SS279: Debt Basics Every Apartment Investor Must Know

SS279: Debt Basics Every Apartment Investor Must Know

Your lender is usually the largest capital contributor to a real estate investment, and the terms of the debt often determine whether the deal wins or fails. In this episode, Charles discusses the fundamental debt concepts every apartment investor needs to understand.

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Talking Points:

  • When purchasing a 1–4-unit property, the loan underwriting is mainly based on the buyer’s income, and the loans are traditionally 30-year fixed loans. When we step into 5+ unit multifamily properties, we encounter commercial lending, which brings different lending requirements, new vocabulary, and loans that differ from residential mortgages. Let’s discuss some fundamental debt concepts that every apartment investor should be knowledgeable about. 
    • 1. Different Valuations and Metrics. Commercial properties are valued based on net operating income rather than comparable sales. There are a few terms regularly used in commercial lending, and others that carry over from residential mortgages.
      • LTV (loan-to-value): The percentage of the property’s value that is financed. A $100,000 property with a $75,000 loan means the property has a 75% LTV.
      • DSCR (Debt Coverage Service Ratio): It is a metric that explains how much the property generates in NOI versus its mortgage payment. If you would like to learn more about what the Debt Service Coverage Ratio is, check out episode SS134.
      • LTC (loan-to-cost): Used in value-add or construction projects. It’s the loan amount divided by the total project cost (purchase price + renovation budget).
    • 2. Recourse vs. Non-Recourse.
      • Recourse: If the property fails and the bank forecloses for less than the loan amount, they can come after your personal assets (house, car, bank accounts) to make up the difference.
      • Non-Recourse: The lender’s only collateral is the property itself. If you default, they take the keys, but they can’t touch your personal wealth.
    • 3. Amortization Vs Term: 
      • Term: How long the loan lasts (e.g., 5, 7, or 10 years). At the end of the term, the “balloon payment” is due, and you must refinance or sell.
      • Amortization: The schedule used to calculate your payment (usually 20, 25, or 30 years).
    • 4. Prepayment Penalties. Unlike a residential mortgage, you often can’t just pay off a commercial loan early without a fee.
      • Step-Down: A simple percentage (e.g., 5-4-3-2-1%). If you sell in year one, you pay 5%; in year two, 4%, and so on. This is most common for investors working with banks.
      • Defeasance: Replacing the real estate collateral with government bonds (very expensive). Common with agency and CMBS loans.
      • Yield Maintenance: A complex calculation designed to make the lender “whole” on the interest they would have earned. Common with agency and CMBS loans.
    • 5. Different Loan Types
      • Agency: For stabilized properties; usually non-recourse, lower rate, and longer term.
      • Bank: For stabilized or value-add properties. Recourse debt with flexible terms and approval, and structuring, is heavily based on the borrower’s relationship with the bank.
      • Bridge Loans: Short-term (1–3 years), higher interest, usually interest-only. For “Value-add” properties that need renovation before they qualify for long-term debt.
      • Permanent Loans: Long-term debt for after a property has been renovated and has been stabilized.
      • Interest Only Periods: Some commercial loans offer Interest-Only (I/O) periods for the first few years, which drastically boost your cash flow early on by delaying principal payments.
  • As many investors saw in the years after COVID, as interest rates increased dramatically, strong debt structuring can make an average deal perform well, and weak debt can kill a great deal.

Transcript:

Charles:
What if the wrong loan could quietly destroy your apartment deal, even if the numbers look great? Commercial loans play by a completely different set of rules than residential mortgages and how you finance a property could be the difference between success and failure. Welcome to Strategy Saturday. I’m Charles Carillo, and today we’re breaking down debt basics. Every apartment investor must know. Once you move into five plus unit multifamily deals, you enter the world of commercial lending. That means new rules, new terms, and very different loan structures. Let’s get started. When purchasing a one to four unit property, the loan underwriting is mainly based on the buyer’s income, and the loans are traditionally 30 year fixed loans. And when we step into five plus unit multifamily properties, we encounter commercial lending, which brings different lending requirements, new vocabulary and loans that differ from residential mortgages. Let’s discuss some fundamental debt concepts that every apartment investor should be knowledgeable about.

