During the fantastic boom our area saw over the last few years it was rare that a deal would fall apart once you got to the financing contingency. Lately death in financing has become the norm. Spot the signs in advance and you’ll save yourself lots of time and aggravation and probably some money.

If your property consists of 5 units or more, the maximum amount that can be borrowed against the property is governed by two items the first is the Loan To Value that lenders are offering and the second is the DSCR sometimes called the DCR or Debt Service Coverage Ratio (I’ll explain more about what that is in a minute in case you’re wondering). Let me say first that for a time, DSCR hardly mattered. The reason the ratio didn’t matter was because so many apartment building properties were traded with the intention of converting to condos and the loan was based on that return. That isn’t happening right now so the rules of engagement have changed.

What is the DSCR and why does it matter when you are selling?
This ratio can be explained as the ratio of NET Operating Income to Annual Debt Service - or - NOI/[Debt Service]=DSCR. The biggest mistake I see multifamily sellers make in this regard is miscalculating the NOI or Net Operating Income. More often than not I see sellers trying to operate from guesstimates and partial equations. When determining your NOI banks include the following expenses:

• Real Estate Taxes
• Insurance
• Utilities
• Water & Sewer
• Management - This is 5% or actual which ever is greater
• Vacancy - This is 5% of your gross or actual, whichever is GREATER
• Maintenance, Repairs and Cleaning
• Reserves $200 per unit per year

Example
Lets say you’re offering your Cambridge Massachusetts 6-Family investment property at $1.2M and the Gross Rental Income is $100,800 or $1400 per unit per month. The rest looks something like this

• Taxes - $7700
• Insurance - $4500
• Utilities - $1000
• Water & Sewer - $6500
• Management - $5040
• Vacancy - $5040
• Maintenance Etc - $5500
• Reserves - $1200

Total expenses then equal $36,480 subtracted from your Gross Income leaves you a NOI of $64,320.

So you list your property with a local broker and everything seems like its going great. Your broker calls you, he’s all excited he’s going to fax over an offer with 25% down closing in 30 days - and its a FULL PRICE offer. Sweet you’re in the money!…. right?

The debt included in the offer in this example is $900,000. If it were financed at 6.5% (and I think you ought to figure on 7% today) Annual Debt Service would be $68,263.32. PROBLEM most lenders today want to see a MINIMUM DSCR of 1.15 and as they get more conservative, and they are, you ought to count on 1.2-1.25. The DSCR in this example is .94. That means that the gross income is coming up short on even covering the debt. A ‘1′ means the debt is just covered so 1.2 or 1.25 means that the .2 or .25 is your profit.

So what it’s a full-price offer!
This is head-in-sand negotiating. Taking this deal will put you through months of pain and trouble. The fact is this deal won’t close. This borrower will not get the money.

The maximum amount of Annual Debt Service that this property can support is $53,600. That means that the maximum amount of debt that you can put on this property is about $705,000, the balance of the transaction has to be cash. In this case that means a down payment of a little better than 40%. Is it possible that you could get the extra 15% cash down payment negotiated into the deal later? Sure, but its highly unlikely. Even if the buyer could come up with it he would not be bound to buy under the conditions of the original contract.

What to do?

1. Be upfront and honest about your expenses. The truth will come out when you’re asked to document them anyhow.
2. Price your property appropriately. True “prize” properties will command exceptional down payments and prices but your run of the mill multi should be financeable (did I make that word up?) with conventional commercial financing at a 75% LTV
3. If you do have the rare ‘Prize’ scrutinize your offers and don’t accept anything that won’t work

Above all else if you are hiring a professional make sure you hire someone who knows the commercial game, your local residential Realtor will probably waste a lot of your time and leave you frustrated with a trail of dead deals - if you’re lucky.