How to acquire the necessary capital for Short Term Rental Financing?
Investors in real estate often look to short-term rentals as a profitable source of income; however, the question remains: how to find real estate investment loans?
I am confident that many of you have, at some time over the course of the last few years, observed the returns that other shareholders are earning on short-term rentals (STRs) and thought, “How can I join in on this action?” You know what I’m talking about if you have gone the loan way for an STR. I’m willing to assume that most of you have similarly pondered, “How the heck does anybody fund one of these?”
As the partner and chief operating officer of a worldwide non-qualified mortgage lender that specializes in property investment loans and is an active investor in short-term rental properties, as you work toward achieving your objective of building a portfolio of short-term rentals (STRs), I would want to provide some recommendations on how to maximize your probability of success. For some reason, I always seem to be getting calls from frustrated investors who had to postpone their closings a few days before they were scheduled to take place because their lender didn’t completely understand the complexities of their loan program or didn’t get the investment strategy.
Can we count on short-term rentals to remain profitable?
The data that is now accessible inspire me to feel confident and makes me want to yell, “Yee-Haw!” This summer, there has been a record-breaking number of requests for short-term rentals throughout the United States. Even though inflation is at an all-time high, short-term rental (STRs) have maintained their robust growth pattern, with evidence pointing toward exceeding demand in previous years. According to the forecast study published by AirDNA, the number of reservations has not shown any sign of slowing down. However, rising prices have started to pressure consumers’ ability to spend.
A positive indicator for investors who already own the property and are looking to purchase more short-term rentals (STRs) that generate a large amount of cash flow compared to the revenue from long-term rentals on the same property.
How to Get a Short-Term Rental Loan and What It Means for You
Is a traditional loan available to me?
The short answer is yes, but there are several limitations. Can it attract investors? Certainly not even close!
Fannie Mae and Freddie Mac’s conventional loans have strict guidelines that prioritise the borrower’s salary above any potential gains from renting the property out for a short period of time. The debt-to-income (DTI) ratio is especially severe for STRs since only 75% of the long-term rent is included in the calculation’s income element.
A traditional loan on your STR may be feasible if you have a high W-2 income and taxable income (i.e., you are not deducting your income with depreciation) and are ready to jump through many hoops.
Do you want to purchase the property via an LLC, own more than 10 short-term rental units, or acquire premium real estate? It is not allowed! Listed here are the 1,243 pages that make up the loan rules that traditional lenders must follow. There are a lot of guidelines there.
Are there any other options for financing?
Yes! The most common approach to real short-term rental (STR) financing and refinancing is via a loan for investment properties based on the debt service coverage ratio (DSCR). The ability to borrow does not depend on your own income but instead on the money generated by the property as a short-term rental, which is a big benefit for an investor who obtains this kind of loan. Investors are thus free to increase their STR holdings without being concerned about the impact on their DTI ratio.
One further possibility worth exploring right now is a bridge loan that is for a shorter duration and only includes the interest. Most of the time, these loans will finance between 75 and 80 percent of the total purchase cost and will provide the borrower with an additional 18 to 24 months before refinancing. Because they do not need a certain debt-to-income ratio (DTI) or debt-to-credit ratio (DSCR), in addition to not having a pre-payment penalty, bridge loans provide borrowers with an incredible amount of leeway and convenience when it comes to the purchase of a short-term rental.
This allows you to take advantage of lower interest rates by refinancing whenever you choose. You’ll be able to close on the deal fast with a bridge loan, giving you the relief needed for long-term tenant leases to end, the resources to upgrade and equip the property to optimize prospective revenue, and the opportunity to develop a history of short-term rentals. Many smart investors use this bridge to long-term financing to remove restrictions that stand in the way of extending their STR portfolio.
How do you determine whether or not you have sufficient funds to pay your debt service?
The debt service coverage ratio, or DSCR, is calculated by dividing the annual revenue from the property by the total of the annual expenses associated with the property, including principal, interest, taxes, and insurance (if applicable). The calculation’s revenue element uses the STR income generated by the property (i.e., 12-month trailing rental income).
The DSCR normally has to be more than 1.10 to qualify for the loan, which indicates that the property will generate positive cash flow. Because the loan takes into consideration short-term rental revenue rather than long-term rental income, it is far more probable that you will be able to be approved for the maximum leverage that these loans allow: 80% for a buy or rate/term refinancing and 75% for a cash-out refinance. This is because the loan considers short-term rental income rather than long-term rental income.
What happens if there is no evidence of short-term rentals in the previous 12 months?
