Getting the right financing for your property purchase is one of the most important things you’ll do when putting a deal together. Getting the right amount of debt along with the best rates will impact your cash flow and your returns.
Let’s go into what you should look for when putting a deal with your biggest partner in your income-producing deal: the bank.
For starters, this discussion is centered around income producing properties. A home is not part of this discussion because a house does not produce any cash flow. In fact, it is a way for a bank to hold your money hostage and just means dead equity for you. I explain more of that in a video I will link in the description, but in short, you have all that down payment locked up in a house that you cannot invest.
On an income producing asset, like a multifamily property, cash flow is coming to you month over month. This is the reason banks will partner and bring money to your deal. Getting this loan is not just based on your credit, it’s based on the property’s income. While commercial loans are tougher to get than residential ones, they are not impossible.
After you find the deal and negotiate the price, getting financing in place becomes key. Each lender is different and will adjust their rates depending on the deal and how they feel about the risk level.
Conceivably, you already have a banking relationship before you land a deal and you have already vetted the bank and the ability to perform. Doing this work upfront with a banking relationship manager will help in getting any proof of financing you may need when submitting LOIs on your deals.
The bank is going to look for these four things, in order of importance:
- Your net worth.
- Your personal credit.
- Your personal background (bankruptcy, liens, criminal, etc).
- Your track record with similar assets, in this case, multifamily assets.
If you are new to the game and are already discouraged thinking that you will never get into your first deal, don’t worry. You can partner with someone that can offset the deficiencies in your net worth or credit. In this case, you can give the partner equity in the deal and the bank will look at their financial background to get the deal done. If you do this, be sure you are also bringing something to the table other than the deal itself, like sweat equity, property management or raising the equity. Ultimately, the bank is looking for certainty when it comes to financing a deal.
If the bank is comfortable with these four things, they will present various financing options. Many times a bank will offer an interest-only loan with only a few points above Treasury rate. These days, many investors are getting up to 4 years of interest only money on larger deals greater than 100 units. This is great for cash flow while you improve the property to raise the NOI and overall valuation. Again, all this depends on the lender and you will need to compare rates to find the best loan and length of term for your deal.
From there, the leverage will come into play. Meaning, how much will the bank lend and what do you need to bring as a down payment. Unlike buying and financing a home, we don’t care too much about paying down the principal. In the case of a commercial loan on a cash producing property, it’s about how much NOI it generates. As the property’s value appreciates, you keep pushing rents up and keep expenses in line, you increase cash flow. This flow covers the debt payment and gives you passive income. There is no value in paying more to bring the debt down. This is why those interest only loans I mentioned a bit ago are so interesting.
Because financing is so important in these types of deals, spend time negotiating financing rather than being so focused on the price. Lenders will sometimes make you believe that these rates and terms are not negotiable. This is not the case, specially on larger deals. This is also why you should vet the bank early and establish a relationship so they can independently underwrite deals you are considering and do the legwork to get the best financing they can. A difference of just a quarter of a percentage point in the interest rate can mean paying thousands of dollars more a year.
Anyway, do you have a good banking relationship already in place? Are you looking for a lender to back one of your deals? Let me know in the comments.