How do you get top rents for DSCR financed BRRRR properties?

Question

In the last years, the rent amount on a BRRRR property has become the defining factor for the loan amount. It used to be mostly LTV and appraisal, now it's the 1.2 DSCR, so in that way rent is becoming the limiting factor. What really took me by surprise was that one of my go-to lenders here in Milwaukee is using my portfolio expense ratio (!) to determine NOI on a brand-new rehabbed single-family property that should not have any operating expenses.

The problem is of course that we have always reinvested a large portion of our cash flow into systematically improving our assets, so I show a substantial % for repairs and maintenance on our P&L. We also don't push rents to the absolute max and rather optimize towards finding really great tenants that stay long term.

That's why we also choose high-end finishes to get great tenants and top rents - here is a walk-through video on some of the things we typically do. This is a property I bought 7 years ago and back then we did not do the same level rehabs as we do today.

Do you run into the same issue? How do you navigate it?

Ko Kashiwagi · Answer

Hi Marcus,Doing the homework and aligning the style of the home to comparable homes getting the top rent is definitely important. For instance, if the top market rent properties have a pool, it would be important to have a pool.For 1-4 units, you could still get qualified for 75% LTV with 1.1 or even 1.0 DSCR. For commercial multi-family, this will be different, and having 1.20-1.25x could be the requirement for best rates and terms.

Robin Simon · Answer

It really comes down to a LTV being low enough it will always make sense to the lender, because truthfully get low enough on LTV then it can even flip where default and foreclosure is preferred! (50% LTV low enough to where if it doesn't cash flow, who cares, lender can take a property at twice the value of the loan)..Theres other sub-1 DSCR situations that make sense at least in reality (vs. not in paper), but this is generally the way to make these deals make sense in this context (high value no cash flow markets like CA)

Carlos Ptriawan · Answer

A lot of industry DSCR requirement doesn't make sense actually, typical cap rate right now for single family with average price of $1.3 mil in SJC is about 1.5-2.0% right now, DSCR is whooping low 0.3-40. I don't know how you guys could qualify DSCR rental in CA these days. Now that our friend in Milwaukee is having trouble getting financing of his own, and we speak about Milwaukee here where not too distant ago, it was in double digit cap rate territory. my question to you lender folks how are you adjust to these situation ? also given a flip interest is 11% and dscr rental investment is 8-9% it's almost doesn't make sense to hold property for too long. This question is for lender.

Robin Simon · Answer

I would say that a 1.20x DSCR ratio minimum for BRRRR is a bit high - plenty of options out there that wouldn't require such a hurdle

Marcus Auerbach · Answer

Absolutely. We have such a housing shortage in Milwaukee that people will get desperate enough to sign up for more than they can/want really handle - and then move. We had one of these guys who is currently in a $4,400 apartment and wants out. Just not sustainable long term. There is a sweet spot though. That is also the reason why we always finish basements in SFR's like I mention in the video: people stay longer and thatis huige for us. I think our average tenure is over 5 years and I figure a turn over will cost us on average 5k. So we basically try to build a golden cage for them, door is open after the 1 year lease, but they don't want to leave..

Marcus Auerbach · Answer

It basically comes down to choosing a demographic. 100% of our tenants would be able to buy a house, they just don't want to. And then you have to figure out what they want. Hint they have high expectations, which is why we spend so much money on assets. But they are also willing to pay for it. I stay away from the luxury segement, I believe it's too volatile. This may surprise you, but we see rents in Milwaukee as high as 4k to 8k - like the new Ascent building downtown or the Spur16. But we like the premium segment that is affordable for two income professionals. And the tenants are generally very pleasant to work with.When I worked for a construction equipment manufacturer, we designed a brand new line of skid steer loaders and what we found was that all the profit came from the large machines. The little ones for the small landscaper were just over break even, because you still need a chassis, an engine, hydraulics, a seat - the cost does not change much. On the flip side, the large models did not cost that much more to produce, but the market would pay much more for a 10,000lbs top model. The same is true for rentals. A water heater costs the same, wether your rent is $800 or $1800 or $2800.

Corby Goade · Answer

Great points, thank you. Interesting to hear about the rent premium you can get in your market.

Marcus Auerbach · Answer

I think you are right from a CoC point of view. There are other soft factors that compell me to shift more of our portfolio in that direction. Asset value and equity is one. Significantly longer tenancy is another, which reduces turnover and cuts down on our turnover cost, which is our single biggest operating expense.Like I discuss in the video the ROI on finishing a basement is pretty terrible, but it ads to the life style we are looking to create.In terms of rent, this is more than double the median for Milwaukee. We are usually at about 1.5 times median and rent to people who are looking for a lifestyle and not just a roof over their head. Number of doors is not an objective for us, we actually want the most revenue with the least amount of tenants, which also means that CoC is usually pretty low.

Marcus Auerbach · Answer

I was a little surprised by the NOI approach. Aparently they calculated it from my 2022 P&L and it results at a quite low LTV. The loan amount is sufficient for me, as I am not looking to borrow more than necessary anyway at current rates (7.35% seems to be cutting edge right now). I always thought NOI comes into play at 5+ units.

Corby Goade · Answer

Honestly, I've found in my market that the ROI on nicer finishes is pretty terrible. There is a 10% variable on rents, meaning we can get 10% more than the market average if we are in the right neighborhood and have the nicest finishes. On the flip side, we have to charge 10% less if the opposite is true. So- in a highly desirable area, in order to get 10% over market averages, we would need to have high end finishes too, which in some cases can be $20-50K in improvements in order to gross another $2400 or so per year. For that excellent location with average finishes, we can still charge around 5% over market averages. Even if that works out to 10% CoC on the rehab, I find the ROI is better if we pile up that capital and put it in another property in almost every case.