I have no issue! If you approach a lender specializing in dealing with investors in short-term rentals, you can be certain that this is not the first time they have seen a situation like this. When a property is purchased, it almost always becomes a short-term rental, even if it was previously used as a long-term rental or as the owners’ main home. Rather than using the long-term rent that is included in an appraiser’s assessment, some lenders may utilize the estimated short-term rental revenue (80-90% of the AirDNA STR Rent Estimation – “Rentalizer”) to determine the debt service coverage ratio (DSCR).
If this is the situation, the lender would probably give preference to the borrower(s) who either have previous experience in managing short-term rentals (preferably in the relevant area) or have an agreement with an experienced STR property management firm such as Evolve, AvantStay, Vacasa, or any of many other similar businesses.
The following example shows this:
- Let’s say you decide to invest in a home that is now unoccupied but has the potential to bring in $3,000 per month in long-term rent and $7,000 per month on average in short-term rent.
- Let’s say you’ve found a 6.75% rate of interest on a $500,000 loan (80% LTC) for a $625,000 buying price. PITIA (principal, interest, taxes, insurance, and homeowners association dues) totaling around $4,000 per month equates to about $3,200 in monthly payments.
- With a DSCR of only.75 (3K/4K), you would not be able to get the 80% loan even if you had $3,000 in rental income. In order to achieve a DSCR of 1.0, the loan balance would have to be decreased to around $375,000 (which is 60% of the LTC). You would be asked to bring an extra twelve thousand five hundred dollars to the closing… ouch!
- You shouldn’t have any trouble meeting the 80% LTC loan requirements, provided your lender allows you to include 90% of your expected revenue from short-term rentals toward the DSCR. 90 percent of $7,000 is $6,300, so dividing it by $4,000 in monthly costs gives a debt service coverage ratio (DSCR) of 1.575. You have it made!
What happens if the house must be renovated before it can be offered as a short-term rental?
There are a few ways to go about this, but the easiest would be applying for a private or hard-money bridge loan to pay all or a portion of the purchase and renovation expenses. In a perfect world, the amount of this loan would wind up being between 75 and 80 percent of the after-repair value. This would allow you to arrange a rate-and-term refinancing instead of a cash-out refinancing (which tends to have higher interest rates and lower maximum loan-to-value).
Further Concerns Regarding STR Loans
Can I get financing for more than ten short-term rental properties? Yes, DSCR loans normally allow an infinite number of loans to be taken out on residential assets. They can also be organized to function as a blanket loan covering numerous properties.
Can I buy them as a limited liability company with many members?
Loan companies that engage with investors in real estate and financial investment properties that the borrower doesn’t live in provide DSCR loans. They strongly prefer dealing with borrowers who are corporations, limited liability companies, or other types of entities. This opens the door for investors to collaborate with a wider range of partners, allowing them to expand and increase the scope of their investing activity.
Can the seller or a third party provide financing for the down payment?
The answer is that maybe. However, lenders normally prefer that borrowers have ownership in the transaction and will only make an exception if they are informed of the plan ahead of time and agree to it. Other people’s money (OPM) can be attracted to a short-term rental investment in many ways, including the use of financing or gap funding in the form of a loan to the limited liability company (LLC) with which you are acquiring the property, or the addition of the seller as a member of the LLC with a profit share proportional to the agreed-upon economics. In this scenario, a lender willing to work with investors should have no problem with OPM.
How are interest rates for DSCR loans determined?
The available interest rate is determined by a number of different elements, such as the loan-to-value ratio (LTV), the FICO score, and whether the rate is fixed or adjustable. The interest rates are normally a little bit higher than traditional interest rates, but the simplicity of the application process and the ability to have properties funded to make it possible for investors to grow their real estate portfolios. This blog post elaborates on the variables that affect interest rates.
Conclusion
We are all highly conscious of how crucial it is to have the appropriate individuals working on your real estate team. Your lender’s ability to comprehend your real estate objectives and provide you with finance that allows you to achieve those goals is frequently the deciding factor in whether or not you wind up with your new favorite cash-flowing assets. If you want to avoid wishing you could have closed that last transaction and instead wind up with another cash cow, it’s worth your time and effort to ensure that the appropriate individual is in the right position on your team.
A long and trusted so source for real estate investment financing is New City Financial, they offer short-term rental loans and refinancing options that can let you grow your investment property portfolio quickly. You can get a Refinance Rate Quote here or you can simply apply for a short-term rental loan here. Or, if you need to reach them by phone you can call 1(855) 848-2862.
