Impossible to get a loan on a single family rental

Buying & Selling Real Estate
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Impossible to get a loan on a single family rental

Daniel Rasmussen
Property Manager · Los Angeles · Member since 2019 · 16 posts · 6 votes

As the title and description suggest, I feel like I have found myself in the perfect storm of circumstances that have made it impossible to find a lending solution for a single family rental property I am interested in. A little back story on my situation:

I currently own one single family rental (almost identical to the one I am currently trying to purchase) in Milwaukee, WI. It is an 800 square-foot, 2br/1ba single family home in a C neighborhood with a purchase price of $52,500 and a rental rate of $750 a month. I bought this property a year ago and was able to get a 30-year conventional loan with 20% down. I am a resident of California, so I am obviously in an out of state market, which poses its own challenges, as I will discuss below.

The property I am looking at now is virtually identical to the one I own. It is a 2br/1Ba listed at $55k and rents slightly below market to a long-term tenant at $700 a month. As we all know, the economic uncertainty surrounding Covid has caused lenders to shrink and/or restructure their lending capabilities. The lenders that were willing to lend me 80% of $53k last year have now told me they cant go below a $50k or even $100k loan amount.

I have spoken to dozens of credit unions in Wisconsin. The only ones that were willing to lend less than $50k had membership rules that required that I lived in Wisconsin, which I do not.

I have spoken to several banks. Wells Fargo was the only one who was willing to lend on it, and they came back the following week and said they just had an update to their lending standards and that they were no longer lending on any investment properties (which makes no sense to me). 

I have also looked at hard money and personal loans. While those are actually attainable, with the high interest rate, the monthly payments put me in a negative cash flow position. In a best case scenario, even if I were to borrow a small enough amount to maybe break even for the first few years, the amount of money I would have to put down would make my Cash-on-cash return not even worth the investment. 

All this to say I feel like I have exhausted every idea and I am not totally sure if there is actually a viable solution that even exists. I am hoping my trusty bigger pockets community can provide some input/advice that might bring some new perspective.

Thanks, and happy investing!


Daniel

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Marcus Auerbach
Investor · Milwaukee - Mequon, WI · Member since 2010 · 5k+ posts · 7k+ votes
6y

@Daniel Rasmussen that's a tough one! 

The issue is with the property, not with the lenders - we had some hesitation in April and May with rental properties, but banks are wide open for business latest since summer. Lenders are currently overrun with residential (owner occupied) refi's and they take about 60days with backlog, so they prioritize purchase loans generally. So they have more business than they can handle at the moment and the paperwork and process for a bank (and the loan officer) is the same, so they rather do a $400k loan than a $40k loan.

There are a few issues with the type of properties  (I used to say sub 50k, but now it's really sub 100k). I have spent a lot of time on the economic model with clients, but mostly for myself - I have been activly buying single family rentals in Milwaukee for over ten years and stil am. I have tried and done a lot of things and learned from my many mistakes, let me share a few concepts, even though you won't like it, I hope it will help.

So, when you look at the economic model of a 50k property, it's not only bad business for a bank, it's also bad business for the investor, for a number of reasons.

Tiny 2 bedroom homes have a really bad income to operatingexpense ratio. As you know rent is quite low (median in Milwaukee is about 1,200 for a single family) yet you have the same infrastructure to maintain: one kitchen, one bath, one HVAC, one water heater etc - cost of replacing a water heater is the same, no matter if your rent is 700 or 1200 or 1600 (which is our typical rent for a SF).

Income (rent) is a function of size: bedroom and bathroom count as well general space meaning square footage. Rough rule of thumb is about one dollar per sf, give or take depending on location and conidtion. 

That's why you have a bad income to expense ratio. Financially the problem with sub 100k properties is that over time capex will exceed capex. This is a very sneaky issue, because you don't realize it until five years in or so and you start hemoraging slowly and first you hope it will get better, but it only get's more expensive. The alternative is to accept the progressing deteriation, rent to inferior people until you can't rent it anymore at all.

The median price point for a single family in Milwaukee is $192k as of September 2020. We have a housing shortage and everything decent sells within a day or two, usually significantly over asking. In contrast inner city properties are a different story, a market with a different dynamic: poverty and crime are high, it is sometimes difficult to sell a property, because nobody who can qualify for a loan wants it or the loan amount is so small that no bank wants it. They are really classified as D neighborhoods. Most experienced PM companies will not take on houses in that area, same with contractors. 

I am not even going to go into mangement problems, tenant drama, domestic and violet crimes, vacancies and rent collection issues..

I have seen the backend of the story as well, because I am getting calls from out of state investors, who have accumulated small portfolios of these low end properties and when they start they are loosing money after a few years they want to liquidate the portfolio which is not that easy. 

I can't even make the numbers work as an agent, the overhead of my team is too high, we are geared up to meet service expectations for 200k plus listings, so your best bet to sell is probably to contact wholesalers.

The only way I have ever seen you can make money with a sub 100k property is by getting in and out before your capex sets in. 

A good way is to lease option it to the tenant, because now it is an owner occupied loan and you can use products like FHA or WHEDA - I should say your tenant/buyer can. These loans are designed to stimulate homeownership (not investments).

Maybe you can get a HELOC on your primary and use that to fund your property until you have a suitable loan or other exit strategy?

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  • Aaron K.
    Specialist · Riverside, CA · Member since 2015 · 6k+ posts · 3k+ votes
    6y

    Not sure if it would help here but perhaps a blanket loan to cover both of the properties.

    2Reply
  • Bonnie LowPro Member
    Lender · Asheville, NC · Member since 2016 · 1k+ posts · 1k+ votes
    6y

    @Daniel Rasmussen have you considered actually going bigger? In other words, find more than one home and put the multiple properties together in a portfolio loan. The underwriting might be more palatable to a small local bank right now. Just a thought.

