Qualifying for a Multifamily-Commercial Real Estate Loan

When you are ready to make the leap from duplexes and fourplexes to multifamily and commercial deals, you will need to understand some of the nuances of a commercial mortgage versus a standard residential loan. Residential loans are pretty much “cookie-cutter” loans by most banks. But if you want to get more than 5 units, you are now needing to get a commercial loan. In commercial loans, lenders are looking at the asset and its ability to cash flow, which allows for flexible financing options.
There are 5 areas a bank will need to make sure you have buttoned up before you approach a bank to give you a loan.
1) Your Credit Score
Unlike a residential loan, where your credit score is one of the top considerations for them to give you a loan, for most commercial banks it is not a top consideration. Keep in mind that the bank is looking at the property as a cash producing asset as opposed to a house that actually costs people money to own. However, you still will want to have good credit - above 600. Anything lower will cause the bank to ask questions about why your score is so low. Keep your balances low to keep your score up.
2) Your Management & Ownership Experience
The commercial lender will want to know about your experience managing and owning other properties. This is a major sticking point since they want to know that the property will be run profitably to cover the note. If you own a handful of single-family rentals or duplexes today, that is good experience you can bring into play. It’s a very different animal, but you can at least point to your ability to run small deals. If the plan is to go way bigger than you have traditionally done, you may want to lean on the background of a strong property management company and their experience.
If you are looking for smaller deals - say 5 to 50 units - some lenders may allow you to self-manage. However, you need to demonstrate that you have previous management experience and know how to underwrite tenants. They understand why you would want to self-manage as the margins on these smaller deals is fairly small. Just bear in mind that ownership experience is valued more than management experience.

3) Your Net Worth
The bank is going to look at your overall net worth, which is the difference between your assets and your liabilities. They are looking to see that your net worth is equal to or greater than the loan amount.
For example, if you want to buy a $1.5M building and want an 80% loan to value, the bank is going to want to see that you have a $1.2M net worth. This doesn’t necessarily mean you are out of the game if you don’t have the net worth. Let’s say that you have $800k of net worth but have a high income, it may be enough to get the deal done.

4) Your Income
Whether you are a W2 employee of self-employed, if you have income, the lender is going to want to understand how much personal income you have - including the income from other properties you own. They are looking for your global cash flow. They want to know that if one of your properties has a problem, that you can still make the debt obligation of the loan you are requesting.

The bank is not looking for a ratio on your global cash flow per se. Instead, they are looking at the property’s loan-to-value and debt coverage ratio. They want to know that the net operating income will exceed the monthly principal and interest payment. Most banks are targeting a minimum debt coverage ratio of 1.25. The higher, the better.
5) Your Liquidity
Finally, the bank will look at your overall liquidity - how much liquid cash you have at your disposal. If you are going for that $1.5M loan I mentioned earlier, and you are putting down $300k for the down payment, the bank wants to see that you still have some money in the bank. Really, you should have extra cash in reserves in case you get hit with a boiler breakdown or a $15k insurance claim.
The liquidity requirement varies from lender to lender. Most lenders like to see 10-20% of the loan amount. This means that is you borrow $1M, you should have a minimum of $100k liquid after your close. Other lenders want to see 6 to 12 months of principal and interest payments in the bank and available. So if your monthly payment is $12k, the lender will want to see $144k in your account. Some other lenders may even have an escrow requirement. It really depends on the lender and their guidelines.