It’s not an uncommon Manhattan dream: Sell the co-op or condo apartment and buy a townhouse or a loft building. Live in it, collect rent and best of all, escape the sometime tyranny of co-op or condo life. If, however, the building being purchased has more than 5 apartments (and/or contains commercial space making it a "mixed-use" property), the cookie-cutter financing provided to buyers of 1 – 4 family homes disappears from the radar screen. If the buyers seek financing, they will be looking for a commercial, not a residential mortgage.

Many buyers assume that they can obtain financing for around 75% of the purchase price. The fact is that they can usually borrow about 75% of the property’s appraised value. Depending on a variety of factors, ranging from long-deferred maintenance to low rents being paid by rent-regulated tenants, there may be quite a disparity between the property’s purchase price and its appraised value. This can result in quite a surprise for a buyer who may need to provide considerably more equity than was initially expected. Today’s low interest rates are certainly helpful, but they will not necessarily result in higher loan amounts due to such valuation constraints.

It is common for a "gap" to exist between the premium price that a Manhattan brownstone or townhouse commands in the marketplace and its appraised value as seen “through a lender’s eyes”. Part of the explanation for the “gap” pertains to elements of ownership that will benefit an owner/occupant, but would be meaningless to an investor. While the lender will size up a property much like a serious real estate investor, concentrating on the property’s cash flow, an owner-occupant enjoys benefits such as living in the property as well as tax benefits which may justify paying a premium price.

A typical recent example involves an eight-unit, Upper West Side townhouse in contract for $4,450,000. 75% of the purchase price would be $3,337,500. However based on the actual income and expenses of the building a lender would barely be able to justify a $3,769,494 value (see chart on page 2). Even if the lender is willing to consider a blend of the sales price of the property and it’s value to an investor, the appraised value may still not exceed $4,059,747. 75% of $4,059,747 is only $3,044,810, which is $292,690 less than the mortgage amount the buyer was hoping for. Yet based on the above income and expense assumptions, ~$3,250,000 is a loan amount that would likely be comfortable for a number of lenders.

Vacancies in a prospective property present less of a problem as lenders are usually willing to attribute “market rents” to those units. Lenders generally assume that the building’s new owner will be able to fill the vacant units within a reasonable amount of time. Of course, the lender will also check public records (DHCR filings, etc.) to ensure that any vacant units are free of rent restrictions. The buyer cannot automatically presume that a vacant unit can be rented at “market value.” Over time, rents may be increased via vacancy and renovations above $2,000 and therefore become deregulated. If a unit that will be owner-occupied could be rented for, say $10,000 per month, lenders will typically include such market rents in their income calculations.

"Projected" rent rolls often make sweeping assumptions about what might happen in the future if all goes perfectly according to plan. A buyer may see huge upside potential in a given property, assuming that deals can eventually be struck with low rent-paying tenants, but a lender will be acutely aware of the risk that any rent-regulated tenant(s) may not leave.

Let’s take a very basic look at how a lender typically analyzes the cash flows in a multifamily rental property. For the sake of simplicity, let’s assume for this example that there are no stores or other commercial spaces:
Purchase Price: $4,450,000 | Proposed mortgage amount: $3,200,000 (73% of purchase price, 75% of value)

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