4 Factors that Qualify You for Multifamily Financing—Are You a Good Risk?Brian Hansen
Every real estate investment involves risk. When considering a potential multifamily investment, you have to ask yourself, “Is this a good risk?”
Once you’ve done your own calculations and are ready to talk to a lender, it’s the lender’s turn to consider, “Is this investment a good risk for me as a lender?” And even more pointedly: “Is this client a good risk?”
In commercial real estate finance, A lender’s decision to provide millions of dollars in capital is based both the financial performance of the underlying asset and the financial strength/stability of the borrower. The strength of the borrower—that’s you!—is determined by several “credit” requirements. Each lender’s credit board will review four essential credit qualification categories to determine eligibility:
- Credit score and history
- Net worth
- Experience and real estate resume
Let’s break down how those four qualifications contribute to your potential risk factor as a multifamily investor. The more you understand what is required of you, the better prepared you will be to qualify for the kind of deals you’re eligible for—and provide the necessary capital and paperwork.
1. Credit Score and History
Some would-be borrowers think their credit history and score isn’t a consideration in commercial real estate finance because the underlying asset’s performance is what really matters. This simply isn’t true.
While the performance of the property, including the Net Operating Income (NOI), and the Debt Service Coverage Ratio (DSCR) all play into your ability to receive financing, you have the ultimate financial obligation. The lender needs to know you have a proven history of repaying your debts.
Typically, a borrower must have a credit score above 680 to join the sponsor team. For most lenders, the very lowest acceptable score is 650, but you’ll likely pay a slightly higher interest rate if you are below a 680 score. For context, in 2017, 67% of all closed FHA loans had a FICO credit score above 700. According to a report by Fannie Mae, less than 10% of closed loans were associated with a credit score 650 or below.
Ask yourself what a lender might learn from reviewing your credit report. If you haven’t reviewed your credit report in a while, definitely do so. It’s best to know what is on there and if your credit history includes any items that might cause concern, resolve them. If you’re short on time, prepare a written Letter of Explanation (LOE) to explain the problems, and the resolution of those problems to a potential lender. Being prepared this way goes a long way to keeping your deal alive and be sure to stress how you made the situation better. Taking ownership reflects responsibility and that is a good thing.
2. Net Worth
How is a borrower’s net worth determined? You will need to provide a Personal Financial Statement (PFS) as part of the mortgage credit review process. A PFS is a worksheet listing all your assets and liabilities to show your net worth.
To determine your net worth, simply subtract your total liabilities from your total assets.
Most multifamily lenders traditionally want to see a 1:1 ratio between the net worth and the loan amount. For example, a borrower with a $2.5 million net worth will qualify a $2.5 million loan amount, assuming other requirements are met.
HUD loans have lower net worth requirements that amount to a ratio as low as 1:4. Many borrowers are drawn to FHA financing because they can be approved for much higher loan amounts than they otherwise would be from banks and other institutions.
If your individual net worth isn’t meeting the target ratio for the loan you need, the simplest way to meet this standard is to bring in a partner. Lenders look at the cumulative net worth of the sponsors (partners) for the loan.
Liquidity is more than cold, hard cash—it also includes cash equivalents available after your equity contributions (down payment). Which assets count towards liquidity and how much liquidity is required varies from program to program.
Money inside a qualified retirement program cannot be counted toward liquidity because it takes time to access the funds and taking out the money creates a taxable event and incurs penalties. The value of art, furniture, and vehicles do not count toward liquidity because it takes time, resources, and the right buyer to convert them to cash. Not to mention valuations of those types of assets vary wildly and are hard to pin down.
Checking and savings accounts, stocks, bonds, and other securities can be counted toward liquidity because typically, those holdings can be liquidated within 24 hours and they generally hold or increase in value.
The most common amount of eligible cash required to qualify for a loan is the equivalent of nine months of principle and interest of the proposed loan. Industry wide, liquidity requirements can vary from 5% – 10% of the loan amount.
4. Experience and Real Estate Resume
Relevant experience is typically required to be approved for multifamily investment financing.
Your real estate resume is a critical piece of information the credit board will use to determine if you have a proven history of multifamily investing experience.
Be specific about the type of projects you’ve done and properties you’ve owned. Describe your leadership and other activities you’ve participated in, professionally and personally, that further qualify you as a competent and successful borrower.
Since you won’t be able to appear in person and properly introduce yourself to the credit board, you won’t have a face to face opportunity to convince them of your qualifications and successful track record. Your real estate resume has to do this for you. Your real estate resume is your chance to tell your story of real estate investing and developing. While you may not be able to alter other capital requirements outlined above, especially in a short amount of time, building a persuasive case about you to the lender is completely under your control.
Are You a Good Risk?
When seeking to finance a multifamily investment property, think like a lender.. Just like each lending institution will have their own set of underwriting and credit requirements for financing, the four factors we’ve discussed should be your personal guide to successfully navigating the credit underwriting process.
Knowing your abilities and limitations allows you to feel confident as you approach lenders for financing. And why not feel confident? With your research done and supporting documents gathered, you’ll be ready to prove to lenders you’re a risk worth taking.