Multifamily http://www.karenhanover.com
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