How to finance a future Padsplit??

[Michele S.]

Hello there,

I believe is my first post so bear with me. I have been lurking on here forever, but just recently became a member so that I can access all the extras.

I am considering investing in a home to Padsplit, but not quite sure what the best structure for financing would be. There will definitely need to be a reno budget to, at the least add bedrooms, and I am looking to stay under 400k. I chatted with a lender about the DSCR loans and he said that Padsplit (room shares) would not technically qualify for DSCR although if it's vacant at the time of closing, it should be fine. I don't want to do anything questionable and want to come out of pocket as little as possible. I have a high credit score but I am also possibly over leveraged. I do potentially have access to private money if needed, and a 401(k). I am new to this idea and in the beginning phases, so I'm not even sure what other questions I should be asking. I do not want to fully apply for anything at this beginning phase since I have more research to do, so hoping I can get some help here.

Thank you in advance for your expertise!

[Andrew Postell]

@Michele S. Ok, so basically if you have your 25% downpayment you can just go buy any property off the MLS. Any reason why we wouldn't just go that route and not need any renovation work?

[Austin Fowler]

Could you elaborate on what you mean by "having access to private money"? What return would that money want?

[Michael Dumler]

@Michele S., as a licensed real estate agent who focuses predominantly on rent-by-the-room acquisition, the majority of my clients finance their deals either conventional, DSCR, or cash. As a self-employed 1099 individual, your best route is most likely DSCR. Even though interest rates and terms won't be as desirable as conventional, you'll have an easier time getting pre-approved. Underwriting will assess the performance and appraisal of the property based on traditional long-term rental comps. Therefore, when you are analyzing deals, it's important that you also run the numbers as if you were to hold the property as an LTR. Moreover, most DSCR lenders require title to be held in an LLC. As far as financing the rehab, this will have either to be cash out of pocket or will need to come from your private lender. Hope this helps!

[Michele S.]

Quote from @Andrew Postell:

@Michele S. Ok, so basically if you have your 25% downpayment you can just go buy any property off the MLS. Any reason why we wouldn't just go that route and not need any renovation work?

I would most likely use MLS to find a property but for Padsplit I would want to add bedrooms and possibly bathrooms to maximize bedroom count.

[Michele S.]

Quote from @Michael Dumler:

@Michele S., as a licensed real estate agent who focuses predominantly on rent-by-the-room acquisition, the majority of my clients finance their deals either conventional, DSCR, or cash. As a self-employed 1099 individual, your best route is most likely DSCR. Even though interest rates and terms won't be as desirable as conventional, you'll have an easier time getting pre-approved. Underwriting will assess the performance and appraisal of the property based on traditional long-term rental comps. Therefore, when you are analyzing deals, it's important that you also run the numbers as if you were to hold the property as an LTR. Moreover, most DSCR lenders require title to be held in an LLC. As far as financing the rehab, this will have either to be cash out of pocket or will need to come from your private lender. Hope this helps!

 Thanks Michael!

[Robin Simon]

Quote from @Michael Dumler:

@Michele S., as a licensed real estate agent who focuses predominantly on rent-by-the-room acquisition, the majority of my clients finance their deals either conventional, DSCR, or cash. As a self-employed 1099 individual, your best route is most likely DSCR. Even though interest rates and terms won't be as desirable as conventional, you'll have an easier time getting pre-approved. Underwriting will assess the performance and appraisal of the property based on traditional long-term rental comps. Therefore, when you are analyzing deals, it's important that you also run the numbers as if you were to hold the property as an LTR. Moreover, most DSCR lenders require title to be held in an LLC. As far as financing the rehab, this will have either to be cash out of pocket or will need to come from your private lender. Hope this helps!

There is unfortunately a lot of issues going on in the DSCR Secondary Markets with regards to PadSplits right now - Wall Street is insistent on considering them SRO/Boarding Houses and are pulling back making financing these (if theres any sort of alteration at all) very challenging at the moment

[Michele S.]

Quote from @Robin Simon:

Quote from @Michael Dumler:

@Michele S., as a licensed real estate agent who focuses predominantly on rent-by-the-room acquisition, the majority of my clients finance their deals either conventional, DSCR, or cash. As a self-employed 1099 individual, your best route is most likely DSCR. Even though interest rates and terms won't be as desirable as conventional, you'll have an easier time getting pre-approved. Underwriting will assess the performance and appraisal of the property based on traditional long-term rental comps. Therefore, when you are analyzing deals, it's important that you also run the numbers as if you were to hold the property as an LTR. Moreover, most DSCR lenders require title to be held in an LLC. As far as financing the rehab, this will have either to be cash out of pocket or will need to come from your private lender. Hope this helps!

There is unfortunately a lot of issues going on in the DSCR Secondary Markets with regards to PadSplits right now - Wall Street is insistent on considering them SRO/Boarding Houses and are pulling back making financing these (if theres any sort of alteration at all) very challenging at the moment

 Thank you for that information! I have a scheduled call to Padsplit in just a few minutes

[Andrew Postell]

@Michele S.  I guess what I am really asking is that if there are 4 bedroom, 4 bath homes that already have what you need - why not just buy one?  Why over complicate it?

