Today’s commercial deal analysis looks at a value-add acquisition of a 12-unit apartment building in Westminster. Strategic Partners William Foy and Marcus Davis of Spearhead Commercial Capital joined me to discuss how to make a value-add property work in today’s high interest rate environment.
- Listen to the podcast “#421: Why Commercial Investors Are Seeking out Shorter Loan Terms” Denver Real Estate Investing Podcast
- Watch the YouTube video (at the bottom).
- Read the blog post. Note, the blog is an executive summary. Get the in-depth breakdown from the podcast or video.
From Part Time Flipper to Full Time Investor
William is running point on this deal with a repeat client. This is the client’s third deal with Spearhead this year, and he’s very active in the multifamily market. He used to have a W-2 job and did fix and flips on the side, but he recently transitioned into full time real estate.
Over the years, he’s grown more comfortable with multifamily deals and taking on bigger projects. Currently, he has about 10 properties, half of which are value-add and half that are rented out single family homes.
Terms of the Deal
This is a classic value-add play on a 12-unit multifamily property. The former owner of the property owned the building for decades and didn’t pay too much attention to market rents. Rents for the units were about 60%-70% of the market rates when William’s client purchased the building.
He plans on rehabbing the interior units to help bring them up to market rates. Because the structure of the building is in good shape, he only needs to make cosmetic changes, such as new carpet, paint, countertops, and cabinets. The budget per unit is between $6K-$7K.
The purchase price was $3.2MM, and he ended up with 75% loan to cost, with 75% of the total rehab budget in the loan. The loan is a 7-year term with 30 years amortization, but the first 12 months are interest only. This will help the client afford the rehab on the property.
The entire rehab project is expected to take 12 months because he is waiting for leases to turn and will then renovate the units individually. This will allow him to complete the project by the time the interest only period on his loan ends.
Even though this is a good deal, it’s hard to get cash flow and have debt service coverage (DSCR) when the seller wants to get top dollar despite under-market rents. The typical way to shore up this deal would be to put down more cash.
Finding a Unique Loan to Cover the Rehab
William was able to find a lender who has a credit policy that allows 1:1 DSCR as long as the improvements made to the property and appraisal net operating income upon stabilization supports 1.25% DSCR. Since the client is rehabbing in order to increase the property’s value, he should be able to meet these requirements.
This client’s experience investing in and flipping properties were critical for being able to get this type of loan. His proven track record makes the lender comfortable with these terms, and a first-time investor would not be able to qualify.
Finding a loan without a prepayment penalty was important to this client. When he gets the units to market rent, he knows the property value will increase. Not having the penalty will allow him to explore refinance options and find the most favorable terms. The 7-year term also gives him the flexibility to take his time and simply maintain the loan.
What Trends Are Developing in the High-Rate Environment?
William and Marcus are seeing more syndication activity as investors need to raise money for bigger down payments. With interest rates and purchase prices both high, it can be difficult for an individual who isn’t using a 1031 exchange to come up with enough cash to meet loan requirements.
Meanwhile, daily interest rate changes are causing lenders to constantly adapt. Most lenders aren’t doing rate locks, and the rate locks available are more expensive. A quick close in the commercial world is 45 days, but that’s a long time in the interest rate environment. Buyers need to pay close attention to these timelines.
Spearhead is underwriting deals at 6%, which is higher than current rates. This allows the clients to know what their deal will look like if anything changes before closing. There’s speculation that rates will come down next year, so some borrowers are looking at 3–5-year terms instead of the typical 7–9-year terms. They’re trying to find the balance between locking in a long-term fixed rate and being able to refinance into a lower rate.
Connect with Spearhead
If you want to see how William and Marcus can help you with a commercial loan, reach out to them. A brief conversation will help you both determine if they can assist you with your lending needs.