Posted by Dave T on December 22, 2000 at 11:21:27:
Putting each property in a separate LLC will not affect the ratio at all. Remember that the ratio is NOT computed on a property-by-property basis.
Even with several properties in separate LLCs, if you are still personally liable for the mortgages, then the total amount of all your monthly payments against your personal liability is a factor in computing debt service ratio.
Hope this helps.
Getting around the Debt to Revenue Hurdle - Posted by Steve
Posted by Steve on December 20, 2000 at 11:45:36:
I’m interested in buying more investment properties for Rentals, but I’m running into problems with the debt ratio. How can I get around it? Do I form a corporation? If I do that, my debt equals my revenue. Whats the trick?
Steve
Thanks for the info…more - Posted by Steve
Posted by Steve on December 20, 2000 at 19:36:55:
Thanks for the timely response Steve & Anthony. In my case, I make a good wage and have some decent savings so I could pay for vacancies if I had to. If I had enough units, it would be worth it to do so (make payments) on a sporadic basis. I own one rental unit and I’ve got a formula that works well for me (i.e., slightly upscale unit, check tenants carefully, etc.) The unit is in the right area, so it always rents. In fact, last time I put out the sign I averaged a call a day while I screened my tenants. In the town I live in (Tallahassee), demand is high for the kind of property I like working with.
That being said, I believe that I could easily rent out more units without great risk (at least in the short term). My credit is good and I will seriously consider that No Doc loan that Steve was talking about.
My viewpoint is that there is less risk in having 10 units with a 90% occupancy rate than having one unit with a 90% occupancy rate provided that each unit makes at least 11% profit on average. Is that correct?
I mean, if you had 10 units, with a 90% occupancy ratio, theoretically, you’d make enough to cover that one missing (out of pocket) payment every month on average with that small profit. Is this true or false?
I could get that 11% just by adding another dependent on my W-4 form (from my day job) every time I get a new unit. I figure the depreciation of the building and the tax break of a dependent are about the same, so I could “have it now” with respect to my profit through tax savings.
I know of a couple of Real Estate agents (a married couple) who own at least 13 units which they’ve aquired over the last 15 years or so. How in the heck do they do that? It seems to me, that if you went to a bank, even with stellar credit, they’d turn you down flat when you applied for the 4th unit, right? Do you think they are using the “no doc” loan to get around that? Or is it possible that they aquire the property, then sign it over to a corporation, or something like that?
Mathematically, if you started a corporation and purchased a condo with a $1000 payment and a $1000 rent, then the debt to revenue ratio for the corporation would be 1:1 or 100%, so that wouldn’t work.
I own a corporation (a surveying and engineering company) and even a credit card held by the corporation shows up under my credit report. I don’t see how I could use one to hide assets anyway. Maybe I’m barking up the wrong tree.
Perhaps I’m thinking too much on this problem. Anthony’s advice is good, but I don’t want to sell anything because most of my debt is my own house and the typical odds & ends. I need leverage! The bank does set up those debt to revenue ratios to protect me, but they only look at cash flow, and not assets (ie. my bank account). I feel I can do more than the bank would consider “safe”.
More ideas, thoughts, tricks or testimonials?
Steve
The trick… - Posted by Anthony - OH
Posted by Anthony - OH on December 20, 2000 at 16:31:59:
Get rid of the debt! You could do some cash deals to pay down the debt on your current rentals and get your ratio in-line.
Also you say they are rentals, if they are SFH, then switching them all to Lease Options will create more revenue. When they sell you will be looking to replace the revenue stream with another property, and at that time your ratio should be in-line.
Trump almost went bankrupt because his revenue to debt ratio got out of line. He had decreasing revenues and increasing costs to maintain his debt. He didn’t go looking to acquire more debt to increase revenues. He looked at creating CASH with what he had.
Re: Getting around the Debt to Revenue Hurdle - Posted by SCook85
Posted by SCook85 on December 20, 2000 at 16:11:39:
Steve,
There is a reason for debt to income ratios, they are in place so that you don’t get over your head. Trying to find a way around them could be detrimental to your future in investing. You mentioned that if you incorporate your debt would equal your revenue. That isn’t good.
But there are solutions. If you are financially stable and you want to continue to borrow you could go for No Income/No Doc loans. These loans will be based strictly off of your credit. The LTV’s are typically lower, and interest rates are higher for these types of loans, but it can be a solution to your problem.
I hope this helps.
Steve
Re: Thanks for the info…more - Posted by SCook85
Posted by SCook85 on December 20, 2000 at 22:43:29:
Steve,
There are many things that you can do. Knowing more about your situation I’ll make a few suggestions. Not everyone is going to turn you down.
I would start with local savings and loans. Many of them are more flexible and will look at the whole picture. They will usually lend you up to a certain dollar amount, not a certain number of loans. For example I have a local bank that has $60,000,000 in assets, by law (something to do with Federal banking regulations) they can lend me up to 1% of that or $600,000. They have agreed to give me up to $600,000 in mortgages. Another bank $500,000, and another at $2,000,000. You will usually be talking to the president of the bank when you go for these.
