Scaling a Bay Area Portfolio

[Michael Hyun]

Hello everyone!

I’ve been trying to figure this out lately, but I recently purchased a negatively cash flowing property. Yes, I know - you should never buy a negatively cash flowing property, but I truly believe in the Bay Area appreciation, so I’m willing to take a negative and pay the remainder.

My question is: how do I buy my next three homes? The problem is with DTI. I recently learned that banks will only consider 75% of your rental income as income. So if I break it down with hypothetical numbers:

W2 Job income(example): 15,000 gross monthly

Rental income from property 1: 3500 monthly

Actual income from rental property 1(according to the bank): 3500x0.75 = 2625 monthly

PITU for property 1: $4200

That means my DTI would be (4200)/(15000+2625) or 23.8%. Is that right?

This is assuming I live with my parents, but if I were to rent a place - add another 1500 for rent.

(4200+1500)/(15000 +2625)= 32.3% DTI.

Now, being in this position, how could I afford another home??

[Dan H.]

Originally posted by @Michael Hyun:

Hello everyone!

I’ve been trying to figure this out lately, but I recently purchased a negatively cash flowing property. Yes, I know - you should never buy a negatively cash flowing property, but I truly believe in the Bay Area appreciation, so I’m willing to take a negative and pay the remainder.

My question is: how do I buy my next three homes? The problem is with DTI. I recently learned that banks will only consider 75% of your rental income as income. So if I break it down with hypothetical numbers:

W2 Job income(example): 15,000 gross monthly

Rental income from property 1: 3500 monthly

Actual income from rental property 1(according to the bank): 3500x0.75 = 2625 monthly

PITU for property 1: $4200

That means my DTI would be (4200)/(15000+2625) or 23.8%. Is that right?

This is assuming I live with my parents, but if I were to rent a place - add another 1500 for rent.

(4200+1500)/(15000 +2625)= 32.3% DTI.

Now, being in this position, how could I afford another home??

The biggest issue I see is not that the property is negative cash flow, but the extreme negative cash flow. PITI $4200, rent $3500. 5% vacancy, $300/month maintenance/cap ex, 8 to 10% PM. This property likely has a negative cash flow of over $1.5k. It kills your debt to income.

San Diego is not quite Bay Area, but has horrendous rent to value ratios.  Most owner occupied, non investment purchases have initial rent to purchase ratio below 0.5%, but the better investors are typically finding over 0.7% ratio.  

The word initial is also very key. You are betting on property appreciation. However there is a correlation between property appreciation and rent appreciation. Most of the cost associate with an residential investment property is fixed or near fixed in CA (p&i, property tax (thank you prop 13)). This implies that the cash flow situation quickly improves resulting in improving DTI. in my market rents are going up over 10% this year and I expect this will continue for the next few years to "catch up" with the property appreciation and to compensate for the elevated risk associated with the covid eviction moratorium.

Good luck