Apartment mortgages bear little resemblance to the loans people take out when buying houses. Properties with more than four units are considered commercial properties and come with their own funding and underwriting rules. Fannie Mae supplies much of the financing for apartment buildings, condominium complexes and cooperatives through a nationwide network of Delegated Underwriting and Servicing (DUS?) and other mortgage lenders.
Here's what you need to know before you buy an apartment building:
How Apartment Loans Resemble Home Loans
Apartment mortgages and home loans do share some characteristics, including the following:
- Buildings can be financed up to 80% of the property's value.
- You can get a 30-year fully amortizing loan (with terms of five to 25 years also available).
- You need good credit.
- You can take out a second mortgage or equity loan against an apartment building.
- The loans are collateralized by the property.
How Apartment Loans Are Different from Home Loans
Apartment loans are secured by residential property but in many ways are more like business loans than mortgages. Here are some ways that apartment loans are not like your home mortgage:
- The loan can be assumed an unlimited number of times over its term. In fact, you may be able to buy a building with a good mortgage that you can assume from a seller.
- Lender recourse is limited in the event of a default, so all your personal assets are not at risk.
- Loan fees can be very high; an application fee runs anywhere between $4,500 and $7,000.
- There are huge prepayment costs (up to 20% of the loan balance!). If you want to avoid the penalty when you sell a property, you are allowed to "defease," or substitute a similar property as collateral but keep the loan to use against the new property. However, there are charges for this (defeasance fees). The other penalty is called a "yield maintenance fee." Yield maintenance nets the lender as much as it would earn if you did not prepay the mortgage.
- Unlike residential mortgages, apartment loans can be taken out by corporations, LLCs, partnerships and trusts.
- You must demonstrate a history of successful multifamily property ownership (duplexes, triplexes or fourplexes, which can be purchased with traditional residential mortgages) before financing an apartment building of more than four units.
- You must document liquid assets equal to or greater than six months of principal, interest, taxes and insurance payments on the property. Your net worth must be "reasonable" in comparison with the loan amount.
Loan Amount Restrictions
Most lenders will not underwrite Fannie-eligible apartment loans under $1 million. This may seem counter-intuitive -- after all, homeowners with larger mortgages have a harder time getting financing and pay more for it -- but financing commercial property is very labor-intensive, and firms prefer not to use their resources for deals that don't yield much profit. If you want to buy something smaller or cheaper, a local bank may be willing to finance your purchase at higher interest rates.
If your loan will be $3 million or larger, you must first form a single asset bankruptcy remote entity that will take ownership of the property. What this does is keep any financial problems arising from your other business or personal interests from affecting your ability to repay the mortgage on the apartments. The idea is that the lender underwrites a nice safe mortgage on a building that generates sufficient cash flow to repay the loan with no difficulty -- as long as the money isn't siphoned off for other projects. Placing it in a single-purpose entity prevents the building's earnings from being used to repay unrelated liabilities, at the same time protecting the lender.
What Kind of Property Can You Buy?
You can purchase apartment buildings with five or more units, including mixed-use (commercial and residential space) buildings as long as at least 80% of the space is residential. The building must be graded at least C+ to be eligible for financing -- that is, it can't be rented daily or weekly, it can't have single-occupancy rooms (like rooming houses), excessive deferred maintenance or obsolescence, or a private well. The property must have been at least 85% occupied for at least the last 90 days before loan application.
What Do You Need to Provide?
Applying for an apartment mortgage is different than applying for a home loan in that the property's ability to pay for itself is more important than your personal financial position. You need to provide the following:
- Personal financial statement or Fannie Mae Form 1003 (mortgage application);
- The property's current rent structure;
- Two years' worth of schedule Es for the property or two years of operating income statements;
- A year-to-date operating income statement;
- Month-by-month income breakdown of the past 12 months;
- Photos of the property; and
- A copy of the purchase agreement.
What Are Mortgage Interest Rates for Apartments?
Current mortgage rates for apartment loans are low, just like today's home mortgage rates. A recent check online turned up apartment loans with interest rates fixed for 3 to 30 years ranging from 5% to 7%, or 6-month LIBOR adjustable rate loans with 2.5% margins. With HSH.com's LIBOR index at 0.39%, that gives you an interest rate of 2.89%.
Gina Pogol has been writing about mortgage and finance since 1994. In addition to a decade in mortgage lending, she has worked as a business credit systems consultant for Experian and as an accountant for Deloitte.