Some Commercial borrowers, especially in multifamily real estate, make some mistakes when estimating the size of a loan for their property. They are light on several areas when underwriting the expenses for a loan. Unfortunately, these mistakes can lead to frustration and potentially kill deals if trying to sell the property.
The good news is that most of the time, the mistakes people make fall into one of the following three categories. Learn about them now and you will have an easy time avoiding them later.
Just because you self-manage doesn’t mean we forget about them.
A lot of proforma’s we see with “family” operators that self-manage, do not list a management fee on the expense side of the ledger. While these operators do not charge a management fee to themselves (IMHO, they should) they need to account for it in the numbers for financing. Depending on the market, management fees typically range from 3-5% of collected rents.
This 3-5% may not seem like much, but it could be the difference in getting the Loan Proceeds the operator wants.
For example: Rents are $400,000 and the market management fee is 4%. That is $16,000 added to the expense side of your pro forma. At a cap rate of 7% that is $228K value haircut.
Underestimating the Tax impact on Acquisitions:
The Tax Man Always Gets His Cut
In this hot market of multifamily transactions, we are seeing many operators selling their properties at very attractive cap rates. One of the main issues we see as we are running the numbers on an acquisition is the underestimating of the new tax liability.
In fact, most of the tax appraisers are on high alert on due to the high-volume multifamily transactions considering the market. Lenders will always underwrite to the appropriate tax levels which in a lot of cases cuts loan proceeds.
It doesn’t matter if the current owner has been getting waivers and suppressing a higher valuation. Once that transaction is in place, the new owner will have a tough time justifying an old value that doesn’t exist. Remember, “The Tax Man Always Gets his Cut.”
Repairs and Maintenance
This is a category that some borrowers and “family” operators tend to undervalue on the expense side of things when looking at financing a multifamily loan. When reviewing these operating statements, especially on smaller transactions with “self-managed smaller properties”, we will often see very light numbers under “Repair and Maintenance.”
Most of the time they are under reported because their “Uncle Joe” takes care of all the property repair. From a financing perspective, we typically see lenders underwrite a minimum of $700-$750 a unit in Repairs and Maintenance. For Illustration, a 100-unit property with $750 in underwritten R/M equals 75K in expenses added to the bottom underwritten NOI.
If the borrower budget comes in with extremely light R/M numbers, it could spell disaster from a loan sizing perspective.
These are just a few scenarios that we see that could potentially cut loan proceeds which can frustrate a borrower. The financing available for an asset can kill a deal if the asset is running light on these expenses. Be sure to check these expenses when determining value of your Multifamily asset.
If you would like us to review your proforma, feel free to reach out to us.