How to Finance Investment Real Estate in Minnesota

Investors typically choose real estate for four reasons: price and rental income appreciation, monthly cash flow, tax treatment, and leverage. The four work together, and a fairly priced property in a good location is the foundation under all of them.

We are bankers, not investment advisors, so we will not tell you what to buy. What we can do is show you how financing shapes each of these levers.

Long-term appreciation and equity build

Well-run investment real estate produces cash flow each month while building equity. Every mortgage payment is made with proceeds from your tenant’s rent, and the money paying off your mortgage is essentially somebody else’s. Coupled with appreciation of the property itself, this is the core engine of real estate investing. Our post on investment real estate cash flow goes deeper.

Leveraging capital to increase returns

Commercial real estate lets investors put 20 to 25 percent down and finance the balance. Leverage lets you buy a larger project than cash alone would allow, which can increase returns. It can also magnify losses when a project underperforms, so use it wisely.

Depreciation and other tax deductions

Real estate investors have access to deductions that experienced tax accountants know well. Whether you are an active or passive investor, work with a knowledgeable accountant. Common items include:

• Interest paid on the mortgage
• Depreciation, including accelerated depreciation opportunities
• Operating expenses
• Business-related travel costs
• 1031 tax-free exchanges

The IRS publishes tips on rental real estate income, deductions, and recordkeeping.

One functional benefit worth knowing: as tenants pay down your debt and the property appreciates, you can often access that equity through refinancing and use it to reinvest in the property or acquire the next one.

Over the years we have seen many forms of real estate investing, and the most successful investors we work with build a niche. They specialize in an area, a property type, or a process, and they get very good at it. Common domains of expertise:

1-4 family rentals

The most common starting point. These properties are relatively easy to rent, easy to sell, and easy to finance, and the secondary market offers long-term fixed-rate financing for up to ten properties. The drawbacks: limited diversity in the rent stream and higher maintenance and management cost per unit. Many local investors focus on submarkets they know well, such as student housing around the University of Minnesota or the University of St. Thomas. Short-term rentals are their own niche with different financing; see our post on Airbnb property rental financing. Security Bank & Trust Co. has extensive experience financing investor-owned residential real estate, so if this is your focus, please give us a call.

Multifamily

A focal point for many Twin Cities investors. Understanding rental rates and expense attributes by building age, quality, and location is the difference between a good buy and a hard lesson.

Rehabilitation: value-add opportunities

Some investors focus on rehab, development, or other value creation. Some are called flippers, others developers, but the concept is the same: improve an existing property to meet new demand or unlock income the property could not reach in its existing condition. We have financed all types over the years and enjoy seeing the before and after.

Triple net leased properties

Probably the most common passive vehicle. The tenant is responsible for the ongoing expenses of the property, including real estate taxes, building insurance, and maintenance, in addition to rent and utilities.

Commercial real estate

Income-producing office, industrial, and retail can be a focused niche, often in a location the investor knows well. It tends to provide good cash flow and consistent payments, but holding periods run longer during vacancies and liquidity is more limited. A commercial property can sit empty for many months or even years.

Financing an investment property at a Minnesota bank generally takes three to six weeks from complete application to closing. The window covers underwriting of the property and the borrower plus a third-party appraisal. Here is how it breaks down at Security Bank & Trust Co.:

• Initial review: we verify your submitted documents and confirm the picture is complete.
• Underwriting: we analyze the property’s income and expenses and the borrower’s financial position.
• Appraisal: a third-party appraisal of the property, often the longest single step in the timeline.
• Proposal and closing: we present terms, and once accepted, move to documentation and closing.

Pro tip: organized, complete financials and a clear project overview are the single biggest driver of a fast answer. The more open and fluid the communication, the better we can customize the structure and work through anything underwriting surfaces.

Project Overview

Prepare a short executive summary covering the property, your plans for it, and the ownership structure. Include property data (square footage, address, other building facts), copies of any leases, and personal financial statements and tax returns for the borrower and any guarantors. Our commercial loan application checklist shows the full document list.

Net Operating Income (NOI)

Net operating income is rental income minus operating expenses, before interest, income taxes, depreciation, and amortization. It is the cash flow available to service debt and the starting point for most investment real estate underwriting.

Debt Service Coverage Ratio

Debt service coverage ratio is NOI divided by annual loan payments. It measures the property’s capacity to carry its debt. A ratio of 1.20x or higher is a common benchmark in commercial real estate lending; your lender will discuss the target that fits your property type and project. Want the math with examples? See how much can my business borrow: debt service coverage ratio.

Capitalization Rate

A cap rate is net operating income divided by the purchase price. It shows what a property would earn if purchased with all cash, and it is the common yardstick for comparing properties. Review the cap rate against historical periods: cap rates move with the economy and interest rates, and where they sit affects both your leverage and your risk profile.

Loan to Value

Loan to value is the loan amount divided by the appraised value. On commercial investment property, 80 percent or lower is typical across the industry, which usually means a down payment of at least 20 percent of the lower of value or purchase price, plus closing costs.

Underwriting works a little differently for income property than for an operating business; our post on commercial real estate underwriting walks through the property-level analysis. Already own investment property? Refinancing commercial properties in Minnesota covers when a refinance makes sense.

What is investment real estate?

Investment real estate is property acquired to generate income, most commonly through rental or lease income or through value-creating development. Common types include agricultural land, retail, multifamily, 1-4 family rentals, office, industrial, self-storage, mixed-use, and development projects.

How much do I need to put down on an investment property?

On commercial investment real estate, lenders typically finance up to 80 percent of the appraised value or purchase price, whichever is less. That usually means a down payment of at least 20 percent, plus closing costs.

How long does investment real estate financing take?

Generally three to six weeks from a complete application to closing. The window covers document review, underwriting of the property and borrower, and a third-party appraisal, which is often the longest single step.

What is a good debt service coverage ratio for an investment property?

Debt service coverage ratio is net operating income divided by annual loan payments. A ratio of 1.20x or higher is a common benchmark in commercial real estate lending. Your lender will discuss the target that fits your property type and project.

What documents do I need to apply for an investment property loan?

A short project overview covering the property, your plans, and the ownership structure, plus property data, copies of any leases, and personal financial statements and tax returns for the borrower and any guarantors. Organized, complete financials are the biggest driver of a fast answer.

Can I get long-term fixed-rate financing on 1-4 family rental properties?

The secondary market offers long-term fixed-rate financing on up to ten 1-4 family rental properties per investor. Beyond that limit, or when a property does not fit secondary-market rules, community banks like Security Bank & Trust Co. finance these rentals directly.

What is a capitalization rate?

A cap rate is net operating income divided by the purchase price. It shows what a property would earn if purchased with all cash, and it is the common yardstick for comparing investment properties and tracking how pricing moves with the economy and interest rates.

What is net operating income?

Net operating income, or NOI, is rental income minus operating expenses, before interest, income taxes, depreciation, and amortization. It is the cash flow available to service debt and the starting point for most investment real estate underwriting.