Category Archives: Financing Options

Today we are going to have a little fun with math. I used to hate math. But in my business now, math is my friend. So sit down. This post might be a long one.

• $175,000 duplex in play here
• 20% down payment ($35,000)
• Financing based on $140,000
• 6.95% interest, amortized over thirty years
• 5% appreciation (on average)
• Rents are $1,500/mo. (not escalating)
• Expenses are $6,920/yr and include property management, taxes, insurance, a healthy reserve fund and 5% vacancy

With the conventional financing for our sample rental duplex the monthly debt service will be $926.73. Or $11,121 per year. Plugging in our numbers from above we know that our formula goes something like:

18,000 GRI
6,920 Expenses
11,080 NOI
11,121 Debt Service
( 41) yr Cash Flow Before Taxes.

So the property is paying for itself. And that’s great! California real estate investors would kill for these numbers. Same is true in Florida and Washington and New York.

11,080 NOI
9,723 Debt Service
1,357 Cash Flow Before Taxes

So now this property is generating a fairly substantial monthly cash flow. At the end of the 6 year holding period the house will still be worth the same as our conventional financing house. Let us take the 6 years CFBT and we’ll show $8,142. We cannot add to that any principal reduction so the entire benefit from the first 2 Benefits only is $8,142.

Q: Why would you need a commercial loan when you are purchasing a residential income property? It just doesn’t seem to make sense.

A: Because the underwriting guidelines say that any residential property with 5 or more living units will require a commercial loan. That’s why.

Take this 5 unit apartment pictured to the left here. Because it is over 4 residential units underwriting guidelines will not allow a residential mortgage. That goes for any investment property 5 units and above.

You may now be asking yourself what are the main differences between a “regular” mortgage and a commercial loan. Well, I’m not going to hit every point but I’m going to highlight some of the biggies.

• Residential investment property loans may allow you to put only 5%, 10% or 15% down. It is very unusual for that to happen with a commercial loan. In fact, 20% is almost a mandatory minimum with 25% being even better.
• You can decide how profitable a residential mortgage purchase needs to be but if a bank is getting involved with a commercial loan they are looking more at the qualifications of the apartment being purchased than they are looking at you. The commercial banks have minimum standards for what cap rates should be for commercial loans they are underwriting.
• Regular mortgage loans can be amortized over 15, 20 or 30 years. Commercial loans are almost always a 20 year am, maximum. Although I have seen a movement towards 25 years on some more expensive apartment complexes.
• Your closing costs will be exponentially higher. Points are usually higher. Appraisals will definitely be higher.
• Experience matters when qualifying for a commercial loan.

Right off the top you can see that you had better not be considering any residential income property that has more than 4 units until you have the cash, credit, experience and banker to do so.

That’s another great reason to begin your real estate investing career with easily manageable, easily affordable single family homes, duplexes and fourplexes. After you’ve been through a 1031 exchange cycle, or two, then you’ll have the cash available to go after the commercial properties.

Fun Fact: I’ve got a 26 year old right now who owns 7 investment properties. He’s on the fast track towards being a multi-millionaire who owns commercial properties by the time he’s 40-42 years old. Now that’s a way to build a retirement worth having.

Are you using a self directed IRA to purchase real estate investment property?

If not, you really need to hunker down and wade through this posting. It could be the difference between retirement and a retirement worth having.

Understanding Your Investment Dollar