Finance Roll

If you are one of those looking into purchasing multifamily apartment buildings, it best to bring yourself up to speed with the common terms and phrases used in the industry. This will help you in speaking intelligently to the various real estate professionals you will engage with throughout the process.

10 Basic Terms Most Commonly Used:

1. Capital improvements: These are non-recurring expenses. Usually these expenses are for new roof, carpet, paint, windows, etc. These expenses only occur once every few years. Many times an owner will put the cost as a normal expense very a capital cost.

2. CAP Rate: This is the percentage figure i.e. 9%, 10%, 7.5%. This is how value for a property is determined. How this works is that the net income from the property divided by the CAP rate will give you a value. Example: net income of $120,000 with a CAP rate of 9%: $120,000/.09=$1,333,000. CAP rate usually translates to the rate of return and investor/buyer would get on a property.

3. Debt Service or DCR: Typically banks want to see at least $1.15 to $1.25 in net income for every $1.00 being borrowed plus all expenses. This function is to insure that the property is in a positive cash flow situation. Banks will not lend on a property that is losing money. Multifamily ownership is a business, and no bank will lend on a business that isn't making money.

4. Adjusted Gross Rents: All lenders will assign some percentage for possible vacancy and collections problems despite what the actual gross rents are.. Depending on the area I can be as low as 3% to a high of 10%. If the property has a vacancy rate higher then 10%, it usually means the area is very unstable and most lenders will shy away from lending.

5. Management Fee: In every case lenders will add management fee as part of the operating expenses of the property. Even if you have clients that will manage the property themselves, all lenders add in management fee. The reason is that lenders assume that if the property is taken back in foreclosure, the bank will hire a property management firm to operate the property. The bank is not in the business of property management.

6. Master metered: Most buildings in Los Angeles are individually metered for each unit. The tenant is responsible for the utilities within their individual units. However, older buildings might have a master meter, which means the landlord pays for all the utilities in the property.

7. Occupancy Rate: Also known as Occupancy Factor, this is a calculation based on the total number of rental units available. Example: If there are 100 units available for rent, and 90 are currently rented, then the Occupancy Rate would be 90%.

8. Operating Expenses: This covers all expenses in the normal operation and maintaining of the property.

Some examples of operating expenses are: Property Tax, Insurance, Utilities, Gardening/landscaping, Repair and maintenance, Pest control, Pool service (if there is a pool), Management, On-site manager & All recurring expenses.

9. Rent Rolls: Record keeping is crucial for proper management and evaluation. Rent Rolls are a current list of what each tenant is currently paying in rent, any credits they are receiving as well as deposits they currently have, These are typical kept on a monthly basis and updated as renters come and go.

10. Reserves: Most lenders will factor in reserves for repair and maintenance above the normal maintenance expenses. The lenders anticipate possible need to replace items like carpet, drapes, paint, window treatment, etc.

Buying multifamily properties can allow you to have relatively low risk and high return for your investment. Multifamily apartment financing is not as complicated as it seems, if you take the time to learn the basics. If you are looking for an long term recession proof investment vehicle, multifamily property investing and ownership is a great way to go.