How hard is it to get financing on SFR rental property

Question

Good Evening everyone!

I am looking for some advice/opinions on a build I am about to do, and greatly value any input from those of you with more knowledge on the subject than I!

I typically buy and sell property to make a quick profit, but have recently been valuing/considering long term income properties in the form of single family homes to obtain passive income.

I recently went under contract for a lot with intentions of building a small house with cash to resell for profit. Only recently I have been tossing around the idea of seeing if it would be possible for me to turn the property into a rental, and after building the house have it financed as income property. I would still like to build in cash so that I can do it on my terms, but would need to cash out when it is done to put into other investments.

So heres the details.

Purchased a lot for 8K in community with strong growth and a very desirable rental market. I plan to build a small simple 3 bed 2 bath home for +/- $100,000. I estimate the value if I were to turn around and sell it the home would be worth approximately $170,000, or rent for approximately $1,300+ per month.

I do not have acceptable proof of income to qualify for a mortgage personally, but am curious if you all have found it easier, or harder to receive a loan for a rental property? I figure I should be able to cash flow around $400 if I were able to finance the $110,000 as sort of a "cash out" finance and use the original money to rinse and repeat while adding $400 +/- passive income each time. Like I said I do not have any experience with rental properties so anyone with experience would be appreciated to chime in! I'm trying to decide which route I want to go with the build before selecting exact plans/finishes etc.

Julie Falen · Answer

As a lender and an investor, I have found it is much easier to receive a loan for a rental property, especially if it is already leased.   Of course I do quicker, easier "subprime/Non-QM" loans that are a little higher in rate than bank loans, but think the concepts are the same.  If the building and lease can service the debt of the Principal, Interest, Taxes and Insurance at 120%-125% of the total payment, (DSCR 1.2 - 1.25)  you are very well situated and not much personal income comes into play.  In my field, we do  not even ask for proof of income, which is why rates are a little higher but well below hard money rates

That being said, there is a BIG caveat to be aware of!  Fannie Mae and Freddie Mac and FHA keep changing guidelines, but right now you are limited to 4 govt-backed (or bank loans) at 1 time.   If you have MORE than 4 properties, even if you only have 4 govt-backed loans (Fannie etc) - you are Not Allowed to take cash out from any of your properties using a Fannie or Freddie loan.  Something to consider or keep in mind. That means you are not going to have >4 loans right now that are in the 3%-4% range.   I don't know what you were calculating your cash flow on, but I suspect it is close to those rates.

Upen Patel · Answer

@Julie F. The limits you stated for conventional loans are absolutely wrong. Each individual is allowed a total of 10 financed properties (including the primary residence). You can do Cash-out financing up to 6 properties. 7-10 can be purchase, delayed financing or rate/term refi.

@Colton Joseph A lot of different incomes can be used to qualify for conventional loan - W2, 1099/Self Employed, Rental income (including rental income of the property being financed). What you want to do is find a mortgage banker that has no/min internal overlays, so you can use all the possible sources.

Ross K. · Answer

Greg S.

Colton Joseph

For the type of loan you're looking at, you could probably take out 75% of the appraised value, or about $127,500 and use the built-in equity as your 25% down payment.  The higher loan amount will slightly reduce your monthly cash flow, but you pull out more money than you put in so you have more capital for the next one!

Thomas S. · Answer

You also need to keep in mind that if the property is worth $170,000 and you refinance $110,000 you are leaving $60,000 in the property. Assuming the opportunity value of the $60,000 is in the 10% range you need to take $500/month off of your cash flow from the property first to insure your equity is also earning a return. Will that still leave you any cash flow on the property or will it then be negative.

Colton Joseph · Answer

Thanks for the responses! Thomas S. Thank you as well! That would definitely be nice if I could pull out as much, or like you said even more than I have in it. That would leave me the opportunity to add and repeat as many times as I can find the right property, and financing adding $400-$500 passive income each time while also building equity in the homes. I would like to shortly add some stable income rental so I have a consistent form of income as well as the buy/sell type deals. That way one bad deal couldn't make me go broke!

Thank you both for the input and Cheers to Success!

Julie Falen · Answer

@Upen Patel  Thank you for the correction.  As I do not do those loans regularly anymore I am not as up to date.  i just had a client 6 months ago who came to me because he had  10 financed  properties and the bank told him he could not do a cash-out refi because he exceeded the limits allowed.  When I checked wtih his lender, I was told the same thing.  Ah the speed of changes!

@Colton Joseph - You might want to talk more to Upen Patel as he can probably tell you more about seasoning than I could also as far  as taking cash out of a completed building.   I recommend you also look into doing a 1031 tax-deferred exchange when you ell your property. I think you would ave 60 days to put that money into a new property. No capital gains, smaller tax.

Colton Joseph · Answer

@Tommy F. that quote holds a lot of truth! Unfortunately I do not own my primary residence. I will have the cash to do the deal myself though, and I'm pretty certain I'm going to go ahead and do it. The only thing really in question is if I will sell imediately on completion accepting the tax burden, or turn it into a rental property! As far as holding it for a year unfortunately that's not in the cards for me at the moment! Thanks again for all the opinions!

Colton Joseph · Answer

Hey @Tommy F. thanks for the detailed opinion. Both positive and negative opinions are appreciated as I am a realist. Although you make valid points, most of them have been checked/dont apply to my situation. First off in the example of a 3 bed 2 bath that is worth 170k in the area that would be built for 100k. The 170k valuation is based on a 1100 square foot home which is much smaller than the 1600 PSF that you assumed. That would put us at about $90PSF of construction costs including permitting, sewer/water tap fees etc that are only $2,700 in the small community that I am building in. This can be done by a quality builder in central texas with lower-mid end finishes. A house as such has comps of $155 PSF in the same area/finish out/ size range putting us at a hair over 170k valuation. Homes are going up like CRAZY in this little lakeside community. (like 30 in a tiny established community at the moment.)

All utilities are available for a low $2,700 at the property which is properly zoned for my intended use. I was sure to check those details before putting the lot under contract...

So what we are looking at is 8K lot cost + 100k home cost (everything from permits to grass included) =108k cost. 170k selling price-108k Build cost= 62k profit minus sales commissions etc due at closing. Now the point I agree with you on the most... TAXES... yes I agree it would probably be considered inventory and taxed at a high tax rate if I sold immediately. That is what made me consider trying to turn it into a rental in the first place.

And last point... my past taxes have been filed however they were filed as "capital gains" last year by my FORMER CPA who had no idea what he was doing. I have tried to get a construction to perm this year and did not qualify because the banks don't see "capital gains" as stable income.

That is where the original question spawned from...Is it easier to finance a house as an income property if you pay for the build in cash, have it leased, then Refi, or "sell it back to yourself" so to speak using the instant equity as a down payment.

RECAP: I buy lot, and have house built for $108,000 in cash.

I have the options to turn around and sell for $170,000 pay commissions and taxes which take a huge chunk.

Or finance it after completion as a rental property and cash flow $400-$500 per month while still getting my original $108,000 back. The lease seems it should serve as proof to the bank that the loan will be repaid plus there is a good bit of equity in it for the bank per the other responses. By that point I will have strong 2016 tax evidence, and my decent 2015 tax evidence filed wrongly as capital gains to back it up as well.

Thanks Again for taking the time to read/ give you response!

How hard is it to get financing on SFR rental property

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