how do the loans work as you scale?

[Andrew C.]

Today, I own a small real estate company (LLC partnership). It owns 1 property, which it rents, and has one mortgage against that property, which it pays. I personally guaranteed that loan based on my assets and income, which is fine for now. But...that clearly won't scale and the point of doing this is to be able to quit that W2-paying job. So at some point there must be a way to not have to guarantee future loans. How does that work?

Let's fast-forward a bit as this RE business scales. Let's say it owns 20 properties, each with PV 150K. It has 3M in assets and 2.4M in mortgages, for net assets of 600K. It gets 1% per month in rent and pays .8% per month in expenses (PMI, maintenance, mgt co, etc).

So at the end of the year, that business files the following:

income: 1.5k*20*12: 360K

expenses: 1.2K*20*12: 288K

profit: 72K

depreciation: 3.5% * 3M == 105K

that entity files (because it's a partnership) and it issues a K1 to each of the partners (me + spouse) that passes everything through. And let's say I've since quit the W2 job. collectively, our personal return would look like:

72K passive income, 105K passive loss. So 72K income and no taxes, with some carried fwd losses. woot.

That's pretty great, but it's not going to support signing as the guarantor for the loan on houses 21-25 that the business wants to acquire, or to sign my personal income against new loans if the business wanted to refi the current 20 houses.

So, at SOME point, it seems the business has to be able to do this on its own. It has, in this example, 360K in income and a track record of renting houses profitably. Are there loan types that it could apply for that would not require me to guarantee it based on my income? Surely this is how larger rental business scale, right? What are those loans called, and what's required to qualify for them?

[Andrew Garcia]

Hi @Andrew C., (great name by the way) most people start off in conventional. You can get up to 10 conventionally financed properties in your name. Those come with the lowest rates but they do not lend to business entities. 

Therefore, you will be looking at a few different options:

1. DSCR - They lend to business entities and they qualify you based on the income generated by the property, not your personal income.

2. Business purpose loans - Similar to the DSCR. They qualify the business based on the business's income generated from properties. You can use this to fix up, buy, or renovate properties.

3. Portfolio loans - This is where you start to have a lot of different properties. You can cross-collateralize them and they typically do not require you to personally guarantee them.

Hope this helps! Let me know if I can be of any assistance.