Crossing From Four Units to Five

One to four residential units is financed like a house. Five and above is financed like a business. Nothing about the building changes at that line, but almost everything about the money does.

What changes at five units

• Conventional residential loan products stop being available
• The lender underwrites the property's income, not primarily yours
• Terms shorten, amortization lengthens relative to term, and a balloon appears
• Down payment requirements typically rise

Debt service coverage becomes the test

Lenders want NOI to exceed the annual debt service by a margin — commonly expressed as a ratio comfortably above 1.0. If the building does not clear that, the loan shrinks until it does, regardless of the purchase price you agreed.

The upside of crossing the line

Value is driven by income rather than comparable sales, so operational improvements convert directly into equity. On a fourplex you are at the mercy of what the fourplex down the road sold for. On a six-unit you are not.

Where people get caught

Underestimating reserves, assuming residential-style 30-year fixed terms will be available, and buying on a pro forma rent roll that the current operator has never actually achieved.