The other thing that I would do if I were you is to get propeties with better cash flows. In other words you need to get your properties for less. This will improve your equity position as well as cash flow. Banks look more at your equity position in each of the properties you own. If they feel that you are overleveraged they won’t want to lend you more.
If the cash that you have is substantial enough, you could pay off the properties that you own so that you have them free and clear, then you can go into a bank and get a line of credit secured by those properties. Then you can just cut a check to buy another property (that you now own free and clear). You can use this new property to secure another line of credit and do it all over again.
It is easy to buy MANY houses once you know what the banks are looking for.
Good Luck!
Steve
P.S. First Union has some really good investor programs right now!
more… - Posted by Anthony-OH
Posted by Anthony-OH on December 20, 2000 at 21:04:53:
Ok you have a rental property, you have a home, you have a high income, but your home and rental property are highly leveraged.
You don’t need to leverage your income anymore. You need to create equity and increase your income. THEN you can go about leveraging to generate more cash flow.
There is a balance.
There is an investor that owns the house next door to me, he has over 100 houses in my metro area.
How does he do it? I would guess that he pays down the mortgages to the point where each property has an acceptable debt to income ratio.
Like this:
House have FMV of 75k he buys it for 65k, he Lease Options it for $800/mth, $80K sale price, $4000 option consideration.
He pays the $4000 and the $150/month profit in addition to his $650/month payment. At the end of the year he now owes 58K on a 75K property. He is approaching an acceptable ratio to go and buy a second house. If he sells the house for the 80K, then when he buys the next 2 - 75K house for 65K he has 10K+ to put down on each house. In five years you could have 16 houses pretty easily. This doesn’t include No Doc loans, or owner financing, or getting them “subject to”, or a zillion other ways that don’t include those picky bankers.
If you own all of your properties free and clear, the bank will be happy to loan you more money than you ever thought about having.
Another reference to Trump: Banks don’t loan him money by how much he makes at his job. Banks loan him money when he shows a B. Plan that shows he will have an acceptable debt to income ratio in the property he wants to buy.
Personally if I was you I would look for some deals and use some CRE techniques.
Re: more…and more - Posted by Steve R.
Posted by Steve R. on December 21, 2000 at 08:25:21:
Anthony,
Thanks for the response. Another poster wrote something a response to your post which zeroed in my concern. Even if I owe only 58K on a house worth 80K, my payment on the house would be $650 while I collect an $800 rent. Just looking at these two numbers, 650/800 is about 81%. With a debt service to revenue ratio of 81%, even this scenario would “pull” my portfolio average up.
Meaning no offense to you, or to bankers, I had to laugh when you said, “if you own all of your properties free and clear, the bank will be happy to loan you more money…”
Kind of reminds me of the old adage…“A banker will be real happy to loan you an umbrella, until it rains”.
I am definitely going to look into this lease option stuff you mentioned. To be honest, I don’t know much about it, and I’m not clear on who pays the $4000 option consideration. Does the buyer pay that? What would motivate them to pay above FMV and an additional $4000 for the priviledge? Am I getting this wrong?
Thanks again for your help (and the education).
Steve
Re: more… - Posted by Dave T
Posted by Dave T on December 20, 2000 at 23:49:24:
“How does he do it? I would guess that he pays down the mortgages to the point where each property has an acceptable debt to income ratio.”
Anthony,
I suspect the picky bankers would say that your early payment scheme is not a sound business basis for computing your debt/income ratio.
First, the debt to income ratio is really “debt service” to income ratio. In other words, the monthly mortgage payment(PITI) divided by monthly income. Paying down the principal balance on a fixed rate loan does not change the monthly mortgage payment amount.
Second, this ratio is not computed for each property. This ratio is the investor’s total debt service divided by the total income. The bank just wants to make sure that you have sufficient income to make your monthly mortgage payments, and the debt/income ratio is their way of checking that.
good points… - Posted by Anthony - OH
Posted by Anthony - OH on December 21, 2000 at 13:36:02:
You and the other poster are absolutely correct that paying down debt doesn’t help your debt service/income ratio.
but…
As Steve Cook pointed out, the banks do look at the total equity in your properties. The whole theory of paying down your debt though is so that you have the ability at some point in time to have an acceptable debt service/income ratio.
For example if your debt service is 1% per month of the debt amount (this is high if you have a mortgage, but accurate for a line of credit), then your house that you owe 58K on is costing you $580/month debt service, and your income is $1130/month (Option consideration/12 + $800rent)
So this almost 50% debt service/income ratio.
If you have rentals that are single family homes they should all be switched over to lease/options ASAP.
What this does.
Lots of stuff to make you more money.Their is an investor in my city (he posts here on occasion), who runs a weekly ad with a list of the homes he has available, and what option consideration $$$ that is required. He moves his properties very quickly.
Thier is another investor on here who claims that you can make 10K/month and not break a sweat doing Lease Option wraps. FSBO’s call him…he L/O the houses from them for $0 Option Consideration (OC,) and takes over thier payments…he then calls up Mr. Jones from his list of people who need houses…Mr. Jones pays 5K OC, and market rent…Investor says he gets 2 of these a week minimum by just running an ad. Thats 5K/house a month upfront, monthly cashflow, and 10K/house on the sale.
