What is the downside of an apartment DSCR loan? An honest look.

A bank that holds your deposits and reads your tax returns will usually beat an apartment DSCR rate on a clean building. So will an agency small balance loan, if the building and the sponsor fit and you can wait for it. That's the price of a loan sized on the building, with no balloon and no deposit requirement.

On a $2 million loan, every 1% of rate is about $20,000 a year in interest. If a bank offers you a meaningfully lower rate and you qualify easily, that matters.

But compare the whole loan, not just the rate. Most bank apartment loans are a 5 year fixed with a balloon, so you refinance again in five years at whatever rates are then. Many use a 20 or 25 year amortization, which raises the payment on the same loan. Many require you to move your operating accounts. Agency loans often come with loan minimums, more third-party reports, and a longer timeline. A 30 year fixed apartment DSCR loan has none of those.

This is the one most owners don't see coming. The NOI used to set your loan isn't the NOI on your T-12. Underwriting adjusts it, and the adjustments almost always go down.

Here's a 24 unit building with an average rent of $1,300:

• Gross rent: $374,400 a year
• Expenses on the owner's T-12: $140,000. The owner manages the building himself and doesn't set aside reserves.
• NOI on the T-12: $234,400

Underwriting makes three changes:

• Vacancy of 5%, even if the building is 100% full: $18,720
• Management of 5%, even if you manage it yourself: $17,784
• Replacement reserves of $250 a unit: $6,000

The underwriting NOI comes out to about $191,900. At 7%, a 30 year amortization, and 1.25x coverage, the owner's NOI would support about $2.35 million. The underwriting NOI supports about $1.92 million. That's roughly $425,000 less loan from the same building.

This isn't unique to DSCR loans. Banks and agency lenders make the same adjustments, and some are stricter. But it's the biggest reason a loan comes back smaller than an owner expects. Knowing it up front means you can plan around it, or choose a structure that offsets it, like an interest-only payment or a program with a lower coverage requirement.

The most common structure is a step-down: 5% of the balance in year one, 4% in year two, and so on down to zero. Some loans use 3-2-1. On a $2 million loan, paying off in year two on a 5-4-3-2-1 costs about $80,000. Some longer fixed terms carry yield maintenance instead, which can cost much more.

A few things help. Some programs let you shorten the penalty in exchange for a higher rate. Some 30 year fixed loans carry a step-down only for the first five years. And select loans have no prepayment penalty at all. The penalty is set when you sign and can't be changed later, so ask before you commit.

A loan based on the building still means paperwork on the building. Apartment loans come with a commercial appraisal, an environmental report, often a property condition report, and a review of the rent roll and the leases. Those reports cost money up front and take weeks to come back. On a small building, the third-party costs are a bigger share of the loan.

Most loans also require a personal guaranty. On larger buildings, that changes: our interest-only apartment loans are available non-recourse at $2 million and up, with standard carve-outs.

Most long-term apartment loans want the building stabilized, usually around 90% occupied with a steady T-12. A building in the high 80s, still in lease-up, or just out of a renovation may not qualify for the full loan yet. Some programs want you to have owned a similar building before.

There are ways around this. Interest-only loans can work on buildings in the high 80s, because the lower payment covers more easily while occupancy climbs. Our Apartment Loans Under 90% Occupancy page covers that situation. But a building at 70% occupancy usually needs a bridge loan first.

For a lot of apartment owners, the tradeoffs above are a fair price for what the loan does.

• You want a 30 year fixed. No balloon, no refinance in five years, and no rate reset.
• You want cash out. Up to 75% of value on a refinance, with interest-only available on many loans for more proceeds.
• You've hit your bank's limit. Many banks cap how much they'll lend one borrower or how many buildings they'll finance in one market.
• You don't want to move your accounts. No deposit relationship is required.
• Your tax returns show a loss. Depreciation and cost segregation make a profitable building look like it loses money. The loan is sized on the building's income.

If one or more of those fit your building, the higher rate is usually buying you something real.