The move to multi-family investment can be the result of several factors. First and foremost, multi-family allows the investor to move further up the food chain and own more rental units while saving time and being more efficient in the process. With this change there are economies of scale, such as lower per unit acquisition price and spreading vacancy risk over many units. Another major factor is that at some point investors “top-out” with the number of individual mortgages for which they can qualify, whereas multi-family mortgages are based on the income from the building itself.
Whatever your motivation, the switch from rental houses to multi-family involves a process that may be quite different from what you’re used to.
Here is an overview of multi-family financing:
PART 1 – Types of Mortgages
First mortgages fall into three categories:
(A) Conventional Mortgages
These are loans up to 75% of lending value (lesser of purchase price or appraised value).
Advantages of conventional mortgages:
• Faster turnaround time for approval
• Lenders are usually more negotiable on business terms
Disadvantages of conventional mortgages:
• Larger down payment usually required
• Interest rates higher than CMHC insured loans
• Usually only available in larger metro areas and not small towns
(B.) CMHC Insured Mortgages
These are loans up to 85% of lending value (lesser of purchase price or CMHC lending value).
The costs associated with a CMHC insured loan are:
• CMHC application fee of $150 per unit.
• CMHC premium based on the loan to value ratio:
Up to 65% 1.75%
Up to 70% 2.00%
Up to 75% 2.25%
Up to 80% 3.50%
Up to 85% 4.50%
Both the application fees and the premium may be added to the loan amount.
There is a 0.25% surcharge for each additional 5 years in amortization over 25 years.
Advantages of CMHC mortgages:
• Lower interest rates
• Usually the loan amounts are higher than conventional mortgages
• Lender competition
• Available in most locations including small towns
• Amortizations to 40 years
Disadvantages of CMHC mortgages:
• Typically a turnaround time of 3 to 4 weeks, which may not work for quick closings
• Do not provide the flexibility needed for buildings that are in transition
• Minimum 5 year term
(C.) Interim or Bridge Financing
Interim or bridge financing is used in cases where there are extenuating circumstances, such as:
• Tight deadlines for satisfying conditions and/or closing deadlines;
• Cash flow from the building does not meet institutional lenders’ guidelines and time is required to increase cash flow;
• Renovation or upgrading is required to bring the building to acceptable standards for institutional lenders.
Underwriting guidelines vary widely from lender to lender; however, here are the general parameters:
• Usually the maximum loan is 85% of acquisition price
• Depending on the strength of the deal, the lender may include funds for a renovation and also an interest reserve
• Typical term is 12 months
• Interest rates typically float over Bank Prime
• Interest only
• Lender fees typically range from 1% to 2%
• There must be a clear exit strategy to show the lender how they will be paid out
• Lender will consider either flat or negative debt service coverage
Part 2 – How Lenders Analyze Debt Servicing
Loans are analyzed based on the net operating income of the building. Net operating income is calculated as follows:
Minus Vacancy & Bad Debt
= Effective Gross Income
= Net Operating Income before debt servicing
• Gross income is based on actual rents, or on rents achievable within a very short term frame, e.g. rental increase notices taking effect concurrently with funding of the mortgage.
• Lenders will typically use the current market vacancy rate. (*Remember, even at full occupancy there will be “turn-over” vacancy and bad debt.)
• Expenses are a combination of actual expenses such as utilities and property taxes and additional expenses such as management, repairs/maintenance, reserves and advertising.
• Be vigilant when confirming utility, repair and maintenance expenses.
(e.g. bulk metered electricity/individually metered electricity)
Debt Service Coverage Ratio = Net Operating Income
Annual Debt Service of the Mortgage
As minimum debt service requirements vary between conventional and CMHC, and are also interest rate sensitive, it is best to consult with your lender/broker for specific requirements.
Part 3. – Information Requirements
Here is the information you will need for a multi-family mortgage application:
• Accepted Offer to Purchase
• Current AACI Appraisal (conventional only)
• Phase I Environmental Report (ESA) satisfactory to lender/CMHC
• Building Condition Report (roof/structural/mechanical)
• 2 to 3 year operating statements for the building
• Current rent roll and 12 month vacancy history
• 2 to 3 years operating statements for the borrowing company
• Personal Net Worth Statements (PNWs) for the principals (including verification of major assets – bank statements, equity verifications)
• Personal CCRA Notice of Assessments (NOAs)
Note: As a very general rule of thumb, the combined personal net worth of the applicants, based on cash and verifiable equity in other real estate, should be at least 25% of the loan amount being requested.
Part 4 – Costs and Timelines for a Typical 24 Suite Walk-up Apartment Building
We suggest that you confirm beforehand that the various report providers are acceptable to the lender/CMHC. At that time, you can also request a specific fee quote for these reports.
For a 24 suite apartment building purchase transaction, here are some “ballpark” costs and timelines:
Appraisal Report $2,000 to $2,500 (3 to 4 week turnaround)
Phase 1 Report: $1,500 to $2,500 (1 week turnaround)
Report: $500 to $1,500 (1 week turnaround)
Lender Fees: Get quote from lender
Legal Fees: Get quote from lender/solicitor
CMHC Turnaround: Typically 3 to 4 weeks
Ideally, your financing condition deadline in the Offer to Purchase should be at least 45 days.
Part 5 – Other Things to be Aware of:
Be aware of both functioning gas stations and de-commissioned gas stations (e.g. long-vacant corner lot). Their proximity may require a Phase II Environmental report which involves drilling holes and testing soil for contamination.
Illegal suite income is not included in debt-servicing or appraisal valuation.
The best way to confirm the number of legal suites is to compare the original building permit with the actual number of suites. (An early indication is to count the number of electrical meters in the utility room. There should be one meter for every suite plus one for the common areas.)
Illegal suites may or may not be easy to legalize due to suite size, insufficient parking or zoning.
The roof, boiler, and windows are expensive to replace so make sure you are comfortable with the condition of the building.
The purchase of a multi-family building should be a collaborative process between you, the investor, and your lender/mortgage broker. By working together you will have a good idea of the level of financing to expect as well as what issues need to be dealt with.
George Hilton has been a commercial mortgage broker with Montrose Mortgage since 2003. He has over 35 years’ experience in the mortgage industry and has been in various management and origination roles with mortgage insurance and direct lending institutions. Reach George at firstname.lastname@example.org