Best case scenario is everyone buys at the end of a year, so doing 2 a month at the end of a year you’ve made 120K in OC, at the end of your second year you could make 360K (120K in new OC + 24 houses sold @ 10K profit)
Any Questions?
Re: good points… - Posted by Dave T
Posted by Dave T on December 21, 2000 at 15:13:21:
“For example if your debt service is 1% per month of the debt amount (this is high if you have a mortgage, but accurate for a line of credit), then your house that you owe 58K on is costing you $580/month debt service, and your income is $1130/month (Option consideration/12 + $800rent). So this almost 50% debt service/income ratio.”
Anthony,
I still have some problems with the example in your post. It does not seem clear that you have a good grasp of the debt to income ratio calculation.
For example, you say that the option consideration can be counted as income in computing the ratio. I would like to know which lenders you use that allow this, because mine won’t. Since the option consideration is a one time payment – not recurring income – it would not be included in the income portion of the ratio.
Additionally, you credit the full amount of the rent as income. This is not the case either. In my experience, lenders only allow 75% of rental income to be included in the ratio calculation.
Lastly, you imply that the ratio is computed on a property-by-property basis. The ratio, instead, is an expression of the portion of an individual’s total monthly income that is needed to satisfy his total monthly debt service requirement. I’m afraid that your oversimplification may be more misleading than helpful.
Just so that we are clear, the debt service ratio is computed by (1) adding up all the monthly minimum payments on loans and recurring obligations (mortgage, car payment, credit card, home equity credit, condo/HOA fees, etc.), (2) adding up the monthly income from all sources (salary, 75% of rental income, alimony, annuities, etc.), then, (3) dividing (1) by (2). There is only one ratio for an individual, regardless of the number of investment properties that individual may own.
Re: good points… - Posted by Dave T
Posted by Dave T on December 21, 2000 at 15:12:10:
“For example if your debt service is 1% per month of the debt amount (this is high if you have a mortgage, but accurate for a line of credit), then your house that you owe 58K on is costing you $580/month debt service, and your income is $1130/month (Option consideration/12 + $800rent). So this almost 50% debt service/income ratio.”
Anthony,
I still have some problems with the example in your post. It does not seem clear that you have a good grasp of the debt to income ratio calculation.
For example, you say that the option consideration can be counted as income in computing the ratio. I would like to know which lenders you use that allow this, because mine won’t. Since the option consideration is a one time payment – not recurring income – it would not be included in the income portion of the ratio.
Additionally, you credit the full amount of the rent as income. This is not the case either. In my experience, lenders only allow 75% of rental income to be included in the ratio calculation.
Lastly, you imply that the ratio is not computed on a property-by-property basis. The ratio, instead, is an expression of the portion of an individual’s total monthly income that is needed to satisfy his total monthly debt service requirement. I’m afraid that your oversimplification may be more misleading than helpful.
Just so that we are clear, the debt service ratio is computed by (1) adding up all the monthly minimum payments on loans and recurring obligations (mortgage, car payment, credit card, home equity credit, condo/HOA fees, etc.), (2) adding up the monthly income from all sources (salary, 75% of rental income, alimony, annuities, etc.), then, (3) dividing (1) by (2). There is only one ratio for an individual, regardless of the number of investment properties that individual may own.
Re: good points…I see what you mean - Posted by Steve R.
Posted by Steve R. on December 21, 2000 at 14:47:58:
Anthony,
I’m seeing the power of the lease option. Basically, it would allow me to do what I’m trying to do, only quicker. I can make more cash flow per unit and pay down the notes quicker (with the excess “profit”) or sell the property. In effect, raising my revenue helps my debt service to revenue ratio, and quick pay downs might make re-financing more feasible (lowering debt service ratio further) depending on the terms of the Option. Interesting stuff.
You did neglect the escrow costs in your analysis, but I still give you an “A-”. 
The concept is sound.
This has been an interesting and educational thread. My next aquisition is one that i want to hold on to, because its the other side of my “investment” duplex unit. However, after that, I’ll look into this lease-option stuff.
I have heard that lease options were also a good thing to do with property when you are older and liquidating because its less trouble getting regular payments. Now I understand why that is so.
Thanks again for your input,
Steve
You are absolutely correct… - Posted by Anthony-OH
Posted by Anthony-OH on December 21, 2000 at 17:35:28:
I did not mean to mislead. I was trying to get the general idea that Steve R. doesn’t need to leverage his income anymore, he needs to change his ratio.
Either by decreasing his debt service cost or increasing his income.
If the debt service ratio is “really” what the bankers are looking at. Then why not put every property in a seperate entity (LLC?). Wouldn’t this "change your ratio?
Serious typo in this post; reposted correction. - Posted by Dave T
Posted by Dave T on December 21, 2000 at 15:20:39:
The sentence:
“Lastly, you imply that the ratio is NOT computed on a property-by-property basis”.
Should read:
Lastly, you imply that the ratio is computed on a property-by-property basis.