100 Percent Financing...Be Careful What You Ask For!

Most investors don't understand what they are asking for with 100 percent financing (100% LTV). This type of over-leveraged loan is the quickest way to have a negative cash flowing property. You will quickly become a motivated seller if you don't run the numbers BEFORE you buy the property!

Now if your purpose for the property is for appreciation, other tax reasons or short term (maybe a development project) then 100% financing might be ok for you. But for me, at this stage of the game, I’m looking for cash flow. Now let’s use an example and see why 100% doesn’t make economic sense.

Calculate the Net Operating Income (NOI)

You have found a 20 unit apartment building that has $120,000 in annual gross income (that calculates into a monthly rent of $500 per unit). For an apartment building, a good estimate on expenses will be 40% (this includes maintenance, management but not vacancy or collection). I like to use a vacancy & collection expense of 8%. If you are looking at a poorly managed building or in a poor area, that number should be 10%.

The Debt

The owner wants $550,000 for the property. You’re thinking this is a good deal because it has a Cap Rate of 11%!

Now the lender is willing to loan you 80% of the amount and the seller is willing to take back 20%. The lender’s rate is 8% interest rate and 25 year amortization. That would calculate monthly payments at $3,396 or annual debt service of $40,752. The seller’s terms are 10% interest rate and 20 year amortization with a balloon in 3 years. That would calculate a monthly payment of $1,062 or annual debt service on the 2nd of $12,744. The total annual debt service is $53,496. Your profit for the year is $8,904 or $742 per month. Oh that is great! That leaves you with a very thin margin – 1.5 apartment units per month over break even point. So let’s hope everyone pays on time and there aren’t any unplanned for emergencies, higher utilities, higher insurance or other expenses that you didn’t plan on.

100 Percent financing is a good tool, when used effectively. Do the math and the numbers never lie. If you’re using 100% financing, make sure you have enough available cash reserves to handle any negative cash flow situations.

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