Our 3rd Investment Property - Which Exit strategy?

Question

We have our 3rd Property under contract and plan to close in a week. The house is in a high appreciation area. Trying to figure out what the best exit strategy is. We are open to suggestions for different strategies than we're currently considering. We've been told seller financing may be a good option and we're open, just don't know how it would all play out, please advise.

We plan on paying cash for Acquisition & Repairs. This would be our first DSCR loan, and while I believe I have an idea of how it will all play out, looking forward to seeing the process.

Initial thoughts when putting property under contract were [repair, Rent, DSCR c/o, hold]. We will be taking possession with renters in place that are currently paying $750 a month. The plan is to wait to give them notice until day of closing, as requested by the seller. Rehab timeline less than 1 month after they vacate.

Now considering letting them stay, raising rent to $900/mo, completing minimal repairs as the house is currently in acceptable shape to them & good condition overall, DSCR c/o on a lower ARV. Will need to increase reserves going this route to account for future repairs. This will require less cash invested, shorter time frame to complete, and more cash we take from the deal.

Exit Strategy 1 - Have current Renters vacate, complete SOW, get new renters @ market rent, cash out on max ARV, HOLD.

ARV: 126,000

Acquisition: $60,251+ Closing $925

SOW Budget: $15,750

Rent after Rehab: $1,000

DSCR c/o $100,600 Loan @ 7.5% 30yr LTV80%: $840 PITI + Fees +/- $4000 (2pts+undw/orig/leg)

Cash Flow: $160 before Reserves

Cash Out - Cash In - Fees: $19,674 (100,600-60,251-925-15,750-4000)

Exit Strategy 2 - Have current Renters stay, complete light SOW, raise rent, cash out on lower ARV, HOLD.

ARV: 110,000

Acquisition: $60,251+ Closing $925

SOW Budget: $2,500

Increased Rent: $900

DSCR c/o $88,000 Loan @ 7.5% 30yr LTV80%: $752 PITI + Fees +/- $3800 (pts+undw/orig/leg)

Cash Flow: $148 before Reserves

Cash Out - Cash In - Fees: $20,524 (88,000-60,251-925-2,500-3800)

River Sava · Answer

Congrats on your third property, Tony!

It really depends on you goals as others have mentioned. Sounds like you are leaning towards the cash out with a lower ARV leaving plently ofopportunity to add value down the road closer to selling.

Also, some lenders allow a shorter seasoning period so that should not be an issue.

Stacy Raskin · Answer

There are less lenders who will do a cash out refinance if you want to use the new appraisal and if they do, they will charge a higher rate. There are lenders that will do a cash out refinance based on your purchase price and receipts at 3 months. You will get the most cash out options with the best rates and guidelines at the six month mark from when the title was recorded if you want to use the new appraised value.

Also, important to work with a mortgage broker or lender who specializes in DSCR programs and who will do them with a DSCR 1 ratio.

On another note, from experience, some lenders will do anything to get your business just to change the terms when they figure you're in too deep. I've been told that a loan would close at a rate that sounded pretty good from a lender, just to be strung along and to have the loan terms change last minute. Legally, the lender can change terms at any time for DSCR loans (it's not possible to drastically change terms for residential loans without a penalty for the lender) so it's very important who you work with on DSCR loans.

In case helpful, more details on DSCR loans: DSCR loans are based off of down payment, credit score and either actual or market rents so it helps to supercharge an investor's real estate goals and net worth. DSCR loans won't use your income to underwrite the loan.Here's a bit more in detail about how rates are calculated for DSCR loans:1. Credit score- the higher the best. 760+ generally gets best pricing for investment property loans with most lenders2. Loan to value ratio: The higher the loan to value ratio (LTV) is, pricing takes a hit. So your pricing will be higher for a 80% LTV loan than for a 60% LTV loan.3. Prepayment penalties- usually 1-5 year terms. The shorter the prepayment term has an impact on increasing the rate.4. Are you cash flowing the property? More on how that is calculated below. Is your DSCR ratio greater than 1-meaning are you cash flowing (according to the lender's criteria of mortgage, property taxes and insurance (and HOA) if applicable). Many lenders will not do a DSCR loan unless cash flowing. If they will do a loan with less than 1, the pricing takes a hit. This criteria is for 1-4 and 5-8 unit programs. I've included an example below to help illustrate this.So different lenders have different rates (which do vary even for DSCR loans) but these are factors they all consider.See example below:DSCR < 1Principal + Interest = $1,700Taxes = $350, Insurance = $100, Association Dues = $50Total PITIA = $2200Rent = $2000DSCR = Rent/PITIA = 2000/2200 = 0.91Since the DSCR is 0.91, we know the expenses are greater than the income of the property.DSCR >1Principal + Interest = $1,500Taxes = $250, Insurance = $100, Association Dues = $25Total PITIA = $1875 Rent = $2300DSCR = Rent/PITIA = 2300/1875 = 1.23DSCR lenders generally let you vest either individually or as an LLC. It's a great way to increase your net worth and these loans can also be used to pull cash out of a property as it appreciates allowing you to reinvest money into new deals.

Debi Kiddle · Answer

I would personally go with the second scenario. Time is money and there is a lot to be said for having a tenant in place. That way you have no vacancy, nor do you have to pay a realtor to find you a new tenant. If you pull permits and renovate, both your property taxes and insurance are very likely to increase, causing your cash flow situation to decrease. As you said, you can always renovate when it's time to sell. Plus, appraisers are very picky these days. Will it appraise at the fully renovated price if in an area that is just starting to turn?

All this being said, I am a flipper solely because I'm too afraid of bad tenants. I would rather carry a rental that is adequate but not renovated for less rent than have someone trash my hard work and investment, so I'm a bit less prone to too much risk. After 32 years in real estate, I have seen some pretty horrific stuff. Knowing the current tenant is respectful of your property and pays on time is golden IMO. Good luck!

Mike Klarman · Answer

Sometimes there's just no manual.  You just have to go through it.

Tony Pellettieri · Answer

Thanks KC! All great points.

I’m leaning more towards #2 as my upfront capital invested for repairs is much less, I’m still cash flowing positive about the same monthly, and the property will already be rented satisfying that requirement for the loan. If it is in fact 3 months before we can do a cash out refi, the entire rent - T/I will be cash flow adding a few thousand extra to the bottom line.

Although the ARV is less, we’re still pulling out more net cash, while investing less upfront. When we decide to sell, we can always complete the full rehab at that time. Currently the area is a little rough but many remodeling projects are taking place which is part of what is helping the appreciation of property in the area.

Mike Klarman · Answer

You'll only be able to cash out at 75% and you may have to wait 3 - 6 months to cash out from a cash purchase, keep that in mind.

I like getting new renters in there and receiving an empty property.  Doing the bigger budget and then renting it out at 1k.

Carrie Matuga · Answer

@KC Pake If it were me, I think I'd look at what your DSCR ratio is in each scenario and how much cashflow you are getting vs. your inputs and compare that to the amount you would be able to cash out refinance at 75-80%. You'll have closing costs in that second refinance to consider as well.

Tony Pellettieri · Answer

Hey Mike, Thanks for the insight. We’ve been talking to some Private Lenders/Brokers recently that say they can do a DSCR cash out refi in 3 months or less. Pulling all of our cash out of the deal, and then some, whether we’re using our own capital or a mix involving private capital is the goal, in regard to the time value/expense of capital. Perhaps there is some mistruth in what they’ve told me. Trust but verify as they say. Looking forward to gaining exposure to see all of the nuances involved and gain that experience.

Our 3rd Investment Property - Which Exit strategy?

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