    [email protected]
    1Reply
  • Daniel Rasmussen
    OP
    Property Manager · Los Angeles · Member since 2019 · 16 posts · 6 votes
    6y

    @Aaron K. and @Bonnie Low thank you both for the advice. On a couple occasions I have discussed the option of combining my existing loan with the new property or getting a portfolio loan for multiple properties. I must admit, I am not as familiar with the nuances of those types of loans, and the one or two people I talked to said they didn't have a loan product like that, so I moved on from the idea pretty quickly. 

    Based on both your comments, however, it sounds like both approaches may be worth looking into further.

    Thanks a bunch!
     

    1Reply
  • Bob Floss II
    Attorney · Northbrook, IL · Member since 2017 · 719 posts · 549 votes
    6y

    @Daniel Rasmussen There's not enough discussion of this topic when investors talk about investment strategies. I always warn my clients that pulling your money out of a single family rental is challenging at best. Underwriters hate them and will either turn them away or give you a long list of requirements you can't possibly satisfy. I've had many clients go in with a portfolio ranging from 5 to 10 single family rentals and the banks treated them like horrible. The reality is you either need a private lender to put a mortgage on the property or a commercial lender that won't let you pull out as much equity as you were hoping. It can be done but you have to work hard at it. 

    0Reply
  • Marcus Auerbach
    Investor · Milwaukee - Mequon, WI · Member since 2010 · 5k+ posts · 7k+ votes
    6y

    @Daniel Rasmussen that's a tough one! 

    The issue is with the property, not with the lenders - we had some hesitation in April and May with rental properties, but banks are wide open for business latest since summer. Lenders are currently overrun with residential (owner occupied) refi's and they take about 60days with backlog, so they prioritize purchase loans generally. So they have more business than they can handle at the moment and the paperwork and process for a bank (and the loan officer) is the same, so they rather do a $400k loan than a $40k loan.

    There are a few issues with the type of properties  (I used to say sub 50k, but now it's really sub 100k). I have spent a lot of time on the economic model with clients, but mostly for myself - I have been activly buying single family rentals in Milwaukee for over ten years and stil am. I have tried and done a lot of things and learned from my many mistakes, let me share a few concepts, even though you won't like it, I hope it will help.

    So, when you look at the economic model of a 50k property, it's not only bad business for a bank, it's also bad business for the investor, for a number of reasons.

    Tiny 2 bedroom homes have a really bad income to operatingexpense ratio. As you know rent is quite low (median in Milwaukee is about 1,200 for a single family) yet you have the same infrastructure to maintain: one kitchen, one bath, one HVAC, one water heater etc - cost of replacing a water heater is the same, no matter if your rent is 700 or 1200 or 1600 (which is our typical rent for a SF).

    Income (rent) is a function of size: bedroom and bathroom count as well general space meaning square footage. Rough rule of thumb is about one dollar per sf, give or take depending on location and conidtion. 

    That's why you have a bad income to expense ratio. Financially the problem with sub 100k properties is that over time capex will exceed capex. This is a very sneaky issue, because you don't realize it until five years in or so and you start hemoraging slowly and first you hope it will get better, but it only get's more expensive. The alternative is to accept the progressing deteriation, rent to inferior people until you can't rent it anymore at all.

    The median price point for a single family in Milwaukee is $192k as of September 2020. We have a housing shortage and everything decent sells within a day or two, usually significantly over asking. In contrast inner city properties are a different story, a market with a different dynamic: poverty and crime are high, it is sometimes difficult to sell a property, because nobody who can qualify for a loan wants it or the loan amount is so small that no bank wants it. They are really classified as D neighborhoods. Most experienced PM companies will not take on houses in that area, same with contractors. 

    I am not even going to go into mangement problems, tenant drama, domestic and violet crimes, vacancies and rent collection issues..

    I have seen the backend of the story as well, because I am getting calls from out of state investors, who have accumulated small portfolios of these low end properties and when they start they are loosing money after a few years they want to liquidate the portfolio which is not that easy. 

    I can't even make the numbers work as an agent, the overhead of my team is too high, we are geared up to meet service expectations for 200k plus listings, so your best bet to sell is probably to contact wholesalers.

    The only way I have ever seen you can make money with a sub 100k property is by getting in and out before your capex sets in. 

    A good way is to lease option it to the tenant, because now it is an owner occupied loan and you can use products like FHA or WHEDA - I should say your tenant/buyer can. These loans are designed to stimulate homeownership (not investments).

    Maybe you can get a HELOC on your primary and use that to fund your property until you have a suitable loan or other exit strategy?

    5Reply
  • Steve Smith
    Member since 2020 · 217 posts · 167 votes
    6y
    Marcus,

    VERY GOOD advise. I'd call this slumming, which is a LOT of work with questionable rewards, as we've already seen.

    With another piece of advise... don't do long distance rentals, they rarely work well. Stay local, even though CA is much higher. However, there are some spots in CA where the numbers are worth looking at. If you're close to Sacramento or Fresno, those are two good starting areas.
    1Reply
  • Darius Ogloza
    Investor · Marin County California · Member since 2018 · 1k+ posts · 2k+ votes
    6y

    Marcus: your focus on the exit strategy (or lack of a viable one) in connection with cheap out of area SFR's is spot on. In addition to accumulating deferred capital expenditures you also have the issue of depreciation recapture so that you could end up with a taxable gain on sale of a thoroughly deteriorated property. Too few people in government and in the media understand this inexorable economic reality and thus try to paint "slumlords" as bad people. Truth is you simply can't fight gravity unless you truly have money to burn. If you are going to light something up, better a smooth Cubano (alongside a snifter of cognac) than a cheap-*** house.

    2Reply
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