Finance Your Income Property Like a Pro
Financing your Income Property Like a Pro requires that you present a persuasive case for your lender. Anticipate their questions and concerns. Understand that their loan review consists of both underwriting the property, and assessing your creditworthiness too. Do you understand what your lender really needs to know? When it comes to property underwriting, assure your lender that the property has both the current, and anticipated cash flow, or net operating income (“NOI”), to adequately repay the loan. The ability to “debt service” is a fundamental concern. Failure to quickly establish that your property’s NOI will carry the loan, and then some, is a quick route to a declined loan application. Present your loan request with confidence.
Why is NOI Important?
Why is NOI so important? Apart from determining whether you can repay your mortgage, it also substantiates the inherent value of the property. This is an important consideration for lenders whose lending policies stipulate that their loan not exceed a particular loan-to-value ratio. The capitalization of net operating income is one of the primary determinants of property value. The particular capitalization rate applied to your property is dependent upon a host of factors, including asset type, quality of tenancy, and property location.
What does your lender look for?
Giving your lender a copy of your rent roll is often insufficient. They rarely include as much detail as is truly required for a complete income analysis.
The amount of detail you provide your lender is largely dependent upon the number of tenants in your building, and the complexity of the leasing situation. At a minimum, your lender wants to know:
-Are the leases structured on a fully net-to-the-landlord basis, a gross basis, or some variation? Understand precisely what your obligations are as landlord. These should be itemized on an income and expense statement in support of your application.
-Are there lease renewal options, and if so, when do they take effect, and what is the contracted rent “step-ups”)?
-There may vacancies within your property. What property expenses are consequently not covered by present rental income. In other words, how much money is coming our of your pocket to carry this vacant space?
– If your leases are structured on a Net basis, do you also recover costs for property management and administration? Ensure that this is captured and presented, to offset some of your expenses.
How should you present your NOI?
You have applied for a mortgage. It may take a month, or perhaps more, to underwrite, approve, and fund. Though your lender will want to know what the property’s NOI is today, would it not make sense to provide a stabilized, or normalized pro-forma, for the next 12 months? Remember, your loan will be repaid with it’s anticipated future net operating income.
Remember to include the following:
–Stabilize the rent. If there are contractual rental income increases anticipated over the next 12 months, consider presenting the average rents anticipated from this tenant over that period. If the creditworthiness of the tenant is undoubted, and the anticipated rent within market rent norms, this is an acceptable approach.
–Account for all income sources. You may have ancillary income from pylon or rooftop signage, parking revenues, laundry room income, or percentage rents from tenants whose Lease incorporate such features. Remember to include all income beyond “base rent”.
–Normalize the income. There may be a vacancy within your building. Consider presenting your income in a manner which contemplates leasing the space within a reasonable length of time. Apply a market rent to the current vacant space, reflective of what can realistically be achieved.
Understand your property’s income generating characteristics, and present your income and expenses with confidence. Understand that the Net Operating Income is key, and forms the basis of the lenders loan analysis.