Are you dreaming of becoming the next Stephen Ross or Jeff Greene? Maybe you want to rub elbows with Leonard Stern or Donald Bren. These billionaire real estate tycoons may be some of the wealthiest people in the world today, but they all started somewhere. For many of us, our dreams start small. As we grow, we gain the courage to dream bigger and bigger. If you want to grow from residential real estate to commercial properties, this article will give you some of the tools you need to make it happen.
The main barrier to making the leap from residential to multifamily commercial property owner-ship is access to the right capital. Many real estate investors start with a series of single-family residential properties because they can get residential loans. Residential loans are much easier to obtain than commercial property loans, especially when you haven’t established consistently high cash flow. The move to multifamily properties requires commercial financing. So, how do you get the business cash flow to back commercial financing without the financing to create business cash flow?
Comparing Residential vs. Commercial Loans
Most residential loans are 30-year fixed-rate mortgages taken out by private individuals and families. Residential properties are intended to be lived in and aren’t typically viewed as money-making investments aside from the equity they generate for their residents. Commercial loans have a range of terms but rarely go beyond 20 years. These loans go to businesses so they can invest in income-generating properties that return capital on a monthly, quarterly, or annual basis.
Amortization is essentially how underwriters calculate the interest on a loan in relation to the payment schedule. For residential mortgages, the amortization period is the same as the loan term. For commercial properties, the amortization period often extends well past the loan term. That means, for a 10-year loan, interest may be calculated on a 30-year time frame. The extended amortization results in reduced monthly interest payments, until the end of the term, at which point the remaining interest is due.
Lenders for residential real estate look at the creditworthiness of the borrower. Commercial mortgage lenders are concerned with the value of the property to be financed and its potential income. While underwriters on a residential loan want to know about your FICO score and tax returns, commercial loan underwriters need information about your NOI, DSCR, and occupancy rates.
Finally, Commercial loans often cost more than residential loans and require a higher down payment. Rates depend on the loan amount, property location, asset class, and other economic factors and can change daily. Contact an experienced broker directly to get current and accurate rates.
Preparing for Commercial Financing
Before you pull the trigger on a multifamily deal, you need to position yourself for commercial financing. But how do you avoid the problem of business cash flow? The answer is by consolidating all of your single-family properties under a business umbrella. A common strategy is creating a Limited Liability Company, or LLC. Landowners often prefer LLCs because they’re easy to set up, protect personal assets, and offer tax advantages.
To start an LLC, you’ll need to file articles of organization (a.k.a. certificate of formation) with the state. Once that’s been approved, check that you have any licenses or permits the state requires. Finally, put together an operating agreement and apply for an EIN through the IRS. If you need support during this process, it’s easy to find agents online and locally who specialize in LLC formation with minimal cost. Check with your broker for a recommendation.
Portfolio Loans
Once you form your business, it’s time to look at consolidating multiple assets into backing for a new loan. Portfolio loans help you purchase larger property (i.e. multifamily) and move into the commercial real estate investment realm. These loans usually come from specialized portfolio lenders because banks don’t want to touch the investment. The bank would have to hold the loan instead of selling it off. Portfolio lenders want to hold your loan as part of their investment portfolio.
Portfolio loans are asset-based, issued on the market value and demonstrated rental income of the properties. That puts less pressure on your personal financial record, including credit score, tax returns, and existing debt. When you consolidate multiple single-family rentals, their combined value gives you the power to borrow what you need to buy bigger investment properties.
In general, you’ll want three or more rental properties and a year or more of experience as a renter to qualify for a portfolio loan. The portfolio lender will look at your Debt-Service Coverage Ratio (DSCR) or the net operating income (NOI) of your properties divided by your loan payments. If you own any properties in your portfolio free and clear, you’ll have a more favorable DSCR.
There are several varieties of portfolio loans and many types of properties you can include in your loan. For example, a blanket portfolio loan can help you consolidate five or more mortgages into a loan with a lower interest rate. A portfolio bridge loan is a short-term loan used to renovate or repair properties so they’re more attractive to potential renters. In addition to single-family properties, you can add duplexes, condos, and townhomes to the portfolio.
While this article is meant to provide an overview of portfolio loans to consolidate your single-family holdings, it’s by no means exhaustive. No online source can provide customized, detailed planning with your personal investment goals in mind. Let’s schedule a meeting to examine which financing options fit.