Founder, CEO of Blue Lake Capital LLC. Helps passive investors grow wealth through real estate. Podcast Host: Ready2Scale. Mentor.
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A lot of attention has been placed on the impact that the pandemic has had on the multifamily market, from occupancy rates to rent collections to different ways that owners and operators can mitigate the pandemic’s impact on their properties. However, before any of those issues can be discussed, it’s important to note that getting a property financed in the first place is not as easy as it used to be.
Many lenders are being careful and more conservative when it comes to lending money for multifamily properties due to the uncertainty in the market brought on by the pandemic. Hence, they may be taking steps to protect themselves from the potential greater risks involved. For one thing, I’ve seen many lenders lowering their loan to value (LTV) threshold. Prior to the pandemic, LTV might be anywhere from 7% to 80%. Currently, it’s more likely to be in the 65% to 75% range. For sponsors and investors, that means that a higher down payment is required and lower returns can be expected.
Overcoming The LTV Threshold
• Occupancy Levels
With an LTV of 65%, for example, a $1 million property would require a down payment of $350,000. However, if you’re a sponsor who has a successful track record and the lender trusts you based on prior work experience, more preferable terms can be arranged. The first priority is to make the lender feel comfortable with your deal and your experience. You can do this by emphasizing how you were able to overcome challenges with rent collections and occupancy rates in the past.
The next step is to carefully analyze the property’s T12 financials for the previous year. This will provide you with a comprehensive overview of income, expenses and net operating income (NOI), which the lender will want to see. One of the most important aspects of the T12 analysis is the recent trends, especially with regard to occupancy levels. If the levels have been falling since the coronavirus appeared, understand why this happened and have a solid explanation to give to the lender. Has occupancy dropped due to unemployment caused by the pandemic? Has the seller had problems replacing tenants? Be prepared to explain the circumstances to the lender, as well as what you plan to do to improve the situation once you take over.
• Collections
Collection issues are viewed in two ways. First, there are delinquencies. This happens when a tenant is unable to pay their rent on time. If the delinquencies are up, you’ll need to have an explanation of why it’s happened. Were tenants laid off or furloughed due to the pandemic? That could explain the increase in delinquencies, as could reduced work hours or trouble with receiving unemployment benefits. In addition to knowing the reasons behind the increase, you’ll also need to show how you intend to deal with the problem once you take over the property.
The second issue is bad debt. When tenants leave without paying rent, it’s hard to collect the money. Often, they do not leave a forwarding address and it would be costly to try to find them and collect the money that’s owed. Hopefully, they’ve paid a security deposit that will cover at least one month’s rent. When a delinquent rent is not considered salvageable, it is termed “bad debt” or written off.
Another issue with collecting bad debt is that the burden is on the landlord to prove that the money is owed. Having a written rental agreement would make the collection process easier, and a written agreement would support the claim. However, it’s up to the landlord to show proof of when the tenant left, how much money is still owed and when they violated their agreement. The rental agreement should specifically outline what happens when a tenant moves out and doesn’t pay rent, which includes how much notice they must provide, how rent is paid and the consequences of not paying rent. Having a written agreement would support the case if it were to go to court.
Remember that the lender is worried that if the cash flow is down before you purchase the property, you won’t be able to pay back your loan after the takeover. So, you have to be prepared to tell a compelling story about why the trends are good or bad and how you’re going to address the bad trends moving forward so they won’t continue.
Summary
The first priority when acquiring a property is getting financing. Since lenders are now more reluctant to lend money due to the uncertainty in the market because of the Covid-19 pandemic, they’ve taken steps to protect themselves from possible greater risks. For experienced investors who have relationships and successful track records with lenders, more favorable terms may be possible.
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