Given the rising costs of homeownership, multifamily dwellings—including rental apartments—increasingly represent an accepted alternative to the detached single-family house. Lending on apartment security combines the skills of the residential lender with those of the income-property lender. High-rise apartment buildings are closely associated with high land values. People living in densely populated, older urban centers have developed a lifestyle based on the amenities offered near their dwelling places. Lower density garden or townhouse apartments tend to represent a lower-cost, more relaxed lifestyle. They are generally located in areas convenient to main transportation routes.
Suburban multifamily units generally are oriented to one of two distinct lifestyles: family or adult only. Privately owned family-oriented rental housing is becoming increasingly scarce. Adult-only complexes, by contrast, cater to highly mobile singles and young married couples with relatively high levels of disposable income.
Government controls affect multifamily housing through zoning, building and fire codes, housing and health codes, and local ordinances. While temporarily helping tenants cope with the rising costs of inflation, rent control can be damaging to a community’s housing situation in the long run, as it tends to limit growth in—and may even decrease—the supply of available rental housing. Open-housing ordinances, when extended to ban adult-only complexes, provide a further disincentive to owners of rental housing. On the other hand, some government controls have been necessary to eliminate racial discrimination and to establish health and safety standards.
The demand for rental housing is a product of demographics in relation to the supply of and demand for other forms of housing. When considering lending for a proposed apartment property, the lender should consider many factors in assessing the project’s feasibility. For example, the age of the targeted population will influence the design and location of the proposed property, as will the income-earning potential of the proposed tenants.
Market saturation of one product in an area may not necessarily signal an oversupply of units in other rental ranges with different characteristics. The lending officer should analyze the product using standards of comparison that reflect market differences. Cost, value, rental rates, and operating expenses should be presented in units of measurement for comparison with similar properties. Care must be taken to make adjustments for minor differences, and dissimilar properties should not be used.
Analysis of the income statement of an apartment property begins with an estimation of the gross potential income. Projected rents should be compared with rents currently posted for comparable units. A vacancy allowance and collection loss allowance should then be deducted to find the effective gross income of the property.
An estimate of the operating expenses of an apartment property can be made from a pro forma operating statement that includes property taxes, management expenses, and a reserve for replacement. The final calculation of net income may be capitalized to arrive at an estimate of the value of the property. Analyzing the property’s income and expenses in relation to the property’s mortgage financing may best be done by using a detailed worksheet.
Chad Mayes is the creator of CEMLending Connection, a resource which provides information regarding commercial and residential property financing.