[Michael Dumler]

@Andrew Ball, there's some slight confusion/miscommunication here. Typically, PadSplit rentals are anywhere from 6 to 9 bedrooms per property. Identifying a home on the MLS that already has four established bedrooms is the route that one would take, however, after closing on the deal, additional bedrooms would be added to the property. Overall, you are correct. An investor would typically finance via non-owner occupied conventional at 20% or 25% down

@Robin Simon, so DSCR lenders use to underwrite the performance of the property based on the actual room rent? Every 1077 appraisal that my clients have received only accounts for traditional rentals/leased comparables in the area. Does this mean they're technically violating lending rules/regulations by not informing the lender that the property will be sourced as a rent-by-the-room asset?

[Robin Simon]

Quote from @Michael Dumler:

@Andrew Ball, there's some slight confusion/miscommunication here. Typically, PadSplit rentals are anywhere from 6 to 9 bedrooms per property. Identifying a home on the MLS that already has four established bedrooms is the route that one would take, however, after closing on the deal, additional bedrooms would be added to the property. Overall, you are correct. An investor would typically finance via non-owner occupied conventional at 20% or 25% down

@Robin Simon, so DSCR lenders use to underwrite the performance of the property based on the actual room rent? Every 1077 appraisal that my clients have received only accounts for traditional rentals/leased comparables in the area. Does this mean they're technically violating lending rules/regulations by not informing the lender that the property will be sourced as a rent-by-the-room asset?

Its still definitely a grey area and DSCR Lenders are different - but typically anything rented by the room (classified as "SRO" or "Single Room Occupancy") is an ineligible property type. Yes, it is a clear violation if you don't inform the lender its a SRO property by not providing a lease when the property is in fact under a padsplit lease. If the property is in fact vacant, the problem it runs into is proper comps where say it might have 9 bedrooms and the rest of the neighborhood and similar properties have 3. For a lender that may have to foreclose, its additional risk because the buyer pool for a nine-bedroom property in a residential area is very small

[Michele S.]

Quote from @Andrew Postell:

@Michele S.  I guess what I am really asking is that if there are 4 bedroom, 4 bath homes that already have what you need - why not just buy one?  Why over complicate it?

Keeping cashflow, maintenance and room sharing in mind, Padsplit works best with about 6-8 bedrooms. It can go higher or lower but according to other hosts that I've spoke to, that's the ideal room count. Also, if I found a 4/4 in the right area for the right price, I would still want to close up any living and/or dining areas and any interior community areas. This helps to avoid conflict. I am not necessarily looking for something that needs a lot of work outside of creating more bedrooms and making it Padsplit ready. 

[Andrew Postell]

@Michael Dumler thanks for the explanation here.

@Michele S. this scenario is quite challenging. It's similar to the whole "Short Term Rental" structure in that not only do we have to acquire the property but then we have to spend extra money to get it up to speed. In the STR world - that extra money is for the furnishings of the home. In this scenario - it's to get the home ready internally. Both require us to have extra money over what's normally required.

With Short Term Rentals - you cannot finance the furnishings.  You have to come out of pocket.  In this situation, I also think you would not be able to finance such renovations because all renovation loans will get their values off of "comps" - meaning, comparable properties surrounding the neighborhood.  So, if there aren't any comps for that property type, then you would be limited in the value that would be given, thus limiting the amount of renovations to be financed.  I would think in this type of a property you would need to be prepared to come out of pocket the entire renovation amount.  That is, unless you have other comps that show differently.

Hope all of that makes sense.

[Jeffrey Weller]

We have 3 Padsplit loan programs none of which require income verification and can close in an LLC. Please reach out to us. www.Padsplitloans.com

I am also a host with Padsplit with over 60 rooms at the time of this reply. 

[Jean Brune]

Quote from @Andrew Postell:

@Michele S.  I guess what I am really asking is that if there are 4 bedroom, 4 bath homes that already have what you need - why not just buy one?  Why over complicate it?

Buying it as an existing 4bd/4bth is doable. Depending on the market and your monthly PITI, you can still break even or even cash flow.

When you're responsible for customizing the layout you can get more creative and find extra space a builder missed out on because they wanted to include some type of flex space or amenity room or it just didn't fit their box. So, in that vein, you can find a home a builder thought was perfect with the extra spaces maybe 70 years ago and convert them into bedrooms. Very likely the seller doesn't know the income-producing value of those extra spaces and therefore has not included it in their pricing.

[Jean Brune]

Hi Michele! If you're still looking for more information on this, check this out: https://www.padsplit.com/host-resources/news/how-to-refinanc...

Quote from @Michele S.:

Hello there,

I believe is my first post so bear with me. I have been lurking on here forever, but just recently became a member so that I can access all the extras.

I am considering investing in a home to Padsplit, but not quite sure what the best structure for financing would be. There will definitely need to be a reno budget to, at the least add bedrooms, and I am looking to stay under 400k. I chatted with a lender about the DSCR loans and he said that Padsplit (room shares) would not technically qualify for DSCR although if it's vacant at the time of closing, it should be fine. I don't want to do anything questionable and want to come out of pocket as little as possible. I have a high credit score but I am also possibly over leveraged. I do potentially have access to private money if needed, and a 401(k). I am new to this idea and in the beginning phases, so I'm not even sure what other questions I should be asking. I do not want to fully apply for anything at this beginning phase since I have more research to do, so hoping I can get some help here.

Thank you in advance for your expertise!