Closing Costs on Multifamily Properties
Closing costs on multifamily purchases can be numerous. The Closing costs on multifamily will also differ depending on the specific property and circumstances surrounding the deal. I emphasize circumstances because the due diligence and purchase period can be fluid. Unanticipated closing costs can arise from different and unexpected sources.
As a multifamily purchaser, you predict the upfront costs the best you can because they impact return on investment. Some people have guidelines that range between 3-5% of purchase price. In reality it’s best to estimate high so that you don’t get surprises. This article describes the closing costs on multifamily properties based on experience from purchasing properties in three different states.
I’ve broken these costs into 4 sections:
- Escrow and Title Fees
- Lender Fees
- Acquisition and Due Diligence
- Building Costs
Escrow and Title Fees:
These fees are typical, even in residential purchases that include title recording fees, title insurance policy, transfer of tax fees and miscellaneous escrow fees (junk fees: fax fees, handling fees, document delivery fees, etc.). There’s also prorated taxes handled by escrow, but most of the time these will be a credit to the buyer, unless the seller has not paid them or contractually shifted them to the buyer. Some states use escrow companies and others use attorneys. Know ahead of time if you’re in an attorney state, so that you can negotiate to have your attorney perform the closing. When using attorneys it’s recommended to check what they charge as there will be differences. While in contract you can periodically request an estimated settlement statement so that you get an idea of what these fees will be. These fees may vary up until the closing.
Lender fees will vary depending on the lender but typically there will be a loan origination fee, which is usually the highest. They will inform you of this fee upfront. There are also appraisal fees, legal fees and loan points involved in this process. If you’re working with a hard money lender the points will be higher than with a conventional lender. With agency financing on larger properties, they will send an engineer to inspect the property and may request repairs to be made and budgeted for. On one of our property purchases, the lender requested a list of items that we were to complete within a year.
Acquisition and Due Diligence:
Acquisition and building costs are where things can start to add up. On the acquisition side there are legal costs associated with how the deal is structured that require an SEC attorney to create partnership documents being filed and set up the business entity. If there’s a partnership there may also be acquisition fees and other fees associated with the partnership described in a document called a private placement memorandum.
With due diligence, you may decide to hire 3rd party vendors. These will typically be building inspectors, roof inspectors, electricians, plumbers to scope the drain lines, contractors etc. There is usually a phase 1 environmental report requested by the lender. If the phase 1 detects soil contamination or something else, a phase 2 will be required. Phase 2 environment reports are more costly depending on their scope.
On the building side there are two important costs to factor into your deal that get inexperienced people by surprise. The first is upfront insurance cost. It’s required by lenders and depending on size of the deal can be in the tens of thousands of dollars. The second is utility deposits. If you’re new to an area or created a new entity that holds title, utility companies ask for a deposit. When utility companies don’t have history with your company or if it’s a new entity they will require an upfront security deposit to protect them from possible nonpayment of utilities. This cost can range in the tens of thousands of dollars subject to the deal size. Depending on the city, some utilities may allow a surety bond which enables you to pay a smaller portion of the deposit in the beginning for the bond holder to insure that you will pay the utilities. Check the utility provider to see if such bonds are permitted.
Rehab and Reserves…
There may also be rehab costs and/or reserves. Your rehab costs are related to your business plan for improving the building. The rehab can change after due diligence – this is not uncommon. After you’ve walked the units and inspected the property thoroughly, you may find deferred maintenance or discover you need to adjust the rehab costs in order to execute your business plan. The reserves is money set aside for unexpected capital expenses that occur during normal operations (malfunctioning water heaters; roof repair, window replacement, etc.). This is very important and should not be discounted. Having reserves helped us on a property that required improvements to the security. This not originally anticipated. After the improvement was made, it allowed us to effectively execute our business plan.
Let’s Close It Out…
Closing cost on multifamily property purchases can involve a lot of details. You can now understand why they can fluctuate while the closing progresses. If you divide them up in these sections you’ll stay on top of them and have clarity on the final number. As you gain experience, you’ll learn to anticipate certain costs and plan ahead so that your ability to predict closing costs at the underwriting stage is improved.
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