Charles:
Number one, different valuations and metrics. So commercial properties are valued based on net operating income and a y rather than comparable sales. There are a few terms regularly used in commercial lending and others that carry over from residential mortgages, LTV loan to value the percentage of the property’s value that is financed. A hundred thousand dollars property with a 75,000 loan means a property has a 75% loan to value DSCR debt coverage service ratio. It is a metric that explains how much the property generates in NOI versus its mortgage payment. If you’d like to learn more about what the debt service coverage ratio is, check out episode SS 1 34. That’s SS 1 34. Next is LLTC loan to cost used in value add or construction projects. It’s the loan amount divided by the total project cost, the purchase price and renovation budget. Number two, recourse versus non-recourse.

Charles:
With recourse. If the property fails and the bank forecloses for less than the loan amount, they can come after your personal assets, your house, car bank accounts to make up the difference. Non-recourse. On the other hand, the lender’s only collateral is the property itself. If you default, they take the keys, but they can’t touch your personal wealth. Number three, amortization verse term. The term is how long the loan lasts. This could be five, seven, or 10 years. At the end of the term, the balloon payment is due and you must refinance or sell amateurization. The schedule used to calculate your payment, usually on a 20, 25 or 30 year basis. Number four, prepayment penalties. Unlike a residential mortgage, you often can’t just pay off a commercial loan early without a fee. Pre PIM penalties come in all different forms. The first one is step down. It’s a simple percentage of the outstanding loan balance.

Charles:
And for example, this could be 5, 4, 3, 2, 1. So if you sell in year one, you pay 5%. In year two, you pay 4% and so on. This is the most common for investors working with banks. I sold the property a few years ago and it was a 3, 2, 1, meaning that after I held the property for four years, there was no more prepayment penalty in the first year. If I did sell it or refinance it, it would be three, 3%. Second year, 2%, third year, 1%. The next prepay and penalty is the feasance. So replacing the real estate collateral with a government bond, very expensive common with agency and CMBS loans. The next is yield maintenance. A complex calculation designed to make the lender whole on the interest they would’ve earned over the lifetime of the loan. Common with agency and CMBS loans. Number five, different loan types.

Charles:
So an agency loan is for stabilized properties, usually non-recourse has a lower rate and a longer term bank. Loans for stabilized or value add properties. Recourse debt with flexible terms and approval and structuring is heavily based on borrower’s relationship with the bank. Next bridge loans their short term, one to three years higher interest, usually interest only for value add properties that need renovation before they qualify for long-term debt. Next is permanent loans. So this is long-term debt for after a property has been renovated and has been stabilized. So it’s typical for value add properties to start with bridge loans and then end up being refinanced into a perm loan or a permanent loan. The next part of this section is interest only periods. So some commercial loans offer interest only IO periods for the first few years, which drastically boost your cash flow early on by delaying principle payments. As many investors saw in the years after COVID, as interest rates increased dramatically, strong debt structuring can make an average deal perform well, and weak debt can kill a great deal. So I hope you enjoyed. Please remember to rate, review, subscribe, submit comments and potential show topics@globalinvestorspodcast.com. If you’re interested in actively investing in real estate, please check out our courses and mentoring programs@syndicationsuperstars.com. That is syndication superstars.com. Look forward to two more episodes next week. See you then. Have

Speaker 2:
You always wanted to invest in real estate but didn’t have the time, didn’t know where to find the deals, couldn’t get the funding, and didn’t want tenants calling you? Since 2006, I’ve been buying income producing properties in great locations that provide us with consistent passive income while we wait for appreciation in the future and take advantage of tax laws while we’re waiting. And unlike your financial advisor, we invest alongside our investors in every property we purchase. Check out invest with harborside.com. If you like the idea of investing in real estate, if you like the idea of passive income, partner with us@investwithharborside.com. That’s invest with harborside.com.

Links Mentioned In The Episode:

  • SS134: What is Debt Service Coverage Ratio (DSCR)

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