By Fred Matera, CIO, Redwood Trust A lack of affordability will lead to near-term weakness,…
More and more investors are turning to residential real estate investing and choosing to build rental portfolios instead of placing their bets on more volatile markets. Rental portfolios provide investors the opportunity to earn a steady stream of rental income from multiple properties while growing equity across all the assets. As their portfolios continue to expand, investors often find that managing multiple properties and loans can be a challenge – exacerbating their potential stress levels. The arrival of specialty lenders, like CoreVest, has reduced the headache of managing multiple loans by offering a blanket portfolio loan solution. These blanket loans simplify the process by consolidating the loans and offering one loan to access the equity across all properties.
However, financing rental properties is slightly more nuanced than the simple home mortgage for example. Lenders base their decision to approve loans based on several factors, including the viability of the rental portfolio and the clarity of its financial statements. It is important for investors to understand the calculations, terminology and lender expectations for rental portfolio loans. Below is a summary of the portfolio loan and how it works.
Entities rather than individuals
First, a portfolio loan will be similar to a commercial real estate loan since the lender will issue a loan to an entity and not an individual applicant. These entities are generally LLCs that usually do not have extensive credit history or record to check their credentials. Lenders, therefore, ask for a loan sponsor when reviewing applications. The sponsors will provide the lender with items such as financial data from the rental portfolio, which in turn, helps lenders determine loan amounts, etc.
Net operating income
Asset-based lenders often calculate the loan amount from the net operating income. This is an important criteria viewed by a lender before approving the application for a rental portfolio loan. Borrowers will present their own rent roll – however, lenders will deduct the reasonably necessary expenses to arrive at a Net Operating Income (NOI). Understanding NOI is very helpful in calculating certain ratios such as capitalization rate and debt service coverage ratio (DSCR), which measures your ability to cover debt.
Debt service coverage ratio
This ratio is calculated by dividing net operating income by annual debt obligations. Lenders typically look for a ratio of 1.20 or higher as it would make them more comfortable about the borrower having enough cash flow to make timely repayments. Meeting this target ratio means that the portfolio needs to have a positive cash flow which will cover 120% of its annual debt.
DSCR = Net Operating Income / Annual Debt Obligations
Loan to value
Another very important factor for the lender when deciding to finance rental property is the Loan to Value or LTV. This is simply the ratio of the loan requested divided the value of the portfolio. Specialized lenders, like CoreVest, will allow investors to access the equity in their portfolio by borrowing up to 75% LTV. This indicates that the value of the property should be at least 25% higher than the amount of loan asked by the applicant.
LTV = Amount of Loan / Value of Property
Duration of the loan
Real estate portfolio loans have a shorter term than a typical residential mortgage. A residential home loan is usually a fully amortized loan, which means that they are fully repaid when monthly installments are paid for the entire duration of the mortgage. For example, if you have taken a mortgage loan for your home that has a duration of 30 years, the loan stands fully repaid at the expiration of this term; provided you have paid all your monthly installments on time.
On the other hand, the financing of a rental portfolio often has a duration that can range from 5 to 10 years. For example, a portfolio loan may have a term of 5 years, but its amortization typically continues for a much longer time period (e.g. 30 years). Under this scenario, you can make low monthly payments for a period of 5 years because it is based on the loan continuing for 30 years. However, the loan will not be fully repaid by the end of the 5-year term.
The items above are important for investors to understand when speaking with a lender because they will collectively factor into the loan amount. When preparing to speak with an investment finance company, remember to have your records in order regarding each property so that lenders could provide you with the most accurate quote. Financing your rental portfolio is a great option to leverage your equity. In fact, thousands of investors have connected with CoreVest to obtain a rental portfolio loan. They have then applied these loans to create passive income for themselves and secure long term wealth and assets.
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CoreVest is a leading provider of financing solutions to residential real estate investors. We provide attractive long-term debt products for stabilized rental portfolios as well as credit lines for new acquisitions.