Creating cash flow is one of the many benefits of building a rental portfolio. Just like starting any new business, taking it one step at a time, in the beginning, is important as you will make some mistakes and learn as you progress. Rental properties are no different.
If you are reading this you most likely understand the benefits of owning rental properties and how it is the most powerful tool for building wealth. However, before you decide to ramp up your portfolio at lightening speed, consider the following situation I have seen with many of my clients and what has prompted me to share this with you.
A Common Rental Scenario
Ready to take it to the next level, Joe buys 4 houses within a 45 day time period (with 2 different hard money lenders) and begins the improvements. Joe is building a rental portfolio and these were the first 4 deals he has purchased. Although he is part of a real estate investor training program that provides coaching and mentoring to real estate investors, Joe decides to do it his own way.
Because he is new, he doesn’t understand that buying this many at one time is going to prevent him from refinancing into a lower interest, longer-term, conventional loan (like you can get from Fannie Mae) as soon as his rehab is completed. Why? His limited experience has exposed him to risk that an underwriter is going to reject. The underwriter’s response to someone like this is – “Joe purchased too many properties at one time and we are not comfortable financing them as he has no experience in the rental business”.
The reality is, Joe was told by his lenders not to buy more than 2 properties and ended up being stuck in multiple hard money loans paying high interest for over a year. After a year (meaning after 12 months of what is called “title seasoning”) the level of perceived risk by most underwriters is reduced and Joe can try again. At this point, he is so frustrated with the ongoing process of getting a conventional loan (by going through this same process with 3 other lenders, only to experience the same rejection for the same reason) that he finally goes to a small bank who is comfortable with the risk and is willing to do a single portfolio loan with all properties under 1 note and lien.
However, instead of getting a 30-year note with a low-interest rate, they have a 15-year note with a much higher interest rate (cutting his cash flow in half). Also, the only reason this bank is going to finance Joe’s deals is because he has waited long enough, is creditworthy, and will base the financing off the value and not the purchase price (most small banks will not do a portfolio loan based on the value of the property until after 12 months). Had Joe tried this with the bank 2 months earlier, they would have either said no or would have based the loan on his cost (or value) whichever is less.
I think you get the point here. Be patient with your investing and take it one step at a time. Be sure to get approval from a conventional lender, or a hard money lender who works with multiple conventional lenders, and get their feedback regarding your financial situation and creditworthiness as a borrower. It’s not just credit score and income that determine your qualification. Your reserves and experience impact the number of deals you will be able to refinance at one time. These lenders will be able to tell you what you are qualified for in terms of dollars as well as the number of deals you can do simultaneously.
Mike Hanna is a real estate investor, mentor, author, and public speaker. He has been an active real estate investor since 2002 in both single family and multi-family properties, and has been in the hard money business since 2005.