By Fred Matera, CIO, Redwood Trust A lack of affordability will lead to near-term weakness,…
By Brandon Sarhad
For rental investors who have begun to accumulate properties, improving cash flow and consolidating the potential debt for those assets into rental portfolio loans can be the next step in maximizing the growth of their real estate investments. Before moving into such an endeavor, it is essential to understand the similarities and differences between mortgages and how factors such as cashflow can affect the bottom line.
What is a Portfolio Loan?
A portfolio loan, also knows as a blanket loan, is used to fund more than one piece of real estate. These blanket loans allow investors to place multiple assets, usually residential, into one consolidated mortgage, where the rental income determines the total cashflow of these assets. Portfolio loans can reduce the amount of loans needed when financing and help maximize efficiency.
What is Cashflow?
Cash flow is the net amount of revenue being yielded from a business – in this case, a rental portfolio loan. Cashflow is important because it contributes to your overall debt to service coverage ratio or DSCR, which can make or break funding requirements. A positive DSCR essentially means you are turning a profit, and many lenders require a minimum threshold above breaking even (greater than a 1.00 DSCR).
Time & time again investors get so fixated on market value, they forget to account for their cashflow metrics. Often investors do not get the leverage they need out of their portfolio due to a lower DSCR constraining them from gaining more leverage. That being said, understanding key benefits of a blanket loan, the effects of cashflow, and taking an efficient approach will allow investors to confidently take the next step.
What are the Benefits of a Portfolio Loan?
Investors choose portfolio loans for many interrelated reasons, including the following:
- 1. Free Up Capital – Just like traditional loans, investors can refinance and often take advantage of increased equity in an appreciating market. The additional benefit is payment consolidation which can reduce payments, often freeing up more cashflow and purchasing power.
- 2. One Monthly Payment – Several mortgage payments are converted into one consolidated monthly payment for multiple assets. This makes for a simplified payment process allowing all current debts associated with your assets to be taken care of all at once.
- 3. Save on Fees – An investor can save on fees by only paying one set of fees, rather than individual fees for each property.
- 4. Better Interest Rates – A larger aggregate loan amount can lower interest rates in many scenarios.
Other things to keep in mind:
Balloon Payment – Often commercial loans can have a balloon payment. This can happen when the loan term is shorter than the payment schedule, or amortization schedule. The benefit of this is that you yield more cashflow during the term of your loan and it allows you to make more frequent adjustments.
Prepayment penalty – Portfolio loans, like most other mortgages, usually have prepayment windows. This means they can charge you a fee if you remove an asset; be sure your prepayment window is suited to fit your needs.
How to Improve Cashflow
Given that cashflow can be crucial to financing, investors are always looking for ways to gain proceeds, without adversely affecting their business strategies.
- 1. Reducing Costs – This one may seem like a no-brainer but can often be overlooked. Shopping around for new insurance rates can lower your annual insurance expenses while also keeping the same benefits. Whether you are self-managed or use a third-party vendor to manage properties, it is always essential to look at different scenarios. If a property is out of state, chances are it will be more cost effective to hire a third party to manage since travel costs alone can put an investor in the red just for a routine checkup.
On the other hand, self-managing is usually the more cost-effective approach if assets are within a reasonable distance. If you pay utilities, look into more cost-efficient appliances. Even though spending money on a quality appliance may seem counterintuitive, in the long-term, it will help reduce expenses for utilities and the repair or replacement of appliances themselves.
- 2. Increasing Rents – This one can be tricky because it can scare away tenants if you raise rents too high or too quickly. Minor cosmetic fixes and tenant improvements can be enough to justify raising rents without experiencing the risk of vacancy. When accompanied by an increase of rent, a tenant is less likely to complain if they can visually see changes along with that increase.
- 3. Lowering Interest Rates – One of the best ways to lower your rate is by simply coming to the table with a larger down payment. A larger initial investment reduces risk to the lender, thus reducing your rate which can eat away at proceeds. Timing can be crucial as well since rates often fluctuate with economic markets. Positioning yourself in an environment to refinance during a ‘low’ period can help secure a good rate for the long-term, reducing debt constraints.
Cashflow plays such a vital role that is often overlooked in the loan process by investors. By keeping cashflow strong, a seasoned investor can consolidate assets and simplify their mortgage experience. Asset consolidation and improved cashflow via a rental portfolio loan or blanket loan can maximize the efficiency of your real-estate investments, allowing an investor to accelerate their growth.