I read an interesting advertisement in a local big city newspaper. It was entitled: “How you can get super rich with San Francisco’s commercial real estate.”
This got me to thinking that we should talk about financing the acquisitions, and how the proper structure can contribute to building your wealth. For starters, let’s look at apartment building loans.
This particular article will focus on how one might build wealth with out-of-state apartment buildings. Some advantages are the cost per unit is substantially lower than California, and the cash return on your investment is much higher. A disadvantage is that you need to be very comfortable that you can hire and control competent managers.
Let’s look at Iowa apartment buildings as an example. A client of mine is purchasing 72 units for $2.22 million. This works out to about $31,000 per unit. As an inducement to purchase the units, the seller gave the buyer a $205,000 credit. Of this amount, $30,000 is needed for upgrading some units, and $175,000 is a credit toward the down payment.
Part of the reason for the credit is that the buildings had a weak operating history and had occupancies in the 75 percent range. However, a condition of the purchase is that the properties would be upgraded and occupancy would be increased to 92 percent prior to the completion of the transaction.
The main lesson in making a purchase like this is that you should shop around for loans to get the best deal. Also, you can get excellent leverage depending on the deal structure:
-- A local bank was willing to make the loan at 80 percent loan-to-value, and they also would allow the $175,000 seller credit towards the down payment. They offered both a three-year fixed-rate loan of 5.52 percent and a five-year fixed-rate loan of 6.30 percent, based on 25-year amortization with no prepayment penalty. Advantage to the borrower: He only has to make a 12 percent down payment. 
-- A local credit union was also willing to make the loan at 80 percent loan-to-value and they too would allow the seller to give a $175,000 credit. The interest rate on a four-year fixed-rate loan was 6.75 percent, with 25-year amortization. The points were $7,500 and there was a three-year prepayment penalty period. Advantage to the borrower: Twelve percent down payment. Disadvantage: three-year prepay.
-- One other local bank was also willing to finance the property at 80 percent loan-to-value. However, they wanted the borrower to keep $200,000 in their bank until the occupancy got to 90 percent for 90 days or more. End result: The buyer would have to put 20 percent, or $444,000 down initially.
-- Fannie Mae and Freddie Mac would not finance these properties initially. The reason is their underwriting requirements call for 90 percent occupancy for at least 90 days. Down the road, though, this will be an excellent source of financing for the buyer because they have low rates.
-- Another local bank passed on the transaction. They weren’t willing to make the loan because they would not allow the seller to give a credit for $175,000 towards the down payment.
In summary, the buyer was able to purchase 72 renovated units for $2.22 million. He only had to put 12 percent down, and got interest rates at 5.52 percent to 6.30 percent with no prepayment penalty.
The buyer also got much better leverage than he would locally. In California, most of the time, you have to pay $100,000 or more per unit. Also, because of debt service coverage requirements that lenders have, his down payment would normally be about 30 percent or more.  A similar-priced property might require a $666,000 down payment or more in California, as opposed to $269,000 on the above Iowa purchase.
In addition, for the above out-of-state purchase, the buyer will have 72 tenants that are paying off his mortgage for him. Furthermore, he will have a 20 percent return on his invested funds. And finally, he will have 2 percent annual rent increases and some of the profits from these units will be sheltered by depreciation.
Can you build wealth by carefully buying and financing apartment buildings? You bet.
But, like everything else in life, do extensive due diligence on the purchase, and shop around for your loans to be sure you are getting the best terms.
Mike Ferguson is with Windsor Financial Services located in Granite Bay. His web address is www.windsorFS.com