How do you get by the Debt to income ratio to grow your business?

Question

Hi All!

I am a part-time investor, own 5 long-term rentals outright and just getting into the STR's (just bought one in FL a few months ago, using the 2nd home 10% down strategy).  I have listened to Avery Carl's book, Short Term Rental, Long term Wealth about 15 times, so far.  (shout-out to Avery! this is hands-down the best all-encompassing book I've ever read or listened to, by a mile) .

I have a few questions like:

1) How does everyone get around the debt to income ratio?  We have very little debt outside of the STR we just bought on a conventional loan, have excellent income, but I fell like we will basically be limited to buying one more STR.  How do you guys get past this hurdle?  My goal is to have at least 4 STR's and keep the long terms going to cover for the STRs if occupancy rates decline (ie, another COVID situation or something worse).

2) I have read a lot about maximizing potential and buying many homes in different markets as 2nd homes.  That's great, but what do mortgage companies and the IRS consider to be a "different market"?  Is this simply a different county within a state (more than 60 miles from the first?), or is it a different state, etc...?  I'd like to know the details behind this, as well.

Thanks

Mike

Zach Edelman · Answer

Another vote for a DSCR loan. What I will add to what has not been said yet is you want to look for a DSCR lender that considers, underwrites, and gives credit to the property's rental income potential as an STR properly. What this looks like is underwriting with Air DNA projections if no history is available, being able to underwrite with actual booking history if it exists, and lastly, being able to underwrite with an STR based 1007. Lots of DSCR lenders out there that will get you in the door by saying they can help finance your STR, when in actuality, they're just banking on the appraisal market rent as an LTR somehow covering, or praying they can find an appraiser that can do an STR based 1007. Make sure you ask the right questions before making your selection of who you'd like to assist with your DSCR STR loan.

I wrote a post about "Best Questions to Ask your DSCR Lender (For STRs)" that I think will help. Here it is: https://www.biggerpockets.com/...

I wrote a post about "Best Questions to Ask your DSCR Lender (For STRs)" that I think will help. Here it is: https://www.biggerpockets.com/...

Luke Carl · Answer

Avery’s Husband here! You rock!

Don’t worry about DTI it’s an issue that only lasts your first year or two. Once your properties show income on tax returns they actually work in your favor.

The hard part is always and forever will be the CASH needed to purchase real estate. Focus on that part as much as possible. Eventually the properties buy the properties :)

Michael Baum · Answer

Another vote for looking at a DSCR loan. No DTI required but you need to find a lender who will use STR income projections. Most DSCR loans are for LTRs but there are a few lenders doing them for STRs.

Of course, paying cashola is the best plan.

Mason Liu · Answer

Hey Michael,

One thing you can do to avoid bumping into the DTI limitation is exploring non-QM products, for example a DSCR loan. Many of these products will only look at the property's income potential as opposed to your personal financials. These options are normally higher cost (higher rate + potentially higher origination fees + prepayment penalties), but you have a much easier time qualifying if you have a good deal, allowing for more scalability.

Matt "Roar" Gardner · Answer

Hey Mike! Congrats on the success so far.  I'll try to consolidate some of the thoughts above and give my two cents as an active agent and investor in the Destin and Tampa markets.

1. You're correct in that your DTI will be hit initially as you're trying to season your properties for the banks.  Most STR investors simply have to wait to show 1 or 2 years of tax returns to prove to a traditional lender that your business is consistently profitable to offset your DTI. Another potential way around that is to lease the property from yourself (this works better with a partnership); however, it is possible.  Banks are much more comfortable seeing a long term lease and consistent income over the variable income of an STR.  You'd still be running it as an STR, but you'd be leasing it from another LLC that you'd use to manage and take any additional profits.

To avoid the DTI discussion altogether, you can definitely pursue DSCR or bank statement loans to continue to grow the portfolio while you're seasoning your other properties.  These loans will look at your credit only and not your debt.  They'll then look at the property to see if it can support the debt.

Beyond that, there's always creative financing to pursue -- You could tackle your next STR via seller financing, loan assumptions, sub-to, seller carryback/down payment with a dscr loan, hybrid models, etc.

In other words, don't think just inside the box.

2. The second home differentiator will be determined by each bank.  I bought a second home just 15 miles from my house, and I've helped investors do it just 5 miles from investment properties that they own.  The simplest way is to be about 50 miles apart to justify it; however, a good loan officer can tell you if there is a way to help justify a second home loan status to the underwriter.

For example, if you have a 2 bedroom condo in Destin, and you want to justify a second home for your next purchase, it's really tough to justify that if your next purchase is another 2 bedroom condo.  However, if you end up purchasing a 5 bedroom, beachfront home as your next purchase, we can probably justify that to the bank that your family really wanted an upgrade and can't wait to enjoy this new luxury purchase on the Gulf of Mexico.

I hope that helps! Best of luck!!

January Johnson · Answer

@Raymond J. Rodrigues is a Florida mortgage broker who can help you with DSCR loans.  I've done several deals with him, and he ROCKS!  If you need info on the Destin market, I'd be happy to help you.  I work for Avery Carl here.

Ricardo Hidalgo · Answer

You need a high income or flip properties for quicker income. The number 1 thing I see is people maxing out their leverage producing 400$ profit a month when they could to make 10x in the money if they are in an equity market. Eventually you have to transition into higher income properties that can refi the equity.

Raymond J. Rodrigues · Answer

@January Johnson, thank you for the mention!

@Michael Littleton I would be happy to go over your loan profile and see what options you have based on your current situation. If you are in need of an awesome realtor, definitely reach out to @January Johnson!

Erik Estrada · Answer

Hey Michael,

Look into seller financing and DSCR Loans.

You can also do 100% financing on hard money loans if the goal is to buy under market, rehab and refi Into a long term DSCR loan.

Zach Wain · Answer

@Michael Littleton - The 2nd home option allows you to only put down 10%, but you can not use rental income to qualify.  And, it needs to be in an area that makes sense for a second home.  Common sense.  Would you buy a vacation home 10 miles away in a similar location?  No.  What about 100 miles away?  Maybe.  Why is it a second home.  Do you have family there, is it on a lake or beach, etc etc.

Once you get at least 1 full tax return done with STR income that will help a lot.  But, do yourself a favor and consult with a lender before your CPA writes everything off.  CPA's usually do their job only, and save you money on taxes, but if your rental losses $30k because of excessive write offs it could make your long term goals more challening.

Text prep with a draft, discuss with your lender before filing, and put yourself in a position to win.  And yes, DSCR is an option too.

How do you get by the Debt to income ratio to grow your business?

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